March 25, 2013 5:37 pm
Brazil: Humbled heavyweight
Growth has stalled and the government is casting about for revival measures
Robert Lima da Silva sits on the ageing motorbike he uses for his job as a courier, waiting for one of São Paulo’s torrential rainstorms to pass.
“I’ve got a motorbike from 2003 and I want to change it for something newer,” he says. But he explains that repayments on his existing debts account for about two-thirds of his monthly income. “The problem is that my debts won’t let me,” he says of the planned upgrade.
Brazil’s motorcycle industry reflects a wider malaise in Latin America’s biggest economy. Two-wheeler sales were growing quickly until 2011, when millions of new lower-income consumers took advantage of easy access to loans to buy a new Honda or Yamaha. Last year, however, that changed as consumer credit became harder to secure, causing production to plunge by more than a fifth. It is a trend that has continued into this year.
Like many other Brazilian manufacturers, the motorcycle industry is now looking to the federal government in Brasília to help solve its problems. They know that the government of President Dilma Rousseff is desperate to revive the country’s former economic miracle. Gross domestic product grew less than 1 per cent last year, the lowest of the Brics club of emerging nations.
Investors are shunning Brazil in preference for Mexico, something unthinkable only two years ago. Although she is still immensely popular, the economy is a potential cloud over Ms Rousseff’s re-election prospects next year.
Her government’s response has been to wade into sectors ranging from energy to telecommunications with a mixture of carrot and stick, from tax incentives to measures forcing producers to cut prices. Yet rising government involvement in business is proving divisive.
On one side, those in banking and the financial markets argue that Brazil is reverting to interventionist ways that were found wanting in the past. The industrial sector counters that manufacturing will sink under high costs and rising imports unless help is forthcoming.
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Brazil vehicle registration, credit to individuals and average wages in manufacturing
The one point of consensus seems to be that the past decade of external tailwinds, provided by robust commodity prices and generous foreign fund inflows from loose monetary policy in developed markets, is over. Brazil needs to fuel its internal engines of growth, particularly investment.
“We are basically talking about what is the potential growth of Brazil – how much Brazil could grow in this new world with commodities not pushing, with developed countries not growing, this is a question [for which] we don’t have an answer today,” says Roberto Setubal, chief executive officer of Itaú Unibanco, Brazil’s biggest private bank. “Clearly Brazil has to change the model.”
Intervention in Brazil can make or break an investor’s fortunes overnight. In March, shares of Petrobras leapt 9 per cent after the government unexpectedly allowed the state-controlled fuel company to increase diesel prices. While the government officially denies controlling petrol prices at the pump, Petrobras is forced to sell fuel from its refineries at below international levels to help control inflation, depleting cash reserves needed to develop Brazil’s giant offshore oilfields.
“It was a positive surprise,” says Brunella Isper at Aberdeen, a São Paulo fund management company. “Maybe the government is signalling it is not that keen to use Petrobras any more as a tool to control inflation, which would be great if true.”
The surge of interventionism dates back to 2009 when Brazil began what it dubbed the “currency war”. The government was worried that foreign speculators were pouring money into Brazil to exploit the country’s high interest rates, in the process driving up the value of the currency against the dollar and hurting the competitiveness of local industry. The episode reached a climax in 2011 when Brazil raised financial transaction taxes on everything from bonds and swaps to foreign loans in order to curb the inflows.
Eventually, the real did weaken. Although the International Monetary Fund cautiously approved currency controls, various economists have questioned the currency war’s value. Nomura economist Tony Volpon argues the currency controls cut off foreign portfolio inflows and damaged investor sentiment just as the economy was slowing down in mid-2011 because of the eurozone crisis. This partly explains why Brazil screeched to a halt faster than other emerging economies – from 7.5 per cent GDP growth in 2010 to 0.9 per cent last year. Worse, the weaker currency seems to have done little to revive industry, which is plagued by high costs and wage rises that are outstripping productivity.
“The imposition of capital controls led to a tightening of monetary conditions just as growth began to disappoint,” Mr Volpon said in a report.
Apart from the currency, the government reverted to direct protection. The big four car manufacturers in Brazil – Fiat, Volkswagen, General Motors and Ford – won a reprieve in 2011 from competition from cheap Asian imports. Excise tax rose up to 30 percentage points on cars with less than a certain level of local content, stopping some Korean and Chinese producers in their tracks.
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In its bid to save jobs, the government began cutting social welfare taxes for 40 industries. Companies applauded the move. But the ad hoc nature of the changes led to more uncertainty in the investment climate, economists argued. Jin-Yong Cai, the chairman of the World Bank’s private-sector arm, the International Finance Corporation, told the Financial Times: “Business looks for stability and transparency and it’s not good to give special treatment to one industry or another which in my view creates distortions.”
In the second half of 2011, the central bank began a dramatic easing cycle, bringing its benchmark Selic rate down to what is for Brazil a record low of 7.25 per cent. Yet Ms Rousseff was dismayed when banks refused to increase lending. What ensued was a messy public spat with the private banks, which resisted exhortations to increase lending, arguing that Brazilians were already too heavily indebted.
“For Brazil, the issue is that consumer spending, which for years was the driver of growth, can no longer continue to increase at rapid rates,” said Capital Economics, a London-based research house.
After the failure of these earlier interventions to return growth to its higher track, official policy took a more strategic turn last year. Ms Rousseff began targeting Brazil’s high costs – Brazil ranks 130th out of 185 countries on the World Bank’s Doing Business survey – below Bangladesh and Russia but above India. She also began trying to boost Brazil’s low investment ratio, which at 18 per cent of GDP last year is below Mexico at 21.5 per cent and Chile at nearly 24 per cent.
First came giant infrastructure programmes. More controversially, the government also renegotiated expiring electricity concession agreements to give operators the choice of extending immediately – in exchange for a sharply lower tariff – or face their contracts being put up for tender when they expired. This sent electricity stocks crashing, angering investors, but it won applause from industry associations.
Critics argue the end result was that while foreign companies remained bullish last year, ploughing $65bn in direct investment into Brazil, the plethora of changes created so much uncertainty that domestic investors and foreign fund managers began withholding their money.
“Excessive interventionism has a cost, it was probably 200 basis points altogether in Brazil last year of growth,” said Marcelo Salomon, economist at Barclays Capital.
Others, however, see some of the interventions as important attempts to move Brazil further down the development path and tackle the notorious custo Brasil or Brazil cost. Interest rates charged by banks on some consumer products, such as overdrafts, soared into triple digits. Ms Rousseff’s campaign to lower rates was an attempt to deal with this.
Brazil has the highest ratio of renewable hydropower electricity at nearly 82 per cent last year. Yet Brazilians pay among the world’s highest energy bills. The government’s intervention in electricity lowered energy costs 14 per cent this year, according to Itaú-Unibanco.
The government is pursuing other reforms, too, that barely register on the investor radar: Ms Rousseff wants to double education investment to 10 per cent by 2020 and she is overseeing an improvement in the rule of law by showing less tolerance for corruption among her ministers and in her party.
“Even though investors take a view that the moment you intervene it is wrong, what investors want doesn’t always necessarily imply what is good for the country itself in the long term,” says Haroon Sheikh of Netherlands-based Cyrte Investments.
The history of rapid development in northeast Asia, such as South Korea’s state-led focus on education and its use of the chaebol business groups to develop value-added industries, were examples of successful interventions. Mr Sheikh adds, however, that not all intervention is good.
Subsidies, local-content programmes, protection, tax breaks and cheap credit should be accompanied by strict guidelines to ensure that industries become globally competitive or cease to receive such benefits. A crucial part of successful east Asian industrial policy is “being able to let things that are not important die and focus on others”, Mr Sheikh says.
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There is a growing sense that the most frenetic phase of the intervention may be ending. A more assertive central bank is pushing back on inflation and threatening to increase interest rates. The fuel-price rise and a promise by officials to improve returns on infrastructure projects were taken as a sign by investors that the government is still listening. The economy seems to be responding, with better growth coming through in January.
Political analysts say that although a more methodical approach to economic reform is needed, Ms Rousseff will probably continue to walk a tightrope between providing concessions to politically important industries and launching more comprehensive changes. If industry begins laying off workers, it would hurt her re-election prospects and provide a boost for new presidential challengers, such as Eduardo Campos, a charismatic governor in the booming northeast state of Pernambuco.
Perhaps for this reason, Marcos Zaven Fermanian, president of Abraciclo, Brazil’s motorbike and bicycle manufacturers’ association, remains confident that help could be on the way for his industry.
“The state-owned banks have increased the volume of finance to our customers but there is still space for further growth,” he says.
Mr da Silva may be able to upgrade that motorcycle after all.
Copyright The Financial Times Limited 2013.
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