During Dilma Rousseff’s six-year occupation of the presidency, she ran Brazil’s economy into the ground. Luckily for the country, Vice President and successor, moderate Michel Temer, has shown an understanding of what’s needed economically, and is making some good appointments.
Yet some of Brazil’s problems remain structural, and difficult for a president without a committed Congressional majority to solve. At best, only cautious optimism is warranted.
And there’s always the possibility that Rousseff could still return, if the impeachment process fails.
A History of Scandal
I wasn’t thrilled about Rousseff’s election in 2010. The outgoing President Luiz Inacio Lula da Silva had already blown out the budget that year, masking the excess spending through massive Brazilian Development Bank (BNDES) loans.
To make matters worse, Brazil’s public sector is too large. It’s running at a Western European-like 43% of gross domestic product (GDP), in an economy that’s much too poor to support such extravagance.
It doesn’t help that Brazil runs its budgeting on the basis of “primary balance” before interest payments. So it’s claimed a “primary surplus” for decades while actually running large deficits.
Rousseff, who started her career as a left-wing renegade, seemed unlikely to improve matters – and she didn’t.
Her impeachment rests on her falsification of 2014 budget figures, making the primary balance appear positive and thereby improving her re-election chances.
In addition, there’s also the morass of corruption scandals surrounding her administration. Many of these involved oil company Petrobras, which, under the leadership of one of her cronies, was used as an all-purpose slush fund.
However, the process isn’t final. It requires a two-thirds majority of the Senate for conviction. And if she returns, it would undo any reforms Temer passes.
Righting the Ship
Temer has moved quickly, appointing people with excellent track records and considerable determination. For example, as central bank governor, he has appointed Ilan Goldfajn, Chief Economist at Itau Unibanco.
Actually, central bank monetary policy isn’t a problem.
The SELIC short-term policy rate is above 14%, while inflation remains below 10%. This means Brazil has a sounder monetary policy than any of the big top four Western economies, all of which are stuck around or below zero.
As minister of finance, Temer has appointed Henrique Meirelles, who was the central bank governor from 2003 to 2011, before Rousseff replaced him. During this period, he notably avoided the mistakes his Western contemporaries were making.
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The new team is already working on one of Brazil’s major problems – its unfunded state pensions.
State salaries and pensions are guaranteed by the 1988 Constitution, one of the reasons why the public sector is so overblown.
Unlike in the United States, ultra-low real interest rates haven’t made the problem worse. The pensions are simply too large, and, in many cases, are tied to the minimum wage, which gets increased during election years.
Brazil’s economy sank into recession in late 2014, and has continued to decline since. For the economy to recover, Brazil needs public sector reform, and it isn’t clear whether or not Temer can achieve this, since he has no secure majority in Congress.
In this respect, 2016 will be especially difficult, because of the flood of public spending for the forthcoming Rio Olympics.
Nevertheless, if a Rousseff return can be avoided, the chances are good that Temer and his team will be able to improve the country, at least somewhat. That will, in turn, reinvigorate the private economy and, with the real having been so weak, revive Brazil’s export sector.
The Economist’s team of forecasters expects a 3.7% decline in GDP in 2016 and only a 0.6% revival in 2017, but that latter estimate could prove too conservative.
For us as investors, Brazil looks as though it’s worth a modest position, though I would certainly sell immediately if Rousseff returns.
One possible Brazilian investment is Petrobras (PBR), which has recently appointed a new CEO Pedro Parente, who’s untainted by previous scandals. Parente has banned political appointments to Petrobras, a source of much waste in the past.
Assuming Rousseff doesn’t return, with oil prices having stabilized in the high $40s, Petrobras looks like an attractive investment, with its new “Lula” (formerly “Tupi”) deepwater oil fields ramping up production over the next few years and leverage beginning to reduce, helped by the modest recovery in the real’s value.
Brazil is still in a very difficult position, but its prospects look better than they did a few months ago, although the specter of a Rousseff return still looms.
However, long-term progress will require structural reforms that an interim President like Temer probably can’t achieve.