Key fact

From 1988-93, inflation in Brazil averaged more than 1,000 per cent a year. Today, inflation is 6 per cent.

Source: MEED

Brazil is the fifth-most populous country in the world, with more than 192 million inhabitants. It is the largest country in the southern hemisphere and the fifth-largest overall. Its size dwarfs that of all its neighbours in South and Central America. And yet, despite its vastness, for much of its recent history Brazil has been consigned to following where other, more powerful nations have led. This is finally beginning to change.

“Brazil has evolved to a position where it is a big market and it now feels that it doesn’t have to follow”

Paula Diosquez-Rice, IHS Global Insight

According to the Centre for Economics & Business Research, in 2011 Brazil overtook the UK to become the world’s sixth-largest economy. It is one of the five members of the so-called Brics (along with Russian, India, China and South Africa), a loose amalgamation of the world’s major emerging markets that is becoming an increasingly important voice on the global stage. It has been invited to attend recent meetings of the G8, a group of leading industrialised nations, and is also a member of the G20, which may eventually supplant the G8 as the main forum for international trade negotiations.

International influence

Just as Brazil’s economic might has increased, so too has its international influence. In March 2011, when the first Nato airstrikes were being launched against Libya, US President Barrack Obama was in Brazil, having decided that trade negotiations with Brasilia were too important to cancel. In May 2010, when the West was struggling to reach a deal with Iran over its nuclear programme, Brazil intervened with Turkey to offer a compromise that came close to resolving the situation without recourse to sanctions.

“Brazil has evolved to a position where it is a big market and it now feels that it doesn’t have to follow, which is a huge change compared with the 1990s,” says Paula Diosquez-Rice, senior economist for Latin America at US economic consultancy IHS Global Insight.

The Brazilian government is not just looking for opportunities to demonstrate its importance on the world stage; it is actively demanding recognition. When the Washington-headquartered IMF requested that Brazil contribute funds to help its efforts to prop up the European economy in April this year, the government responded by demanding in return a greater role within the organisation for emerging economies.

Over the next four years, Brazil will host two of the leading high-profile events on the international calendar. Following Rio de Janeiro hosting a UN conference in June on sustainable development, marking the 20th anniversary of the Earth Summit, the country will not only host football’s World Cup tournament in 2014 but will also be the home of the 31st Olympics in 2016.

Brazil’s dramatic rise has its roots in an almost total recasting of its economy over the past 20 years. From 1988-93, inflation in Brazil averaged more than 1,000 per cent a year and at the dawn of the new millennium there were still more than 60 million Brazilians living in poverty. Today, inflation is just 6 per cent and the number of people living in poverty, while still high, has fallen to 40 million.

Renewed commitment

The transition has been far from smooth. In the 1990s, some public companies were privatised and there was a certain amount of trade liberalisation. The government’s efforts at reform, however, were undermined by a series of external shocks that led to the depreciation of the Brazilian real and the eventual cutting of ties with the US dollar.

“The central bank is starting to ease some of its monetary measures, and I think we’ll see a recovery in late 2012 and growth gaining momentum in 2013”

Shelly Shetty, Fitch Ratings

A change in government in 2003 brought a renewed commitment to structural reform and coincided with a more favourable external environment. Since then, improvements to the economic management of the country have found some traction. According to UK-US dual-headquartered ratings agency Fitch Ratings, potential growth in Brazil has increased from an average of 2.3 per cent in the 1990s to about 4 per cent today. Although Brazil’s investment ratio remains modest in comparison with other emerging markets, it too has improved, to 19.3 per cent in 2011 from 15.3 per cent in 2003.

Brazil’s economic growth has been particularly impressive. In 2004-08, real gross domestic product (GDP) growth equalled or exceeded 4 per cent in every year except 2005, when it was 3.2 per cent. And after a brief downturn in 2009, when the economy contracted by 0.3 per cent as a consequence of the global financial crisis, growth rebounded to 7.5 per cent in 2010.

“There was a little bit of luck involved,” says Diosquez-Rice. “Brazil produces commodities that have had a high price in the last couple of years, such as soy, and its oil discoveries have enabled it to project a positive future. But at the same time it has gone through a reform process to put its fiscal accounts in shape, unify subsidies and start the process of bringing down its international debt. It’s been a combination of luck and hard work.”

In 2011, however, Brazil paid the price for its above-trend growth the previous year and real GDP growth dropped to just 2.7 per cent. Growth this year is expected to be modest too, at about 3-3.5 per cent.

But economists are not too worried. Infrastructure construction ahead of the World Cup is suffering such delays that the bulk of the spending is due to take place in 2013-14. The associated increase in private-sector spending, combined with a relaxation of monetary policy, is expected to drive a rebound in growth.

“Brazil is going through a period of economic slowdown as payback for its growth in 2010,” says Shelly Shetty, head of Latin America sovereign ratings at Fitch Ratings. “It’s a cyclical downturn, mainly reflecting a tightening of fiscal and monetary policies and an erosion in global investment towards the end of last year. The central bank is starting to ease some of these monetary measures, and I think we’ll see a recovery in late 2012 and growth gaining momentum in 2013.”

Economic weaknesses

This is not to say the Brazilian economy is without its weaknesses. There remain significant structural problems, including high inflation, an uncompetitive industrial sector, a cumbersome tax regime and a lack of public spending on infrastructure.

The government has a target inflation band of 2.5-6.5 per cent and says it is aiming for the middle of that range. But in 2011, inflation reached 6.6 per cent, the highest rate since 2005. “It seems the central bank is not interested in the centre of the band any more,” says Elisa Machado, an economist at the Centro Brasileiro de Infra Estrutura, in Rio de Janeiro. “They are prioritising growth rather than inflation. We expect inflation to be about 5.5 per cent in 2012.”

The government has tended to use interest rates as its primary tool for keeping a lid on inflation, but this has had the secondary effect of fuelling the appetite of overseas investors for Brazilian securities. This has contributed to a rapid rise in the value of the real, from $0.38 in 2004 to $0.54 in 2012. This, in turn, has made it more difficult for Brazilian companies either to export their goods or to compete with cheaper imports on the domestic market.

To address the situation, the central bank has reduced benchmark interest rates from 12.5 per cent in July 2011 to 9.0 per cent in April, close to the historical low of 8.75 per cent in 2009. But this could have worrying implications for inflation.

“It’s a very dangerous policy, because there is a kind of inflationary memory in Brazil, where inflation has been high for almost 20 years,” says Machado. “It’s not a problem yet, but it’s something to keep an eye on in the future.”

If inflation gets out of control, it could undermine the foundation of Brazil’s economic potential: its strong domestic market. “We have low unemployment [it has halved since 2004 to 5.7 per cent] and we have a middle class earning good salaries,” says Machado. “Inflation could harm this by eroding purchasing power. It’s happened before.”

Growth in the internal market is also held back by a high tax burden and a lack of infrastructure development. In 2010, government taxation revenue equated to 34 per cent of GDP. “Brazil has structural weaknesses, including a high tax burden, relatively weak infrastructure and inflexible labour markets,” says Shetty. “Strong growth in current spending makes it difficult to increase public investment. It needs to work on all of these areas.”

Reform programme

The government plans to address these problems under its 2011-14 programme, known as ‘Brasil Maior’ (‘A Bigger Brazil’). “Brasil Maior focuses on increasing the competitiveness of Brazilian industry,” says Peter Stossel, an adviser to the Development, Industry and Foreign Trade Ministry. “We will be reducing the cost of doing business, improving infrastructure, reducing the level of taxation and reducing interest rates. A lot of bottlenecks are being addressed.”

As the government has realised, maximising the potential of Brazil’s internal market is essential to ensuring the country’s future prosperity. Brazil’s spectacular growth in 2010 owed a lot to the influx of foreign capital attracted by high interest rates and a healthy private construction sector. But the appetite of international investors for the Brazilian market might not always be as healthy.

“Brazil’s status in the global economy has improved because it has grown and others have not,” says Machado. “But this is more to do with others not growing than with Brazil doing its homework. Brazil has improved a lot, but the crisis in Europe and the US means that at the moment the markets are out of equilibrium. One day, someone in Wall Street will conclude that it’s more interesting to finance US consumers than Brazilian investments and the money will go back home.”

When that day comes, Brazil must make sure that it is ready.