As Luiz Inacio (Lula) da Silva is sworn in for a second four-year term as president of Brazil, it is worth a glance at the country’s economic prospects.
The risk is that after steadily revising their growth aspirations downward in the past four years, Brazilians may be in for more of the same.
It is useful to recall the ruckus that erupted in mid-2002, when investors first learned that Lula was leading the race for Brazil’s presidency. To put it bluntly, investors panicked.
The Brazilian real depreciated from around 2.3 per U.S. dollar to nearly 4.0, and the risk spreads on Brazilian bonds over U.S. Treasury bonds widened from around seven per cent to more than 24 per cent.
This despite the fact that, although Brazil’s debt situation was admittedly fragile, its economic fundamentals were solid, the new government was clearly pro-growth and credible people were being appointed to key posts.
As it turned out, Brazil represented a fantastic bargain in late 2002, and the astute and brave have been rewarded handsomely for their faith in Lula. The exchange rate has recovered to 2.1-2.2, while bond spreads have collapsed to about two per cent. Nevertheless, economic growth has disappointed persistently, posting an average of about 2.7 per cent during Lula’s first term.
This is similar to the average of the past 15 years, and a far cry from the heady growth rates seen in the 1960s and the 1970s. More to the point, it is well short of Lula’s own goal of five-per-cent growth.
The president is now under considerable pressure to deliver a higher economic growth rate, a challenge that will be made even more difficult by the global slowdown that is now underway.
EDC Economics is forecasting global growth of four per cent or slightly less during 2007, which is much less than the nearly five-per-cent rate posted in 2006.
This will mean lower commodity prices and slower economic growth throughout the emerging world, and a recalibration of financial risks – in other words, a widening of bond market spreads against such countries as Brazil.
Even so, Brazil should be reasonably insulated from global turbulence. The country will continue to reap the benefits of the steady decline in inflation engineered by the central bank, a process that is gradually translating into lower real interest rates for companies and consumers.
A much stronger fiscal position has dramatically reduced Brazil’s external vulnerability. Further, Brazil is still a relatively closed economy, with total trade accounting for only about 25 per cent of the country’s GDP. Moreover, prices of the commodities that Brazil specializes in – iron ore and agricultural products – should remain solid. Growth is forecast to be 3.5 per cent in 2007, slightly higher than 2006.
Nevertheless, shifting growth onto a decisively higher plane will require a big increase in investment, by both companies and governments. Opening the country to more trade will be an important part of this equation, as foreign investors are likely to be much more attracted to an economy that can be used as a base for global aspirations, as opposed to simply local ones.
he bottom line? Brazil still looks like a good bet, but its policymakers will need to do more than just stay the course in the next four years if their lofty economic goals are to be met.
Certainly, Brazil’s miracle will not simply happen by itself, so this is no time for complacency.
(Stephen Poloz is a senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)