CSFB's Mega-Brazil Report's cover page.
Nilson Teixeira (nilson.teixeira@credit-suisse.com) and his team at CreditSuisse Brazil, one of the formidable analytical teams among Brazil’s brokerage firms, today published a comprehensive 170 page guide to the Brazilian economy. Timely, given that the world’s eighth largest economy is now one to be watched, invested in, and profited from. CSFB says this guide is good for experts in Brazil’s economy as well as neophytes. The summary pages can be found below.
An old Brazil hand myself who met annually for years with Teixeira and his predecessors (who included a number of members of the board of Brazil’s central bank), I found the work interesting and noticed only a few points that I would stress differently, add to or subtract. They are as follows:
- CSFB highlights as Brazil’s number one economic challenge to improve the quality of the country’s primary and secondary education system, including by adding more schools. I couldn’t agree more.
- Brazil’s sovereign default in the 1980s-90s is blamed on the oil shocks and consequent balance of payments pressures, which is well and good; however, blame should be layed as well at the doorstop of Brazil’s Import-Substituting Industrialization (ISI) policies and massive government borrowing program. Brazil’s problems were (and are) everywhere and anywhere a fiscal problem. While CSFB does mention Brazil’s “fragile fiscal accounts,” it does not stress this aspect enough.
- I agree with the outlook for stronger potential GDP growth in the coming years (in the neighborhood of 4-5% growth per year, not stellar relative to other emerging market economies, but not bad, given Brazil’s history). I agree that this is due to a decade of sound macro policies since 1999 — with the arrival of Arminio Fraga at the central bank — including inflation targeting, a floating exchange rate, and the Fiscal Responsibility Law.
- On the other hand, I would stress more the role of the sharp rise in commodity prices earlier this decade, driven to a great extent by demand from China, for Brazil’s improved growth performance. Brazil is a major exporter of soy and other agricultural commodities, minerals, and soon, oil.
- Brazil’s sound policy management has underpinned its weathering of the 2008-09 Global Financial Crisis. In previous global crises, Brazil was always one of the first dominos to fall.
- CSFB says that Brazil, in spite of running a countercyclical fiscal policy during this crisis, should see net government debt decline in the coming years, unlike in most countries where debt will be rising. Fitch Ratings, which expressed its worries about fiscal policy in a publication earlier this month, may beg to differ.
- Brazil, in spite of experiencing economic contraction last year and into this year, began expanding again in 2Q09, a good indicator for the future.
- Brazilian banks are well capitalized. I might stress a bit more concern about recent rapid credit growth in Brazilian banks.
- I agree that Brazil’s infrastructure needs are sizable, and investment here could go far to raising potential GDP growth.
- Likewise, Teixeira and his team were correct in highlighting the challenges of reforming a distorted tax regime, reining in social security deficits, and freeing up a very rigid labor market.
All to say, well worth the read. Start with the summary below:
“In recent decades, the Brazilian economy has oscillated between periods of strong economic growth (late 1960s and early 1970s) and periods of low growth with high inflation (1980s). Despite the introduction of several economic plans since the second half of the 1980s, inflation was not effectively reined in until 1994, when the Real Plan was implemented.
In step with recurrent balance-of-payment crises in emerging countries, imbalances in Brazil’s external accounts persisted, and average GDP growth was relatively sluggish until the mid-2000s. As the global outlook improved and Brazil maintained responsible macroeconomic policies, the economy’s average growth gained speed in 2004, resulting in the longest cycle of growth and investment since the 1970s.
This growth cycle was interrupted by the global crisis of 2008, but the Brazilian economy has proved much more resilient to crises than in the past. The evolution of its economic fundamentals suggests that, after several decades, the country is likely to experience higher and – even more importantly – less volatile economic growth than in the past. But after fulfilling many of the necessary prerequisites, we believe there are still challenges to be overcome for Brazil to reach a higher level of development in the next decades. For instance, it will have to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools, but also by improving the quality of education provided.
Brazil is a federal republic composed of 26 states and a Federal District, which comprise 5,565 municipalities. It is the world’s fifth largest country both in terms of population and land area and has the eighth-largest Gross Domestic Product (GDP). The Brazilian population has grown 1.5% annually on average over the past few decades to 189 million inhabitants in 2008, most of whom reside in cities.
From 1964 to 2008, GDP grew 4.5% per year on average. In the late 1960s and early 1970s (period referred to as the “Brazilian miracle”), GDP grew by more than 11% yearly in a scenario of heavy investment. At that time, Brazil was known as the “country of the future,” a title that has not been revisited in subsequent decades.
In the 1980s, referred to as “the lost decade,” Brazil’s economy was marked by high inflation and low GDP growth. During that period, an oil shock destabilized the global economy, and consequently several developing economies, including Brazil, were unable to roll over their large foreign debt and were forced into default. The balance-of-payments crisis was associated with high interest rates, a sharp depreciation in currency, and high inflation. In the second half of the 1980s and the first half of the 1990s, Brazil implemented several stabilization plans to thwart skyrocketing inflation. Some of these plans included price controls, a freeze on bank deposits, and some unorthodox inflation-reduction measures.
After several unsuccessful attempts, the government implemented the “Real plan” in 1994, which established the Real as its new currency and rapidly reduced monthly inflation from around 50% to less than 1%. Even after lowering inflation, the country experienced several balance-of-payments crises in the late 1990s and early 2000s, some originating in emerging economies and others homegrown. Brazil faced some onerous constraints for financing its foreign debt on several occasions. In order to keep inflation low, the government kept real interest rates very high for several years, which in turn led the economy into a sequence of stop-and-go business cycles. Fragile fiscal accounts and risk of insolvency revealed the weaknesses in the economic adjustment during this period and produced a steep devaluation in Brazil’s currency and a return of inflationary pressure. Despite lower inflation, economic growth remained weak during these years.
In 1999, the government adopted economic policy based on three main points: an inflation target regime, a floating exchange rate policy and adoption of fiscal responsibility law. After decades of huge economic uncertainty, observance of these policies for ten years has helped increase the predictability of the Brazilian economy.
Combined with a favorable global scenario in recent years, characterized by strong economic growth and high liquidity in financial markets, these policies contributed to a significant improvement in Brazil’s macroeconomic fundamentals. From 2003 to 2008, the government maintained relatively low inflation, bought back all sovereign debt originated from the 90s’ debt renegotiation, improved the risk profile of its government securities, maintained primary surpluses, and substantially increased the level of international reserves, contributing to Brazil becoming the fourth-largest holder of U.S. treasury bonds. The global crisis that began in 2008 has proven that the macroeconomic policies adopted in recent years have been effective; despite its magnitude, the impact on the mid-term fundamentals of Brazil’s economy have been rather moderate. One of the main differences versus other countries has been the absence of any balance of payments crises within Brazil. This greater freedom in relation to external accounts has allowed the government to implement a set of countercyclical fiscal and monetary policies to reduce the negative impact of the 2008-2009 crises on economic activity. The primary surplus has fallen, raising net debt to GDP in 2009. In upcoming years, we expect the net debt to GDP ratio to retract, unlike the forecast for many countries hit hard by the crisis. For the first time since the 1970s, the Brazilian economy has proved more resilient than most developed and developing countries, in our view.
Brazil’s potential output growth has increased substantially in recent years. Despite the retraction in 2009 brought on by the international crisis, we believe average GDP growth in the next few years will likely reach 4% or 5%, much higher than the average pace of 3% during the first half of the decade. This higher growth should be associated with a return to investments, which grew consistently from 2004 to 2008, forming the longest investment cycle since the 1970s. Over the past few years, investments have been spread out over various economic sectors, especially infrastructure and commodities. But despite this long growth cycle, the country’s infrastructure is still quite deficient. Heavy investments in infrastructure are needed to foster higher growth in areas ranging from transportation to expansion of the power grid.
Sectors with clear competitive advantages in the last few years are primarily those associated with commodities. Brazil is the largest producer of many soft commodities, such as sugar, coffee, and oranges, the second largest producer of soybean and ethanol, and the number one exporter of all these products. The country is also the second largest producer of beef and ranks third for chicken and fourth for pork. Brazil exports more beef and poultry than any other country. The cost of production in the Brazilian agricultural sector is currently lower than for most producer countries. The agricultural sector is likely to see sustained growth in upcoming years and reap benefits from existing competitive advantages, even if the elimination of non-tariff barriers and improvement within the logistics infrastructure are gradual.
Brazil has huge mineral reserves – especially iron ore, aluminum, copper, chromium, gold, tin, nickel, manganese, zinc, and potassium – and clear advantages in sectors associated with these commodities. Notwithstanding the halt in heavy investment in these sectors on account of the 2008-2009 global crisis, investments will likely remain high in the next few years to meet the growing demand, especially from emerging markets. At the same time, the huge discoveries of oil reserves in the pre-salt layer in recent years should make Brazil a major player in the world market and a net exporter of fuel in the next decade. In principle, much of the massive investments in this sector will be financed by government institutions, but the participation of private corporations, especially from abroad, will tend to attract rugged investment in years to come.
The capital ratio of local banks has been well above the Basel requirement for many years, resulting in a lightly leveraged financial system. This has prevented the international financial crisis from contaminating local banks. The government’s economic policy reaction has brought relatively low fiscal costs and has managed to contain the negative effects of the contrition in external credit. The economic policy response has shown that the banks are able to efficiently intermediate private savings and contribute to sustained high growth in credit, which reached nearly 45% of the GDP in mid-2009. Credit expansion in the next few years will probably have a different profile from the most recent cycle. The new phase will be marked by the lowest basic interest rate in 30 years, which will require a different set of financial instruments available to depositors. At the same time, financial institutions will change their focus, offering longer-term credit and reaching out to more corporate and real estate borrowers.
Greater stability in the local economy should continue to encourage a shift from short- to longer-term investments in addition to increased participation by foreign investors. The need for heavy investments in Brazil within the next few years will require increased risk capital, both from here and abroad, to finance activities. This favorable scenario is expected to stimulate growth in equity markets. Although investments in Brazil have historically been financed largely by public-sector institutions, corporations have been able to raise funds lately in capital markets to finance their investment plans. The private sector will account for a growing percentage of long-term investments in the next several years, either through bank loans or direct financing through equity offerings. High-risk investments will account for a large portion of these funds, and primary and secondary equity offerings are projected to increase significantly in the next few years.
The effects of the 2008-2009 global crisis were less drastic than expected at the outset, which signifies to us that Brazil’s growth pattern is less susceptible to changes in course as a result of the external outlook. However, this does not mean that the Brazilian economy is immune to the global crisis. On the contrary, the crisis has caused Brazil’s GDP to backtrack from an average expansion of 1.6% quarter on quarter from 1Q2008 to 3Q2008 to a peak-to-trough fall of 4.4% in 4Q2008 and 1Q2009. But the return to economic expansion has already taken hold in 2Q2009, demonstrating that Brazil’s solid fundamentals have enabled rapid adjustment to the change in global outlook.
This greater resilience to the external crisis has favorable consequences for the middle- and long-term outlook for the Brazilian economy. Uncertainty regarding the resilience of the country’s economic fundamentals dissipated fairly significantly as the crisis unraveled. Overall country risk and real interest rates should decline even further in the next few years, since severe macroeconomic crises in Brazil do not seem as likely as in the past, leading to higher investments and, therefore, higher potential output growth. Thus, the path of Brazil economic fundamentals suggests that, after several decades, potential GDP growth should be higher than in the past and, even more importantly, less volatile. We, therefore, think this dynamic should allow Brazil to regain its reputation as the “country of the future.”
There are still several challenges to be overcome. First, the country needs to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools but by improving the quality of education. Second, Brazil needs to address certain structural constraints, such as its highly complex tax system, imbalances in social security and very rigid labor legislation. It will also be up to future administrations to reopen debate concerning the state’s role in the economy, particularly with regard to its efforts to stimulate manufacturing and strengthen the regulatory framework. These reforms will require serious discussion, because congressional approval tends to lag in light of the complexity of the issues. For example, although there is a consensus in society that the country’s tax structure is complex and tax burdens too high, approval of tax reform is uncertain, because it requires debate regarding which specific fiscal expenditures need to be reduced.
During the preparation of this publication, its target audience focused on those readers with a basic understanding of Brazil, wanting to learn more about the country’s fundamentals and economic outlook. For this group, this guide can hopefully serve as a starting point. Nonetheless, we believe the in-depth scope of this report will also interest readers with a more comprehensive knowledge of the country. We note that this publication is not meant to provide a complete guide to Brazil; it is not intended to offer extensive coverage of the individual topics included. This guide contains a sizable number of graphs and tables, which together provide a relatively general review of information we believe will be relevant for our readers, offering a broad reference base, with information and statistics supporting our overall view that Brazil meets many of the prerequisites needed to take it to the next level of economic development.
The guide is divided into nine chapters, including this introduction. The second section provides a panorama of the country’s geography, climate, mineral resources, biomas, and water resources. The third addresses topics related to population, age ranges, life expectation, labor market, and income distribution. Chapter four contains a brief history of economic policy since the mid-1960s and details policies implemented in the past decade, especially inflation targeting, the floating of the foreign exchange rate, and fiscal responsibility. This chapter also highlights the organization of the country’s political institutions. Chapter five describes the primary characteristics of Brazil’s infrastructure – especially modes of transportation and power generation, transmission and distribution. Chapter six enumerates the primary industrial sectors, such as oil, petrochemicals, steel, automobiles, mining, and construction.
In chapter seven, we present the most important issues in relation to farming, listing the main crops and herds, and describing how they are distributed throughout regions. Chapter eight addresses services, with an emphasis on financial services. In chapter nine, we discuss current business trends in Brazil and certain aspects of the local tax structure. Finally, the appendix provides useful reference material, acronyms, and Web sites to access for additional information.”
