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AmericasDecember 2 2002

Optimistic outlook for Brazil

Roberto Setúbal, CEO of Banco Itaú, considers the outlook for Brazil under a newly elected leftist government after a decade of reforms.
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For the past decade, Brazil has been implementing economic reforms that attempt to strengthen the market and achieve macroeconomic stability. In several aspects, results have been remarkable. Inflation has averaged 9% since stabilisation in 1995, compared with more than 1000% during the preceding decade. Liberalisation has attracted foreign direct investment, which jumped from an average of $1.2bn during 1988-1994 to an average of $21bn during 1995-2001. Progress has also been made on the social front. During the 1990s, poverty was reduced, infant mortality per 1000 live births dropped from 48 to 35 and, more recently, secondary school enrolment soared (increasing 57% from 1994 to 1999).

However, despite achieving stabilisation, GDP and per capita income growth have been meagre. Several international shocks have hampered economic growth, which averaged 2.4% since 1995 compared with 3% during the 1980s, increasing unemployment from 5.1% to 7.5%. These mediocre results explain the will of change, shown by the people in the recent election. Demand for higher income and job creation have brought in the opposition. However, these expectations will be difficult to fulfil.

Better economic shape

The new president, Luis Inacio Lula da Silva, will receive an economy in better shape than any other president has received in recent history. Apart from inflation being under control, there is a fiscal primary surplus of almost 4% of GDP and an external sector that is rapidly adjusting to a new global context. The current account deficit will fall from 4.6% of GDP in 2001 to less than 2.5% this year, making it possible to comply with all short-term sovereign commitments.

Nevertheless, adequate fundamentals will be insufficient to guarantee economic growth. The new government will have to gain the confidence of the domestic and international financial community. It has to show that it will be able to maintain the sound economic policies that are needed to recover the country's creditworthiness. This will be the new government's main challenge. As the market learns more about the new administration, it will rise. Yet that will not be enough. Strong efforts need to be made in recovering creditworthiness.

Creditworthiness

It is possible to ignite a virtuous circle of reduction in interest rates and economic growth that will, as a by-product, increase fiscal revenues. The first step, though, is to insist on (and perhaps deepen) fiscal austerity. The new government has repeatedly expressed its will to preserve fiscal equilibrium. However, that is easier said than done. There is significant pressure from states and municipalities to alleviate the burden of servicing their debt. Public servants are also pressing for an increase in payrolls. In short, it will require strong political support and discipline for the new government to be able to resist pressures to increase public expenditure. Curbing similar demands was the first step of several successful governments: that of Margaret Thatcher in the UK, Ronald Reagan in the US, Tony Blair in the UK and Fernando Henrique Cardoso in Brazil.

Fiscal discipline will eventually recover creditworthiness and allow for a recovery in economic growth. But, to guarantee long-term financial solvency, structural reforms need to be implemented. Fortunately, there is consensus that this has to be done. During the election campaign, all parties proposed, among others (tax, labour and political), a reform of the pension system for public servants. Most of the proposals for reform in this area maintain a minimum pension as a defined benefit system and a complementary pension as a defined contribution. This is extremely important because retirement expenditure in Brazil is more than 11% of GDP.

The failure of the previous administration to pass these structural reforms through Congress during the past four years only shows the magnitude of the task ahead. There is a sense that the leftist government might succeed where Mr Cardoso failed. This generalised feeling is pure intuition, though. After all, the support that the new government will have in Congress, which is essential to approve anything, is smaller and somehow less reliable than the one that Mr Cardoso had. Despite having increased its share in the House of Representatives from 11% to 19% and in the Senate from 10% to 17%, the Workers Party and its allies have not gained enough seats to guarantee a simple majority in either chamber.

Chances of success

However, despite the difficulties, the hopes might be well founded. Historically, the Workers Party has been the major opposition voice against these changes. If the proposals now come from the left, they have quite a good chance of being approved. Moreover, political parties have become more responsible when it comes to fiscal austerity and economic policy in general. Political maturity flourished during the campaign, not only in the proposals defended by candidates but in the generalisation of the idea that support for sound economic policies could be a survival strategy in itself. If the new government manages to pass the necessary reforms, there is a chance of guaranteeing long-term financial solvency and, consequently, securing access to the foreign capital that the country needs to sustain economic growth. These are where efforts have to be concentrated immediately to set the country back on a sustainable growth path but they are just necessary conditions for growth. Development, in every sense of the word, will require further effort to create enough incentives for investment.

Still, there are several sectors in state hands that could be managed privately. Mainly, the oil sector, electric power generation and a share of the financial sector. Past experience has shown that sectors that are usually run by the public sector but have been privatised have attended better to the population's needs, increasing the overall productivity of the economy. Telecommunications, water and sewage are good examples.

The Brazilian economy needs to reinforce its external sector. Exports have been able to grow 3.5% in a year of stagnant international trade - furthermore, exports to countries other than Argentina will be growing 7%. This is a remarkable result of an extreme depreciation of the currency. One of the important tasks of the next government will be to preserve that result, keeping a competitive exchange rate with less volatility if possible. That, would be a better incentive to exports than any other industrial policy.

There are reasons to be cautiously optimistic about the new government. This is the first time that a rotation of power is taking place in the young Brazilian democracy; this experience will unveil the doubts that surround the consequences of a leftist government ruling the country. Second, the leftist Workers Party has won the election with a programme oriented towards reform of the public sector and macroeconomic stability. Third, the people have matured enough to demand stability as a prerequisite for any administration.

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