Key Note covered in an earlier blog how Brazil, Russia, India, [the People’s Republic of] China (PRC) and South Africa (or the BRICS countries) got going. Their expansion has galloped ahead, trebling their share of total global gross domestic product (GDP) between 2000 and 2014, even as developed economies floundered in the wake of the financial crisis. Once, they were all those examining the global economy could talk about.
Now, though, despite coming on leaps and bounds and with the ink barely dry on the paperwork to set up the BRICS New Development Bank, the developing world rival to the World Bank and the International Monetary Fund (IMF), it has become increasingly apparent storm clouds may be gathering in these five emerging superstars. Leaves, or maybe the wrong kind of snow, are on the line of economic growth, hampering progress. Every day this week, Key Note will publish a blog on a BRICS economy to answer one question: are they heading for derailment?
Brazil: A Samba with Two Left Feet
In Brazil, a multi-billion-dollar corruption scandal at the huge state-controlled oil behemoth Petrobas involving kickbacks to politicians has paralysed construction and infrastructure spending. (Most of Brazil’s biggest construction firms are linked to industrial conglomerates through Petrobas’ long tentacles; accusations of padded construction contracts swirl.)
As Petrobas’ parlous finances emerged into the spotlight, credit ratings agencies slashed its credit status to junk. It and its subsidiaries won’t be making any borrowing or investment at all for the near future; much growth in Brazilian construction has therefore now stalled. This is a particularly screeching halt given the boom preceding the 2014 football World Cup. As the corruption scandal builds and the Brazilian economy edges closer to a cliff, any foreign construction firms that may have come to the rescue have taken pause. Not only is this hurting any growth through the construction industry, but the stalled construction would have built the infrastructure Brazil desperately needs to boost output. It’s a double blow.
Brazil has struggled to attract foreign investment in recent years, despite being an exciting, burgeoning market. This is partly because of red tape and a history of government intervention in business, as well as a labyrinthine tax code. Many foreign investors are put off by the bright red tangles they feel they might find themselves in.
Brazil, so dependent on hydropower for electricity (and its coffee crop, of which it is the world’s biggest exporter) continued to suffer drought in 2014. The resulting spike in electricity prices pushed up inflation and slashed power-hungry manufacturing output. Unsurprisingly, the Government wishes to conserve water; by imposing higher prices on water and electricity, it hopes to cut use and save Brazil from both blackouts and water shortages.
Brazilian manufacturers have been hit by rising electricity prices: one steelmaker shut down two furnaces in May 2015 because powering them became too expensive. Plus, the domestic market was a big buyer of steel given the recent construction boom; the slowdown continues to ripple through the wider economy.
Higher water and electricity bills have caused inflation to spike at a time when wages just aren’t keeping up (today, Brazilian productivity does not merit wage rises). With part of Brazil’s mammoth rise to growth being consumer-based, this is problematic. Older consumers remember the 2,000% inflation of the early 1990s and are easily spooked by inflationary pressure, turning off the consumer spending taps accordingly. Also spooked are the international currency markets: there is a hint of déjà vu about Brazil’s current situation and Brazil’s real has slumped, pushing up the price of imports.
Faced with these pressures and with an eye on the economic malaise of the past — its IMF rescue in 2002 still smarts — the Brazilian Government has now moved to tackle the yawning deficit spawned from a little too much enjoyment of the good times during Brazil’s boom. It has high debts, among the highest of the BRICS countries, and its credit rating is at risk. A fuel duty rise is imminent; the middle class Brazilians who splashed out on cars as the economy surged will feel this keenly. Discretionary public spending has been slashed to the bone, despite infrastructure crying out for investment, and all the opportunities for economic growth this would afford.
Splashing out has been the problem in Brazil, for consumers, Government and businesses alike. Debt is high and the central bank faced the tough choice between keeping interest rates high to stave off inflation and support the currency, or cutting them to boost consumer spending and business investment, reducing the burden of debt but risking an inflationary spike. In the end, faced with sliding demand, rising unemployment and plummeting business confidence as prices spiralled, it chose a rate rise to 13.25%, the highest for 6 years.
But most of its monetary policy levers are jammed by the tight corner it has been squeezed into. The central bank lacks the autonomy to do what it must. Recession looms. For now, the carnival’s over.
Michael joined the company in October 2010 and works as Key Note's Lead Writer. He specialises in producing our range of financial services and insurance titles.