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Editor’s blogMarch 27 2014

Brazil needs a reform plan

Brazil's economy may be growing, but not fast enough. Standard & Poor's sovereign downgrade, on the eve of this year's Inter-American Development Bank in Brazil, is a call to action for a country in desperate need of economic reform.
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On the eve of the Inter-American Development Bank (IADB) annual meeting in Costa do Sauípe, Brazil has suffered the ignominy of a sovereign downgrade. Standard & Poor’s has lowered its credit rating by a notch for both domestic and foreign currency bonds – to BBB+ in the case of Brazilian real bonds and BBB- for foreign ones.

Brazil’s finance ministry complained that the downgrade did not reflect the country’s sound fundamentals and 2013's 2.3% growth rate. True, the economy is light years away from how it was back in the 1980s when it suffered from hyperinflation and regular debt crises. Since the adoption of the 'real plan' in 1994, the fundamentals have improved so significantly that the country was able to gain investment-grade status in 2008, when much of the rest of the world was engulfed in financial crisis. But with emerging markets now facing headwinds, there is a marked difference between economies that used the benign conditions of the past few years to reform such as Mexico and those such as Brazil, which have achieved much less.

Brazil has the fifth largest foreign exchange reserves in the world and has received $65bn in foreign direct investment in the 12 months up until February 2014. It is not in the position of an economy that will struggle to service its debt and the ratings downgrade is not saying that. However, the country has not managed to achieve the consistent 5% to 6% growth rates that it needs to continue to improve living standards and to meet the rising expectations of its population.

Street protests over bus fares and the costs of staging the football World Cup provide evidence of this. Economists are concerned about poor growth and fiscal deficits and the use of one-off transactions to meet fiscal targets, such as the sale of oil field concessions.

For all that has been achieved over the past 10 years or so, Brazil is still an economy with an oversized state bureaucracy and largely unreformed pension system. Lending by state-owned banks plays too large a role while manufacturing struggles to be competitive. Interest rates are among the world’s highest, indicative of deeper structural problems and bottlenecks. With presidential elections in October, few analysts expect immediate reforms and there are fears of a pre-election spending splurge.

By contrast, Mexico’s export sector is booming – helped by its 20-year membership of the North American Free Trade Agreement – and the government has been embarking on key reforms in banking, telecommunications and, most importantly, the state monopoly in the energy sector. There is a big focus on small and medium-sized enterprises and education, which augur well for future growth. Mexico’s sovereign rating, according to Moody’s, is now single A, the only Latin American country with that rating apart from Chile.

In recognition of Mexico’s achievements The Banker made the country’s finance minister, Luis Videgaray, our Finance Minister of the Year for 2014. In an interview he said: “For the past 20 years, Mexico’s gross domestic product has grown at an average of 2%; this is remarkably low for an emerging market. The main purpose of these reforms is to achieve growth in a sustained manner. Mexico’s growth should be about 5% – that’s our goal. With these reforms we will be able to increase our potential growth rate for the next decade.”

Brazil now needs the same kind of thinking and a reform plan for the medium term that will make last year’s 2.3% growth rate a thing of the past. No doubt there will be a lot of discussion about this at the IADB.

Follow The Banker’s coverage of the IDB meeting. Brian Caplen is the editor of The Banker.

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