Dilma's dilemma

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In the Brazilian elections in October 2014, after a long and fraught campaign President Dilma Rousseff won a narrow victory. Political uncertainty may have subsided but with the Brazilian economy in the doldrums and commentators banging the drum for harsh reforms, what are the prospects for the dilapidated poster-boy of South America? Solange Srour, chief economist at ARX Investimentos, the Brazilian investment boutique of BNY Mellon, looks at the economic challenges facing the president in her second term. 

As President Dilma Rousseff addressed the Brazilian people following her narrow re-election in October, she could have been forgiven had her relieved smile collapsed into a worried frown. She may have won the election and in-so-doing gained another four years in power, but the position of strength enjoyed by her Worker’s Party a few years ago is now long gone. The election result was too close. Gone are the buoyant days of her early presidency.

Her victory speech was one dominated by words of collaboration and compromise. She spoke of greater dialogue with industrial leaders, banks and business in general. She talked of her desire to be a better president in her second term. That she failed to mention her rival, Aécio Neves da Cunha, who had gained 48% of the vote, spoke volumes, though. The market-friendly Aécio campaigned and spoke for industry, banks, business and the squeezed middle classes. Indeed, it was a damning indictment of Dilma’s first term in office that 2014 saw an almost perfectly negative correlation between her strength and weakness in pre-election polls, and the performance of the Brazilian equity market.

But how has the president managed to put up so many hackles in the business world? The list of blemishes is a long one. In 2012 she forced state-controlled banks to reduce consumer lending rates, hurting the rest of the sector; in 2013, changes were forced upon electricity companies to lower tariffs; while the oil and gas giant Petrobras – which makes up around 13% of the domestic index – has been hampered by enforced price controls. The ‘business-unfriendly’ tag has firmly stuck.

Giving with one hand…

It is unfair to brand her presidency this far as one wholly dominated by investor-unfriendly policy, though. Certain tax cuts have made sense and made a real difference; her commitment to Bolsa Família – the country’s largest social welfare programme – continues to keep millions from the clutches of poverty, while she has also been good on education. However, ultimately her first port of call when it comes to policy is ‘intervention’ – this has affected foreign investment, while it is no surprise that business and consumer confidence are back to their 2009 lows. Ultimately, Dilma bears this responsibility.

Bolsa Família, the brain-child of the former, and revered, President Luiz Inácio Lula da Silva, has provided invaluable financial aid to poor Brazilian families. Yet while its success can’t be ignored – around 12 million Brazilian families benefit – it has had its fair share of critics who cite the problems of benefit addiction and the programme acting as a source of discouragement from work. The programme may well help around a quarter of the population but for the remaining 75% the overriding concern is inflation and the rising cost of living in the country’s major cities. Some 85% of the population lives in urban areas.

In her victory speech, Dilma declared the country undivided. While this may be true in terms of the north/south divide alluded to by many external observers, it is a country divided by those reliant upon welfare programmes and those who aren’t. It has reached a stage at which the heavy focus upon social welfare programmes is proving too big a burden for the Brazilian economy.

Tightening belts

The economic situation in Brazil is not a rosy one. Currently in recession, a near-term rebound seems unlikely. Inflation remains high, the primary surplus is close to zero (it needs to be closer to 1.5% of GDP) and the strength of the Brazilian real continues to hamper the economy. It is the squeezed middle classes who are bearing the brunt of this pain.

With inflation sitting at more than 6% and greater inflationary pressures set to come as price controls expire, interest rate rises seem imminent. And they are needed. Dilma has spoken much about the importance of employment and economic growth but this is not possible without fixing the underlying problems. Even with progress on inflation, the primary surplus and the currency, the sad truth is that an interventionist government underscores an inefficient and uncompetitive economy.

For example, the effects of inflation will only get worse as areas in which the government has frozen prices, such as fuel, are released. At the same time, fuel price freezes have severely hampered the ability of largely state-owned companies, such as Petrobras, to thrive. Dilma’s administration has limited the value of these companies by using them as a political lever. It is a similar story with the state-owned banks; used as a tool for cheaper credit availability, there is a need for significant capital raising within the banking system over the next few years. In her second term, Dilma will have to let go of the price controls if she has a genuine desire to improve investor confidence in Brazil, increase the primary surplus and allow efficiency and competitiveness a foothold in the economy. However, long-term gain would come at the cost of short-term pain.

Building for the future?

Infrastructure spending, or the stark lack thereof, is also high on the agenda of Dilma’s critics. The country is held back by significant public transport limitations and remains some way behind the rest of the world when it comes to infrastructure spending. According to The Economist, Brazil invests just 2.2% of its GDP in infrastructure, well below the developing-world average of 5.1%. It is also barely high enough to keep up with depreciation of existing infrastructure. Meanwhile, just 14% of the country’s roads are paved, according to The World Bank. Seemingly simple processes such as transporting corn to ports are made needlessly more expensive and strenuous by a lack of basic infrastructure.

Yet the crux of the spending problem is that the public sector just doesn’t have the money to invest. It needs to attract private sector investment but, given the track record of the Dilma government, who would want to do business with them? Too much focus on subsidised public sector bank investment is now coming back to bite the government. Ultimately, over the longer term these challenges are surmountable. A greater emphasis on business-friendly policy would do much to build bridges with the private sector.

Dilma is rightly proud and protective of Lula’s first-world standard welfare legacy but the cost is now being borne by the middle classes; those who should be at the core of the country’s economic impetus. Action is required and pain is necessary if the country is to reawaken from its post-commodity boom slumber. Is Dilma capable of changing her spots and becoming pro-business? To some degree, perhaps, but a wholesale change of heart seems highly unlikely.

The more probable outcome is four more years of high inflation and low growth and competitiveness. Dilma’s dilemma is likely to be one she largely ignores.