The Brazilian economy: Recent turbulence and future uncertainties

For Latin American countries, many of which are already in the throes of an economic crisis, the proposed FTAA constitutes another obstacle to their recovery. A leading Latin American economist examines the plight of Brazil and argues that the liberalisation process and the closer linkages induced by the FTAA will be a danger to its future development.

by Adhemar S.Mineiro

Facing a difficult economic scenario

THE Brazilian economy is facing a new period of strong financial instability; at the same time, uncertainty is growing fast in different fields. From the beginning of this year till the middle of June, the real, the Brazilian currency, depreciated around 24% in relation to the US dollar (for the same period, inflation rates were between 3% and 4%, according to different national price indexes), in spite of the efforts of the Brazilian Central Bank to avoid a quick devaluation of the national currency. Diverging from interest-rate movements in the main international financial markets in the recent period, Brazilian interest rates are slowly moving up, dangerously affecting the national budget due to a total (i.e., including all levels of administration) net public debt that represents 50% of Brazilian GDP. Since the last big financial crisis in the last quarter of 1998, the Brazilian current account deficit (a deficit in the trade in goods and services that must be financed) has remained at a level of 4% to 5%, which is a difficult level to manage.

After the financial crisis in 1998, which led to a severe devaluation of the real1, the Brazilian economy experienced a new period of accommodation, which represented a certain recovery in production and income, and a slow decline in unemployment rates from the last quarter of 1999 till the beginning of 2001, although structural economic-strategic vulnerabilities, such as the current account deficit and the public debt, persisted.

Any accurate analysis of the Brazilian macroeconomic situation at that time could have indicated the fragility of the economic recovery, and many observers were skeptical about the future possibilities of the country's sustained economic growth. However, a conjunction of the considerable influence of Brazilian economic authorities in the media and the optimistic hope characteristic of Brazilians that things could get better - obviously associated with effective economic indicators showing signs of economic recovery - sustained an enthusiastic vision of the future. This view of the economic situation was so strong that when the signs of turbulence emerged recently, the new situation was blamed on the critical situation of the Argentine economy and the slowdown of US economic growth, which were, however, only part of the explanation for the new scenario unfolding within the Brazilian economy.

The persistence of old problems

Since the beginning of the Plano Real (the Real Plan)2, the authorities responsible for the management of the Plan have faced the challenge of dealing with growing current account deficits that must be financed through recourse to capital inflows, ranging from foreign direct investments to 'hot money'.

In order to attract the inflows required to make the model work, high remuneration and good profits were offered to international capital. These inducements have variously included very high interest rates, a quick appreciation of stock exchange performance, the opportunity of channelling financial flows towards worthy assets offered at attractive prices (in the many sectors of the Brazilian economy that were privatised over the last six years or under the denationalisation of other sectors controlled in the past by Brazilian national capital) - or, most of the time, a combination of these elements and other resources.

As the dependence of the Brazilian economy on these capital inflows grew, so did the fragility of the model. Since 1997, the Brazilian current account deficit passed 4% of GDP, and the international financial turmoil which erupted that year rendered management of this deficit increasingly difficult. This dangerous route pushed the national economy to a crisis situation in 1998 and - given that the Brazilian authorities were not prepared to change the model established in 1994 - to a new set of agreements with the International Monetary Fund (IMF) and other multilateral financial agencies, such as the World Bank and the Inter-American Development Bank, at the end of 1998.

As part of the same movement, the necessity of sterilising in the national money market the inflows of international capital, and the rise in interest rates, led to a huge public debt, which has grown about nine-fold since the beginning of the Plan (from R$62 billion at the end of 1994 to R$554 billion in April 2001), and which now includes around 25% in public bonds indexed to the exchange rate.

Although the causes of the public debt were grounded in financial maladjustments, the Brazilian economic authorities systematically resorted to national budget cuts in order to deal with the problem. As a result, cuts in social programmes, the freezing of public employees' payments and a dramatic decrease in infrastructural investments3 have become common in recent years. While this kind of measures scarcely helped to deal with the public-debt problem, which continued to grow, they have contributed to declining living standards in recent years.

This situation also signals risks in the national financial market to those interested in the opportunities still offered by the Brazilian economy.

In this context, the slowdown of the US economy in the recent period or the recent Argentine4 crisis are important, but may not be the main, elements. Perhaps it is time to face up to the growing fragility of the Brazilian economy.

Obstacles in the future

If the current scenario cannot be viewed as cause for optimism, the future throws up potential new obstacles to the management of the Brazilian economy, especially if the insistence on remaining on the path defined in 1994 continues.

At least three different problems could be listed as important obstacles to be addressed in the near future.

The first is the compromise leading to the scheduled establishment of the Free Trade Area of the Americas in 2005. The path that leads directly to the FTAA is a problem not only because it represents more use of the same medicine which is weakening the patient - more trade and financial liberalisation - but also because through the FTAA, Brazil will be more closely linked to the United States economy, which represents an enhanced danger to the country. Contrary to the tendency of a great many countries with a complex economy like Brazil's, Brazil has a commercial deficit in its relations with the US. And unlike in many other Latin American countries, US enterprises are not the main investors in Brazil - if we take the European countries together, their enterprises have invested more in Brazil than enterprises from the US, but it is those last which will be privileged by the integration process of the FTAA. Finally, many of those who were in Quebec, Canada, last April in conjunction with the Summit of the Americas argued that the 'spirit' of the Multilateral Agreement on Investment - protections for investments against any change in the institutional sphere, posing difficulties for states to regulate the operation of the economic system and private foreign capital - seems to inform the draft FTAA agreements, through the intention of deepening the terms of Chapter 11 of the North American Free Trade Agreement (NAFTA, which involves Canada, the US and Mexico)5. Even the current Brazilian government, which cannot be accused of any vacillation in supporting the liberalisation process and the subordinated integration of the Brazilian economy in the world market, is here and there expressing doubts about the FTAA process and its schedules.

In addition, the lack of investments in infrastructure is not only weakening the country's possibilities of a competitive integration into the world market, but also putting the brake on investments of firms operating inside the country (be they national or transnational enterprises) and deterring new flows of international capital - the last point being a problem where the maintenance of the path taken by official economic decisions since 1994 is concerned. Whether or not the path is maintained, problems in infrastructure - a clear example of which at this moment is the difficulties in guaranteeing the supply of electricity all over the country and the increasing risk of blackout in a great part of the country - will constitute a problem at the end of the current government's term and for the future government. They also highlight a problem pointed out by many who criticised the privatisation process in Brazil, questioning the priority attached to offering profitable opportunities to international financial investors rather than to considering the capacity of the sectors being privatised to operate well and guarantee the basis of a future model of growth.

Finally, there is the important question of how to deal with enhanced external liabilities, especially the remittance of profits and the servicing of external debt. The combination of financial liberalisation and incentives to foreign direct investments on the one hand, and the inability to generate hard currency through trade on the other, leads to an increasing dependence on net financial flows, which cannot be a priori guaranteed, particularly in an environment of financial instability. One possibility of addressing this is to generate a huge trade surplus, which demands an enormous increase in exports (if it is indeed possible in the international market as it operates currently), a sustained decrease in imports (new process of import substitution) or a combination of both. Another possibility is to change the current model, imposing controls on financial flows and according priority to operations with a favourable effect on bringing in foreign exchange. And, as suggested by some financial institutions, especially to some of Brazil's neighbouring countries, you can surrender your sovereignty on money by adopting a hard currency directly and solving the contradiction - this will result in a lower capacity to manage your own economy, but this kind of solution is normally advocated by those who are no longer restricted to thinking in terms of national economies.

As time goes by

As the end of the year draws nearer, Brazilians face an important time for decision. As time goes by, the contradictions become more acute, and answers must be found. That presidential elections will take place next year is a key element of catalysis of this process.

But the critical situation of Argentina and the slowdown of the US economy, side by side with international financial instability, the dilemmas of the Mercosur (Southern Cone Common Market) process and the evolution of the FTAA schedule, are also important elements inside this melting pot. So are the problems of infrastructure that have to be solved lest they paralyse the country; and in order for them to be solved, investments and definitions concerning the regulatory scenario of operation are required.

Other issues that must be considered are general questions related to the model of growth, the relation between the Brazilian economy and the world economy, financial liberalisation and trade liberalisation, and how to have a sustainable growth path that generates income and jobs.

Perhaps the most important question of all is: how is Brazil to deal with the dramatic social crisis that appears to be dividing the country and be both cause and effect of each of the country's problems?

As has repeatedly been the case in the last 20 years, the Brazilian people will have, next year, a new possibility of decision, to choose the right path to solve the main problems confronting the country, to try to solve their country's contradictions, and to plan their lives. This process can create more turbulence for the irritable financial capitals and instability. But the prevalence of the current model itself is generating instability and enhanced problems.

And the opportunity to decide is becoming clear to Brazilians - is there time to find a sustainable path?  


1.         The real lost, in the period from the end of 1998 to February 1999, about 40% of its value when compared to the US dollar. 

2.         Plano Real, which name is derived from the new Brazilian currency, the real, created in July 1994, is a Brazilian stabilisation plan launched in 1993-1994 which consists of a combination of trade and financial liberalisation. Under an overvalued exchange rate, 'cheap imports' are made use of to force a quick movement backwards of prices. At the same time, capital inflows are used as a resource to deal with the current account deficit provoked by the combined measures.

3.         As a consequence of the agreements with the IMF and others, Brazilian authorities treat public investments and public expenditures as the same thing. As many of the infrastructural investments in Brazil are carried out by public enterprises, cuts affecting those investments, due to the agreements with the international financial institutions, not only led to the current malfunctioning of many infrastructural sectors such as energy (at this moment, Brazil's energy system is unstable, and the country is facing a real risk of blackout in three of its five regions, including the Southeast Region, the main Brazilian region, where Rio de Janeiro and Sao Paulo, the country's two biggest cities, are located) and transportation, but also pose a risk for future development.

4.         Argentina is the main trade partner of Brazil, and Mercosur - the Southern Cone Common Market, an attempt to establish a kind of customs union among Argentina, Brazil, Uruguay and Paraguay - further tightened financial and diplomatic relations between the two countries. A good attempt to explain Argentina's difficulties - persistent current account deficit, difficulties in dealing with the external and internal debts, high unemployment rates and economic stagnation - may result in a kind of structural explanation quite similar to the description of the Brazilian situation, except for the facts that the more recent stabilisation plan in Argentina was launched in the beginning of the 1990s, the privatisation process in Argentina went far away compared to the Brazilian process, the Argentine stabilisation plan includes a permanent relation between the local currency, the peso, and the US dollar (1 peso = US$1), and the Argentine economy has been facing a lack of dynamic possibilities of sustainable growth for a longer period.

5.         Lopes, J. R., 'O capital est nu', Jornal da Cidadania, n. 101, May 2001, p.5, published by IBASE, Rio de Janeiro, Brazil.

Adhemar Mineiro is an economist and President of AEALC (Associacao de Economistas da America Latina e Caribe - the Latin American and Caribbean Association of Economists).