In the face of a significant range of issues, the new Rousseff administration looks to have started to build foundations for growth. But investors are still cautious. Only time will tell if the president will see through the necessary reforms to change Brazil from sluggish underachiever to emerging market darling, writes Eleanor Wragg.


When incumbent candidate Dilma Rousseff squeaked past pro-business rival Aecio Neves to victory in the closest Brazilian presidential election since the return of democracy in 1985, investors made clear their discontent clear. With hopes of a fresh beginning for the country’s stagnant economy seemingly dashed, Bovespa, the Sao Paulo stock exchange, tumbled almost 3%; the Brazilian real fell by over 3% against the dollar; and shares in Petrobras – the state-owned oil giant – dropped 14%.

In an apparent response to the disquiet, in her acceptance speech Rousseff said: “I want to be a better president than I have been up until now.” And with the canny appointment of a finance minister who is roundly seen as a safe pair of hands, as well as a hard-line agricultural minister who wants to redefine how Brazil trades with its neighbours, could the former Marxist guerrilla’s second term in power hold some surprises?

From booming BRIC to Fragile Five

After inheriting a booming economy from her predecessor and political mentor Lula – whose Bolsa Familia project pulled vast swathes of the population out of poverty – Rousseff spent her first term extending the nation’s decade-long effort to reduce inequality. The most recent IMF report about the country praised its “adoption of far-reaching social programmes that have produced a remarkable social transformation – in particular, a substantial reduction in poverty and the increase in living standards of large segments of the population”.

But the programmes had a heavy fiscal impact.

As did the heterodox “New Economic Matrix”, brainchild of then-finance minister Guido Mantega, which implemented ad-hoc tax breaks for consumers, lavish public spending and state control of energy prices, none of which boosted investor confidence. Brazil went from booming BRIC to one of the so-called “Fragile Five” – economies whose currencies are considered by Morgan Stanley to be under the most pressure versus the US dollar.

Speaking in August 2014, Brazilian entrepreneur Benjamin Steinbruch, top shareholder of steelmaker Companhia Siderúrgica Nacional (CSN), said that the government’s interventionist policies had stifled confidence and trade. Pointing to its high interest rates and tax burden, he declared that “only crazy people would invest in Brazil today”.

Ratings firm Moody’s appeared to agree with him, as it cut the country’s sovereign rating to negative in September 2014, citing a sustained reduction in Brazil’s economic growth, a marked deterioration in investor sentiment and fiscal challenges. “We believe that weak business confidence and investment will pose headwinds for an economic recovery given limited prospects of a reversal in investors’ sentiment. In the absence of stronger private investment, a sustained recovery in economic activity is unlikely to take hold,” said the firm.

Time for change

Today, apparently chided by her very narrow margin of victory – she won by just 3 million votes out of a voting population of 146 million – there are indications that Rousseff is ready to win back investor and consumer confidence and get Brazil growing once again.

Rick Torken, CEO for Brazil at Dutch bank ABN Amro, which returned to Brazil in 2013 after a six-year absence, is cautiously optimistic about the new Dilma administration. “It seems that the president has taken notice of the criticism that was levelled at her during the campaign,” he says. “She has hired a well-respected economic team, and the first policy measures that she has taken are the measures that many economists were actually hoping that she would take.”

But she faces a myriad of issues. Brazil’s exporters are being hammered by low commodity prices and shrinking demand due to the Chinese slowdown. Inflation reached 7.14% in January 2015, the highest figure since September 2011 and well above the central bank’s 4.5% target. The country’s GDP is tipped to go negative in the first half of 2015, with Morgan Stanley forecasting a contraction of 0.4%. Former shining star Petrobras is embroiled in a corruption scandal which could yet ignite a political crisis. And if all this weren’t enough, on the horizon looms the 2016 Olympic Games, which have become something of an albatross for a country which didn’t see the results – both economic and sporting – that it wanted from its hosting of the 2014 FIFA World Cup.

“In terms of the medium-term outlook, we were of the opinion that 2015 growth would be weak whoever won in October’s elections – reforms take time and can be painful – and so the election result prompted no change to our 2015 forecast,” says Craig Botham, emerging markets economist at analyst firm Schroders in a note.

The firm however takes a gloomier long-term outlook, as it is sceptical of Dilma’s commitment to reform. “For now, corporates are still expressing reluctance to invest, waiting for clarity before they do so. Clarity can come only if reform plans are kept to despite economic pain. Consequently, if reforms are enacted and, importantly, not rolled back by the second half of 2015, investment should pick up,” adds Botham.

Chicago Bull or Chicago Bear?

Investors are pinning their hopes on the president’s newly-nominated finance minister, Joaquim Levy. Nicknamed “Chicago boy” by the Brazilian press in reference to his PhD from the University of Chicago, the same institution from which former Chilean dictator Augusto Pinochet drew his principal financial and economic officials, the fiscal conservative wouldn’t ordinarily be a natural choice for Rousseff.

Speaking to Brazilian daily Estado de Sao Paulo, sharp-tongued ex-central banker Arminio Fraga called the former treasury secretary and prominent banker “an island in a sea of mediocrity”. Faint praise indeed, but Levy has the support of the markets behind him.

“Levy is conveying confidence that he will run the economy on a very tight ship, which is what investors want to hear,” explains Corina Monaghan, SVP, credit, political and security risks at JLT North America. “He will provide investors with the comfort level that they are looking for. This is where the change has come in. It would not be typical for Dilma to nominate someone like him to run her economy but she has had to because of the external markets. She has made a very smart move in nominating Levy.”

However, concerns abound with regard to how effective Levy will be allowed to be. “It’s one thing to have the right person in place with a government that doesn’t really embrace his ideas fundamentally, but given that fact, will he be able to operate? The jury is out as to whether that will happen,” says Monaghan.

Or, more succinctly, as one Brazilian analyst puts it: “Let us pray that Dilma lets the man do his job.”

“Despite some slippages, the government has the will and the means to make the necessary adjustments to respond to the new global environment and foster a new cycle of growth, with improved fiscal indicators and increases in labour productivity,” said Levy in a presentation in New York in late February. Highlighting significant structural reforms, Levy also noted that additional (and subsidised) treasury loans to development bank BNDES would no longer be a policy instrument. This is good for transparency, and will create a fairer playing field for foreign players, who will no longer be at a perceived disadvantage due to BNDES’ privileged financing of so-called national champions.

“We are working hard to balance the ongoing fiscal adjustment with our mission of providing long-term financing for projects that are important to Brazilian development,” says Paulo Braga, chief press officer for BNDES. “In terms of our specific credit lines to support Brazilian exports of capital goods, the maximum amount we can finance is now 50% to large companies, down from 80% previously. The rate was raised from 8% to 11% a year. To SMEs, the maximum share of 100% was lowered to 70%, and the interest rate went from 8% to 10%.”

Another big push from finance minister Levy is for infrastructure funding. He pointed to the US$295.2bn infrastructure programme from 2011-2017, which is mostly made up of concessions and private investment. “I’m absolutely confident that once we get the house in order, the private sector will find new opportunities, new markets, and we’re going to get back to a path of growth,” he said.

A fractious trade bloc

One more key area for Brazil to work on is trade. The country posted its first annual trade deficit in 14 years in 2014 as exports fell amid declining iron ore, soybean and other commodity prices, slowing demand from Asia and the knock-on effects from trade partner Argentina’s ongoing flirtation with economic oblivion.

January iron ore exports to China, which buys 50% of the country’s shipments, fell 31% year on year, while sales to number two customer Japan dropped 9%. And it’s not just raw materials that are feeling the squeeze: The country, which is the world’s fourth major pork producer, saw exports of the meat tumble by 19% in January versus the previous year.

Mercosur, the fractious trade bloc of which Brazil is a member, seems to hold little opportunity for new frontiers. Its glacial progress toward greater trade integration was illustrated in a February visit to Paraguay by an increasingly frustrated delegation of European parliament members. They have been trying since 1999 to get the bloc to sign a free trade agreement with them, and have all but thrown in the towel.

Kátia Abreu, President Rousseff’s newly-appointed agricultural minister, has been vocal in her criticism of Mercosur, saying that it must ensure freedom to its members to negotiate with other parties and must not become a burden. Speaking at a press conference in January, she said the government’s aim was to “widen our commercial horizons for Brazil’s produce and to strengthen our presence in international markets”.

ABN Amro’s Torken sees plenty of scope for Brazil’s exporters. “If you have a country that has a devaluated currency, that country becomes much more competitive,” he points out. “Brazilian agriculture, metals and mining are some of the most important exporting sectors, and all of these sectors are now having local costs which have gained 25% in competitiveness. Every cloud does have a silver lining. If the currency stays where it is, a lot of imports will also be replaced by home-grown production because suddenly that becomes much cheaper.”

Another enormous opportunity in Brazil is in its energy sector. Parastatal Petrobras announced that it would invest US$220.6bn from 2014 through 2018, with 70% of this investment being destined for exploration and production. According to the US Department of Commerce’s International Trade Administration, Brazil accounted for 63% of all deep water oil discoveries in the world from 2005 to 2010. Once these oil fields are developed, Brazil will post the largest oil production growth among non-OPEC countries, sometime in the late 2020s.

However, the brakes are currently on any expansion by Petrobras as the country’s lawmakers attempt to unravel a huge money laundering and bribery case that is currently engulfing the firm.

“We expect to see a huge impact from the Petrobras issue on the country. It’s too early to say how that’s going to pan out. We are following that very closely. Ultimately the petroleum is there and it will come out. The question is who will pump it up and who will supply the equipment that pumps it up and on that we have to wait. Just like everybody else, we are looking on and trying to understand what is going to happen next,” says Torken.

Although the Petrobras scandal is an international embarrassment for the country, JLT Re’s Monaghan sees a positive side. “From a foreign direct investor standpoint, the perception is that there is a lot of corruption in Brazil. The country is not doing itself any favours by conveying this image to the outside world and that in itself is affecting the confidence of foreign investors. However, Brazil is showing the world that there are repercussions for corruption, which is a good thing for confidence.”

Not over yet

But the scandal, as well as the delicate economic situation of the country, is hurting the president.

At 23%, Rousseff’s approval ratings are at their lowest level since she first took power in 2011, having plunged from 42% in December. Political tensions are running high and it’s unclear how much economic adjustment Brazil’s people will accept, given that a 9 cent rise in bus fares last year led to widespread protests.
“Brazil needs to, in a relatively quiet way, find its way back to economic growth and to rebalancing its economy,” says Torken. Compared to other emerging markets, he thinks Brazil still looks attractive. “In comparison to China or Russia or India, Brazil is a solid democracy and it has a very strong free-market tradition. Ultimately those are the foundations on which Brazil will continue its, albeit slow, growth.”

He goes on to add that the country’s massive population will continue to generate domestic demand for everything from cars to white goods to supermarket products. “It’s an emerging market; people need to keep both feet on the ground. There’s a lot of space for people who are serious but it is not an easy country to operate in,” he concludes.