Itaú BBA - 2015 – An Unfinished Year in Brazil

Op Ed

< Back

2015 – An Unfinished Year in Brazil

December 29, 2015

Restoring confidence is the key factor for economic recovery. This will only be possible when the political/fiscal knot is untied.

It will be a long time before 2015 really ends. It is already the last week of the year, and political issues continue to loom even during these final days. In the economy, fiscal accounts are not balanced, and the recession is not over. What we have seen this year will likely extend into 2016. The hoped-for recovery will probably come only in the more distant future.

The heart of the problem is still the simultaneous fiscal and political fragility. One rarely finds a fiscal situation that is so dependent on the legislative branch and a congress that is so fragmented that it can barely legislate. Political difficulties have delayed approval of the fiscal adjustment, and this has paralyzed the economy. Investors don’t know how the necessary adjustment of almost 3.5% of GDP (excluding the adjustment in social security) will be carried out, so investments, which have been declining for nine consecutive quarters, are unlikely to rebound. No one knows which private projects will be viable after the adjustments in the public sector are made. Consumers are also holding back in the face of these uncertainties. All of this means that the economy is unable to recover. In this political/fiscal/economic quagmire, days and weeks and months go by. In fact, after January, it will be years!

The fiscal problems are certainly not close to being solved. The primary fiscal deficit for 2015 will probably be close to record -2%. And the 2016 fiscal results do not offer much optimism. Congress has approved a fiscal target of 0.5% of GDP for next year. But revenue projections are too optimistic. More likely 2016 will be the third year with a primary budget deficit, with debt continuing to rise.

The 2015 recession is not finished either. There are still no signs of economic stabilization. Sales are falling (-11.5% year over year), as is industrial production (-10.8%). GDP shrank 1.7% in the third quarter (an annualized drop of about 7%), and we do not expect a much better performance in the final quarter of the year. Hence, GDP will drop close to 4% for full-year 2015. The most painful consequence is unemployment. The unemployment rate calculated in the National Continuous Household Sample Survey (the so-called Continuous PNAD) for all of Brazil (and not only for state capitals, as was previously the case) will likely reach 10% this year as jobs become harder to find and more people go back to the labor market looking for work.

We expect the recession to continue next year. Even if economic activity were to stabilize from here on, average GDP next year would be about 2% lower than this year (due to statistical carryover). However, all signs indicate that the activity deterioration will continue at least until the beginning of 2016. Hence, the GDP contraction in 2016 could easily reach 3%. In that case, the national unemployment rate would reach about 12% next year (again, according to PNAD). But the risk is that current fiscal and political problems drag on and the economy continues to slide in the second half of next year. Looking ahead, the main challenge will be to preserve recently achieved social improvements (such as income distribution and less poverty) in this unfavorable environment.

Facing these tough conditions generates a lot of anxiety, and people are already offering up “life-saving” ideas. Certainly one of them is to resume the expansive policies of the recent past — meaning to spend what one does not have. However, a fiscal problem cannot be solved by spending more. If spending more were the answer, then no government would have fiscal difficulties; it would just be a matter of changing the economic mindset. Clearly, the solution for Brazil’s trouble cannot be the very recipe that led to the current situation: growing expenditures that became too large and are difficult to reverse. A return to expansive policies would lead to a deeper fiscal crisis, with greater risk, ratings downgrades, capital outflows, exchange-rate depreciation, more inflation, lower real wages, declining confidence, a deepening recession and more unemployment – ultimately, a deeper economic and political crisis. It would be a sort of "suicide by expansion," as I mentioned in a previous article.

Not all fiscal issues are short term. A rebound in growth depends also on the right long-term signals. Some measures, if approved by Congress may improve confidence and help to reboot the economy even if not affecting the short-term results. There are many examples. Approving a minimum age for retirement to rebalance Social Security would reduce country risk and long-term interest rates. Attracting more investment for infrastructure is vital. Also important is signaling a new posture towards international trade, one that is open to trade agreements and turns the page on global isolation. Another helpful measure would be to allow agreements between employer and employee to prevail over existing rules under currently antiquated legislation, which would be a big step toward increased productivity in the economy.

The consequences of the past will not end in 2015. They will continue to be felt in the new year. Expansionary policies, as we have noted, are not the solution for fiscal problems. Restoring confidence, we believe, is the key factor for economic recovery. However, this will only be possible when the political/fiscal knot is untied. Meanwhile, medium- and long-term measures may signal a better future, helping to boost confidence. We must allow 2015 to end, whenever that might be.


Ilan Goldfajn is the Chief Economist and a partner at Itaú Unibanco.


< Back