Brazil’s economic prospects darkened further after more than a million angry citizens took to the streets on Sunday to call for the impeachment of President Dilma Rousseff. The protests increase the likelihood of policy inaction and add to the headwinds — low growth, high inflation, currency meltdown and corruption scandals — Brazil faces.
After almost following Argentina into default in 2002, Brazil made a spectacular recovery under newly elected President Luiz Inácio Lula da Silva. Growth accelerated, foreign reserves strengthened and investment flooded in. As its currency, the real, appreciated, the challenge of surging capital inflows replaced worries about capital flight. Most important, poverty declined as job opportunities opened up, along with an intense government focus on health care and education.
Brazil’s economy had so much momentum that it was among the first to recover from the 2008 global financial crisis. The quick turnaround was a striking contrast to previous episodes of global instability, which derailed Brazil’s economy for a long time. But this proved to be the last bit of good news for a while.
Rather than build on Lula’s progress, Rousseff, an economist by training, lost her nerve and reverted to old habits of statism. For example, she significantly expanded the role and scope of the national development bank, an institution never known for its effectiveness. She delayed cleaning up anti-growth influences in the tax system. And she failed to focus on sectoral reforms, including pensions and labor markets. As a result, growth sputtered.
Brazil is now in a vulnerable position. Its domestic challenges are compounded by two negative influences from abroad that are beyond its control. First, commodity prices have fallen, robbing the country of export receipts and of foreign and domestic investment. Second, much of the foreign capital that had flooded into the country reversed course, sucking oxygen out of the economy in a similarly sudden and disorderly manner.
With the government responding rather timidly to the self- reinforcing pressures of slower growth, higher inflation and a weaker currency, the central bank had no choice but to raise interest rates. It was only a matter of time before the country’s underlying weakness became visible to all, starting with widespread corruption at Petrobras, Brazil’s flagship oil- and-gas company.
The urgent task now is to reverse the self-reinforcing economic, financial and political dynamics that are eroding important gains achieved since 2002.
The good news is that the government has at its disposal the policies and experienced technocrats to put them into force. What it lacks is the political determination to press ahead.
Sunday’s protests should serve as the catalyst for Rousseff’s government to press forward with reforms that will unlock the country’s huge but underdeveloped potential. If the protests instead serve to make the government politically more timid and economically more hesitant, as I fear, Brazil could end up in a downward, stagflationary spiral whose consequences would be felt throughout the emerging world.
Mohamed El-Erian is chief economic adviser at Allianz, chairman of President Obama’s Global Development Council and the former chief executive officer and co-chief investment officer of Pimco.