Itaú BBA - Brazil Needs Rebalancing, by Ilan Goldfajn

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Brazil Needs Rebalancing, by Ilan Goldfajn

diciembre 6, 2012

Two years of weak growth shows clearly that Brazil needs to rebalance its economy.

We all need to reinvent ourselves from time to time in order to keep evolving. Countries need it too. Two years of weak growth shows clearly that Brazil needs to rebalance its economy. Strong consumption growth within a heated job market and thriving domestic market is not enough. In order to continue expanding, Brazil will need more investment, more education. Productivity must rise to sustain the current high wages and increase companies' competitiveness. Rebalancing the economy requires vision and planning, providing confidence in the future. The result would be a rebound in investment, which would bring both the desired recovery of short-term activity and sustained growth in coming years.

Third-quarter Gross Domestic Product (GDP) in Brazil disappointed and confirmed a worrying trend. Growth was only half of what was expected (by the government and analysts). More alarming was the composition of such growth. While household consumption continued to grow strongly, investment fell for the fifth quarter in a row, despite several incentives adopted by the government. The absence of a rebound in investment (currently at 18.0% of GDP) reflects the current challenge to rebalance the economy and maintain the country’s economic growth.

The need for rebalancing is not unique to Brazil. Five years have passed since the global financial crisis of 2007/8, and several countries had to change their paths. There was no longer room for economic growth based on increasing indebtedness in mature economies. The balance sheets of the private sector were the first to adjust, forcing governments to deal with the risk of recession and deflation. We now come to the difficult phase during which governments' balance sheets need to adjust in order to balance the increasing debts.

Emerging economies have also had to reinvent themselves. Growth based on exports to mature economies ceased to be the swift and certain path to development. China is the most emblematic case of such necessary change.

China’s needs, in a sense, are the opposite of those of Brazil: more consumption and less investment. The country needs to rebalance its economy for its own sake and for the health of the rest of the world. Investment reached 48% of GDP in China, but consumption has not grown at the same rate. The reasons for the lack of rapid growth of consumption are paradoxically similar to the reasons for the lack of investment seen in Brazil. China lacks perspective and confidence in the future. Chinese fear spending because of the lack of public pensions. Or fear the lack of resources to pay for healthcare, in light of the absence of a public health system accessible to all. China’s need for adjustment has resulted in lower growth in recent quarters. But recent signs point to stabilization of growth at a still high 7.5%, and prospects for wage increases and reforms that should encourage consumption.

In Brazil, growth in the third quarter came in at 0.6% from the second quarter, seasonally adjusted (approximately 2.5% annualized). The recovery has been much slower than anticipated. Growth was expected to reach twice that figure, or 1.2% (around 5% annualized). Disappointment this time was not a consequence of industry weakness, which grew 1.1% in the quarter, or agriculture, which showed some recovery with a 2.5% gain. The service sector was the one that disappointed, as it simply did not grow.

The lack of growth in the service sector was not expected. The transportation and financial intermediation sectors fell, and public administration, health and education services gained only 0.1%. Trade grew only 0.4%, even with the positive effect of vehicle sales.

Looking at GDP growth from the standpoint of spending (consumption versus investment) rather than the division of sectors (industry versus services) may be more instructive. Consumption doesn’t seem to need more stimuli. Favorable job market conditions, high confidence and incentives for the purchase of durable goods have supported consumption growth.

Attention should focus on investment, which disappointed once again. The decline accumulated in five quarters reached 5.9%. A declining investment rate means less capacity to grow in the future. This process must be reversed, providing confidence and conditions for a rebound in investment.

The disappointing third quarter and lukewarm growth prospects for the fourth quarter will lead to lower growth in 2012, at around 1%. This is a very modest number, especially when GDP grew only 2.7% in 2011. Usually, we would expect some recovery after a weak year.

Business confidence suffers as a result of lower-than-expected growth. What we see is lack of trust in the future, leading to a reduction in investments. And that may impact growth in 2013, which should pick up, but only moderately (around 3%).

As a result, the government is expected to announce further stimuli, such as more tax cuts, lower interest rates and further exchange rate depreciation (this year's toolkit applied in 2013). The stimuli may help the economy, but it is critical to reduce domestic uncertainty in order to optimize the effects of the incentives, especially as the world remains uncertain.

Confidence in the future, in a stable regulatory framework, and an adequate return for long-term projects, are essential to the sustained growth of the Brazilian economy.

Ilan Goldfajn is chief economist at Itaú Unibanco and a partner at Itaú BBA.

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