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back to index backLATINtalk July,  2005

Political Crisis, Economic Aftermath: Slow Growth For Brazil...

For those who've followed the Brazilian economy over the past decade, it would be reasonable to conclude that the current political crisis could have a significant impact on the economy. After all, that's what happened following the external crisis in Asia and Russia in 1997 and 1998, and the domestic crisis of 2001 and 2002. Why, then, would the present turbulence in the political arena not affect the economy?

The answer to that question is that the Brazilian economy has toughened up quite a bit compared to its status in recent years, with economic fundamentals as well as institutional aspects gaining strength. In practical terms, this means the probability of any change in direction affecting economic policy because of political troubles is low, which reduces uncertainties about what lies ahead, as well as fears about volatility affecting asset values.

Nevertheless, it would also be incorrect to presume that Brazil will escape entirely unscathed: the current mess in Brasilia is bound to take its toll. While it seems probable that short term impacts will be slight, the possibility of more robust economic growth in the medium and long terms are certain to be negatively affected. Congress is virtually paralyzed, which creates a real obstacle for the advancement of a positive agenda, and that contributes to make Brazil less attractive to investors. This scenario leads to slower growth and lower productivity, and more modest growth potential down the road.

In the short term, risk levels are quite low. The three pillars that have been accounting for the added premium placed on Brazil 's sovereign risk assessment – public and external account balances, and international liquidity – are all at much more favorable levels than in the recent past. By the same token, the smooth political transition following the election of President Lula and his Workers Party in 2002-03 was a vital ingredient to consolidate a macro and microeconomic agenda for the country. This suggests greater consensus at the helm of economic policy than in the past.

Considering economic fundamentals, which explain the low volatility of the premium on Brazil 's risk assessment, one can say that the economy appears less vulnerable to sudden jolts. The debt-to-GDP ratio is stable and a downward trend is projected for the future. In the same manner, the current accounts surplus is now in its third year, a novelty in recent Brazilian economic performance. With that, all indicators that measure internal and external solvency are in better shape than in the past. To solidify the overall picture, international liquidity has returned to quite favorable levels, similar to those observed prior to the Asian crisis of 1997.

As a result, the sovereign risk premium has not only remained relatively stable during the present crisis: it has actually dropped in recent days. A far different situation from what was observed during the 2004 crisis involving Waldomiro Diniz, a top aide to the powerful former Chief of Staff, José Dirceu: in an incident that became known as Waldogate”, Diniz was caught on tape asking a gambling boss for a kickback to help pay for political campaigns.

There have been advances and mistakes at the institutional level as well. Monetary and fiscal management by the current administration has the merit of consolidating a standard, and making it clear that there is less and less room for speculation about how things are done in this area. Behind this particular trend is the fact that Brazil has been confirming a significant advance: it is indeed a market economy, featuring a society that thrives in a vibrant democracy.

This leaves no room for irresponsible management moves in the economic arena – any rash decisions would immediately translate into pressure on financial assets, which generate time-lapsed impacts on inflation, interest rates and growth. Any notion of a less responsible” approach regarding fiscal policies would bring about instantaneous effects on risk assessments and currency exchange rates. Gradually, these effects would become noticeable to all, in the form of added pressure on prices, more conservative monetary policies, and higher unemployment rates.

Because democracy is clearly working in today's Brazil , an underperforming job market leads to a poor assessment of the government, which corrodes the administration's political capital and increases the likelihood of poor results at election time. In this way, there is an excellent political incentive for responsible economic management to remain a priority.

This combination was openly tested with the political transition in 2002. An open economy and a healthy democracy contributed to drive away any possible lack of continuity in Brazil 's economic policies. Once fundamentals and institutional maturity were duly tested, the economy gained an improved ability to face sudden rough spots. Considering the current situation, only a far more serious institutional crisis, involving top-level names like the President or the Finance Minister, would have the potential of harming confidence in the electoral process.

Given the information currently available about the political scene, the crisis seems limited to well known members of the political establishment who are not key to Brazil 's economic policies and management. Impacts on the economy, in this case, have been felt primarily where medium term investor expectations are concerned, because the crisis has had a more direct effect on the progress in Congress of badly needed reforms. This draws attention to the fact that Brazil is not as attractive as it could be as investment options go. One consequence tends to be slower productivity gains in coming years.

In the end, what rises above other details is the impression that the Brazilian economy appears to have conquered a reasonable level of stability, which is nothing to sneer at considering events in the not too distant past. At the same time, stability alone doesn't make Brazil 's economy as promising as it might be when it comes to growth potential. Projections by the Tendencias Economic Consultancy indicate that growth should remain steady in coming years, but at a pace that's hardly satisfactory, averaging around 3 percent per year.

So the ongoing political crisis is unlikely to generate short term impacts, or anything capable of paralyzing the economy as was the case with similar experiences in the past. But it does add strength to a fateful scenario for Brazil : low economic growth rates over the next few years.


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