BRAZIL AFTER THE CUP: THE HANGOVER IS COMING

Sao Paulo, 08 July 2014

Brazil is shattered by the end of 2 illusions: the ‘futebol arte’ is definitely gone and the ‘Plano Real’ will not carry the country ahead anymore.

END OF ILLUSIONS

Brazilian football has been infused by the samba touch to produce the world acclaimed ‘jogo bonito’ or the ‘football art’. A visit to the football museum in Sao Paulo reveals a treasure of some of the best Brazilian goals of the past 50 years. They are truly inspiring and artistic. The 1970 team was especially remarkable.

This World cup had dried out the art of Brazilian football. When the host team beat Chile by penalties in the first round, all the frailties were revealed. The team play and nerves were just not up to par with the dreams of a nation and the best competitors in the field. Brazil won the game but at the cost of losing the cup altogether.   The implacable 7-1 result in the semi-finals will resonate for generations. The tragedy was somewhat predictable, the collapse was unprecedented.

National tears will now roll the ball onto the political arena, where presidential elections are scheduled for this October. President Dilma is hoping to survive the football upset. Once the Cup got going, the festive mood edged her up to 38% in the polls, against 26% for the runner-up, Aecio Neves. Now the expensive price tag of $11 B and the whiff of corruption are likely to resurface. Mrs. Havelange, daughter of former FIFA boss, acknowledged in El Pais some 2 months before the Cup opening that ‘all that could be robbed had already been so’. An astounding revelation. During the cup, a newly constructed overpass collapsed, killing and injuring several. From a recent survey measuring the confidence Brazilians display over their national institutions, political parties scored only 7%, right down at the bottom, while national congress barely passed with 15% of the population.

THE PT IS STRETCHING

The PT (Partido dos Trabalhadores) is seeking a 4^th term this Fall. It is still riding on the Plano Real put in place by past president Fernando Henrique Cardoso (FHC) 20 years ago, in 1994. The Plano Real ended a decade of hyper inflation and economic retrenchment. Past president Lula, who succeeded FHC in 2003, had a great first term, cleverly combining liberal economic policies and new social programs. The commodity boom permitted this experiment. It won swaps of voters on the left, and sufficient voters from the center to win a majority. Lula completed 2 terms before anointing Dilma Rousseff. She easily won the presidency in 2011.

The first term of current president Dilma is not ending as well as predicted (see previous blog in 2011 – http://www.sdaconseil.com/blog/?p=6). The economy is slipping into a troubling pattern of low growth and high inflation. Recurrent corruption scandals are grating the new middle class. Short of new ideas and effective reforms, the PT is increasingly embracing a more leftish agenda bent on keeping power at any cost.: Higher spending, opaque government programs, administrative price controls, high import tariffs, troubles and delays in infrastructure programs, and a sense of prolonged improvisation.

THE ECONOMY TANKING

With the fun now officially over, the next government will have a hard time to fix the economy. Like other emerging nations, GDP growth is tapering to 1.3% this year and the outlook remains rather bleak. The heart of the matter is that residual inflation remains stubbornly too high, mining productivity and competitiveness.

Inflation rates averaged in the last 10 years about 5.3% and is expected to hit 7% this year. Not terribly high, but high enough to attract short term financial funds and to strengthen the Real. Over a 10-year inflation period, real price differentials with the USA have now come to exceed 30%! This hurts industry and exports. The duty-free shops at the international Guarulhos airport look decisively ‘duty-added’. Some popular cereal boxes in Sao Paulo are down to 180 gr at $C 3.50 each! This combination of high prices, high interest rates and a strong exchange rate are taking their toll on the economy.   Awkwardly the government is now resolved to use a strong Real to put a brake on inflation.

Manufacturing is suffering from a combination of sluggish productivity, high international prices and from the ever encroaching Chinese competition. Car production in Brazil is dropping by 10% this year, and for the first time ever below Mexican production. Capital investments are thus down by 5% this year compared to 2013. Ominously, Chinese business men are organizing and transposing THEIR own trade shows inside Brazil. Chinese exports to Brazil have gone from $16 B in 2009 to $$37B in 2013. The trade balance is thus taking a beating.

Brazil keeps the highest import tariffs in the world and not surprisingly ranks only 43^rd in the McKinsey Global Index.   Still, behind the barriers, the trade account has moved last year from a surplus to a deficit for the first time in 10 years. It is expected to remain negative in the near future. As a result, the current account deficit is hovering around -4% of GDP this year, still within a comfort zone, but just about it.

The only sector performing well is agriculture, registering strong investments and trade surpluses. As for the consumer, he is putting on the brakes as well in light of rising unemployment. The consumer confidence index has lately been dropping like a stone, in spite of the Cup.

The Plano Real celebrated 20 years last 01 July 14 with good reason. The middle class at last rebounded and found a new voice. Yet, for all the thanks bestowed to FHC, the Plano Real has reached the end of its useful life. The Brazilian economy is now caught in a trap and requires a new Plano and fresh initiatives.   Can the PT be up to the task? It controls the purse, benefits from some election momentum, and can count on the votes from the left.   At this stage the election is theirs to lose. But policy wise, doubts are creeping up the ranks of the middle class.

WRONG DIRECTION

The 2016 Olympic games in Brazil will present an opportunity to stimulate the economy. But the costs and the benefits of the World Cup will surely generate a string of local debates and quite possibly generate additional delays in infrastructures. The world cup is likely to leave a sour taste in the mouth of Brazilians. Furthermore experience in emerging economies tells us that corruption shoots up when a party stays in power for a third term, and spills over in a 4^th term. Lousy politics and a stumbling economy will breed bad news ahead.

Odds are that the Brazilian ‘jeitinho’ (improvising, finding a way ahead) will pull the country through for the next 2 years, until the staging of the Olympic games. It is just that the hangover will then hit harder.

André Du Sault, MBA, MPA (Harvard)

References : Folha de Sao Paulo, Estado de Sao Paulo.