Brazilian Economy - The New York Times

After a Year in Economic Overdrive, Brazil Hopes to Elude Pitfalls

By ALEXEI BARRIONUEVO

The New York Times, October 8. 2011

SÃO PAULO, Brazil — In the first major test of her stewardship of Latin America’s largest economy, President Dilma Rousseff is struggling to break free of an economic trap.

Coming off a year in which it recorded its highest growth in a quarter century, Brazil is faced with rising inflation, an overvalued currency and an industrial sector losing competitiveness to cheap Chinese imports.

But Ms. Rousseff’s promising efforts to fix those problems could be undermined in the coming months as the government embarks on one of its biggest spending sprees in decades.

The leaders of the United States and Europe, struggling to right their listing economies, would count themselves lucky to have problems like Brazil’s. Its economy — driven by soaring prices for commodities, robust Chinese demand for raw materials and a domestic consumption boom spurred on by expanding credit — grew 7.5 percent last year, its highest rate since 1986.

“Like other emerging countries, Brazil has thus far been less affected by the global crisis,” Ms. Rousseff, an economist, said at the United Nations last month. “But we know that our capacity to resist is not unlimited.”

Her strategy so far has been bold. Predicting that the global economy will not improve this year, Brazil’s Central Bank has slashed interest rates, making a risky bet that already high inflation would not soar further. That move, aimed at encouraging growth and reducing the value of the currency, was paired with measures to protect Brazil’s industries from a flood of Asian imports.

That approach has shown early signs of success. The stubbornly high Brazilian real began losing value to the dollar last month, reaching its lowest point since 2008 two weeks ago before recovering somewhat last week.

The shift has been front-page news in Brazil, dampening a buoyancy among Brazilians who felt richer than ever. Even as the overvalued currency slowed industrial production, it fueled consumer spending at home and abroad at a blistering pace.

The average per capita purchases by Brazilians in the United States grew 250 percent between 2003 and 2010. Only the Japanese and the British spend more in the United States than Brazilians, figures from the United States Commerce Department show. The foreign spending, which diverts money that could support Brazilian industry, has alarmed government officials here, who have tried to slow the pace of consumption by imposing restrictions on credit card purchases.

But government spending represents the bigger threat.

Next year, the government will be obligated to meet tens of billions of dollars in promised payments for social welfare programs, minimum wage increases and infrastructure projects for its twin billing on the global stage, the 2014 World Cup and 2016 Olympic Games in Rio de Janeiro.

A 14.7 percent increase in the minimum wage is scheduled to take effect in 2012 at a cost of $13 billion, new low-income housing subsidies will cost $6 billion, and investments for the sporting events are expected to cost at least $4.5 billion, said Luiz Schymura, director of the Brazilian Economic Institute at the Getulio Vargas Foundation in Rio de Janeiro.

Since her inauguration in January, Ms. Rousseff has shown a willingness to take a red pen to fiscal spending. Her government approved $28 billion in budget cuts, privatized airports — a move considered long overdue by economists and many policy makers — and stood up to unions demanding even higher wage increases.

But standing up to the minimum wage or the World Cup may be politically impossible.

“For all her good intentions, the political pressures on her will be enormous,” Dr. Schymura said.

The surge in spending, accompanied by lower interest rates, could produce a cycle of higher inflation, economists fear. Whether the new policies will be enough to revitalize Brazil’s industrial sector remains to be seen. The economy’s growth has slowed this year to about 3.5 percent, economists say, about half that of last year. And the consumption boom is slowing. Housing, grocery and retail stores are all reporting reduced sales, said Alfredo Coutiño, director for Latin America at Moody’s Analytics.

“Now everybody is questioning if the consumption boom was sustainable or not, because everybody is losing now,” he said. “The future in Brazil is not certain, or at least not as certain as believed at the beginning of the year.”

There are also concerns that structural shifts are under way that will continue to stymie growth. Industry’s share of total economic production has been slipping, to 15.4 percent last year from 19.2 percent in 2004, government figures show.

“Some people say that Brazil is immersed in a de-industrialization process,” Dr. Coutiño said.

The government has moved aggressively to protect industry, saying last month that it would raise import taxes on foreign cars and trucks by 30 percentage points to protect jobs in Brazil’s flagging auto industry.

Brazilian industry pins its decline on the overvalued real, which reduced demand for Brazilian products, and for that Finance Minister Guido Mantega blames the United States and China for exacerbating a “currency war.”

But the real has also strengthened because of high interest rates, which have attracted a heavy influx of dollars from overseas investors. Brazil’s benchmark interest rate of 12 percent — which was slashed in August from 12.5 percent — remains among the highest in the world.

The government is determined not to repeat past mistakes. After the September 2008 collapse of Lehman Brothers, Brazil waited four months to begin cutting interest rates. The surprise cut in August came as inflation climbed to a six-year high, and more cuts could be coming.

“As the financial crisis worsens, this time we will take advantage of it,” Ms. Rousseff said to business leaders here last month.

Despite the moves, analysts fear that Ms. Rousseff will pay a political price for Brazil’s economic dip.

When former President Luiz Inácio Lula da Silva was re-elected to a second term in 2006, Brazil’s economy was taking off. His government’s approval ratings steadily soared, topping 80 percent in some polls as he left office on Jan. 1.

Ms. Rousseff, his chosen successor, was elected last October just as Brazil’s economy was starting to overheat, with another global slowdown months away. But so far she has not mustered the same political support that Mr. da Silva enjoyed, and she has struggled to contain unrest in her governing coalition. Five ministers have resigned in the past four months, the latest being Pedro Novais, the tourism minister, who stepped down last month amid allegations of ethics violations.

Ms. Rousseff “is embarking upon a politically more difficult path precisely when her base of support in Congress could start to wane and her approval ratings are more likely to drop over the next four to six months,” said Christopher Garman, an analyst at Eurasia Group, a political risk consultancy in New York.

“She is embarking upon a bold strategy,” he said, “but she won’t be able to fully deliver on that strategy.”