BRAZIL: Government moves to boost sagging growth

Analysis

Until the collapse of Lehman Brothers, the Brazilian leadership appeared confident that continued rapid growth -- which reached 6.8% year-on-year in the third quarter -- and record foreign reserves of 200 billion dollars would shield it against difficulties. However, the outflow of capital from Brazil has accelerated since mid-September (see BRAZIL: Rising current account deficit fans concerns - November 17, 2008), as investors gave priority to their interests in home markets, while the Central Bank has been forced to pump more than 50 billion dollars into capital markets, mostly through swap arrangements to be repaid later, taking 10 billion from reserves.

The aim has been to prevent further depreciation of the real, which has fallen by almost 30% against the dollar since mid-year. Export finance has also dried up, while stocks of Brazilian companies have lost an average of half their value:

• Demand for basics such as iron ore, soya and maize, as well as low technology manufactured goods such as meats, pulp, steel, timber and others, have fallen by an average of 30% since peaking in mid-year, as have their prices. In recent years such goods have been responsible for more than half Brazil's export earnings.
• The substantial trade surplus since 2001 could virtually disappear next year, depending on how severe the recession proves to be.

Government efforts. The government has been spurred into action following job cuts by a number of major players:

• In early December, mining giant Vale announced the loss of 1,300 jobs, with some 5,500 employees being sent on paid leave.
• In addition, most vehicle assemblers, leading meat processor Sadia, several steel companies and the world's leading pulp exporter, Aracruz, have shed workers.
• More than 30,000 industrial workers have already lost their jobs in Sao Paulo state alone and many thousands more worry what awaits them when factories re-open early in the new year.

President Luiz Inacio Lula da Silva has exhorted companies to use the profits of the past few years to keep workers on, and urged citizens to maintain consumption. However, several companies lost hundreds of millions of dollars after they failed to exit hedging operations designed to protect them from a strengthening exchange rate fast enough to avoid major losses as the currency collapsed. The measures taken so far by the government have included:

• small cuts in taxes and the promise of aid for industries with a large workforce -- notably the motor and civil construction industries, both experiencing a slump in demand;
• promises to fund the liabilities of companies with large dollar-denominated debts, with up to 20 billion dollars of foreign reserves to be used for this purpose next year; and
• a December 26 'provisional measure' authorising a bond sale of some 6 billion dollars to finance a new sovereign wealth fund, to be used for public investment, though the opposition has called on the Supreme Court to block the move as unconstitutional without congressional approval.

The Brazilian banking system was completely restructured in the 1990s and is subject to tight controls (see BRAZIL: High borrowing costs bolster banking sector - December 17, 2008). State-owned banks remain strong, allowing them to take on new roles such as export financing and loans to companies such as state-controlled oil company Petrobras (see BRAZIL: Petrobras euphoria fades with oil price - December 11, 2008).

Credit crunch. Even before the crisis intensified, the economy was overheating dangerously. Generous credit terms had allowed consumers to pay for vehicles over ten years, with the result that a record 2.7 million new cars have been sold this year, 70% of them financed. However, tens of thousands of new buyers have been unable to maintain payments, and automakers and their banks are owed about 4 billion dollars. Moreover, with repayment periods now cut to five or six years, vehicle sales have collapsed in the past couple of months -- 300,000 unsold vehicles are in stock, and factories have closed until prospects become clearer.

The motor industry is just one of several that have persuaded the government to aid them, including civil construction and sugar and alcohol:

• The steel industry, which is part way through an expansion scheme involving building half a dozen new mills, is also in the queue.
• Buoyed by strong demand from China, the pulp and paper industry had planned to build several new export orientated mills, but these have now been shelved after the pulp price fell by 30% in as many days.
• The crisis intensified just as farmers were preparing to plant the 2008-09 main crop. Despite efforts by the government to persuade state-owned banks, normally responsible for about a quarter of farmers' borrowing, to increase lending, most farmers have been obliged to use their own resources. As a result, the 2009 grain and oilseed harvest will likely fall by 10% year-on-year, making it the smallest since 2005.

The government has responded by making some timid tax cuts and has promised to accelerate its 'Growth Acceleration Plan' (PAC), which envisages the investment of tens of billions of dollars in improvements to infrastructure, including new power stations, railways, roads and ports.

Consumer caution. Aware of job losses and deteriorating prospects for next year, most consumers have become cautious and are disregarding government calls to continue spending. Although consumer debt in Brazil remains a fraction of that in developed countries, it has grown massively in recent years. Most of those in employment are using the extra 13th monthly wage paid in December to reduce debts rather than sustain consumption.

The Central Bank came under intense pressure to reduce Brazil's high benchmark Selic rate in early December. Probably as a gesture aimed at reminding the government of its independence, the Bank held the rate steady. Because imports will now cost more, the bank suggested inflation might increase. However, in practice, with falling food prices and with stocks of most goods at high levels, deflation will probably become a greater problem in the near future, and the interest rate will likely be cut in January.

The government claims that, largely because of the PAC, and because Petrobras plans to maintain its ambitious investment programme, the economy will grow by 5.5% this year and 4.0% in 2009. This is the minimum needed to absorb new entrants to the work force and prevent unemployment, which fell by a record amount in the first three quarters of 2008, from rising as it is now expected to do. However, on December 22 the Central Bank cut its 2009 growth forecast to 3.2%, while private analysts suggest growth of 2.0-3.5% (see PROSPECTS 2009: Brazil to weather worst of downturn - November 24, 2008). Companies and unions are pressing the government to take action to ease tight labour laws; some unions say they are prepared to accept a reduction in the working week and wage cuts, if workers can keep their jobs.

Cautious optimism. There remain some grounds for optimism:

• Following the recent depreciation, Brazilian manufactured goods will regain some of the competitive advantage lost in recent years, although US and EU export markets will be hard hit by recession.
• Because prospects for the Brazilian economy now appear brighter than for most others, some of the 150 billion dollars Brazilians have invested abroad is beginning to be repatriated.