Economic recovery a major challenge in Brazil, analysts say

In 2007, when Brazil's biggest-ever petroleum discovery was confirmed in the so-called pre-salt layer, the moment Brazil was going through was unique. Boosted by agricultural commodity exports, the economy had grown 6.1% that year. Inflation dropped from 6.88% in 2005 to 3.6%, the lowest rate since 1998. Confidence was unwavering and investors agreed that Brazil was the most promising country in the BRICS bloc (Brazil, Russia, India, China and South Africa), with a stable democracy, a young population, and abundant natural resources.

Less than a decade since, the picture has changed. The leading Latin American economy plunged into the worst economic crisis of this century, exacerbated by a sharp plunge in commodity (raw material) prices, an unsustainable increase in government debt, impeachment proceedings that have brought Congress to a standstill, and a corruption scandal of unprecedented magnitude.

The scenario facing acting President Michel Temer is far from favorable. Brazil's gross domestic product (GDP) shrank 3.8% in 2015—the worst decline in 25 years. Another downturn is expected to hover around 3.8% in 2016. Inflation has more than doubled compared to 2007, bringing the key interest rate to over 14%. Unemployment has hit a two-digit mark: 10.2% of the workforce is jobless, accounting for 10.4 million Brazilians.

Amid a deepening recession, millions of Brazilians who joined the so-called “new middle class” in the more economically prosperous days are sliding back into poverty. A study by the São Paulo-based Tendências consultancy firm suggests that 3.1 million families (about 10 million people) will once again be among the underprivileged. The upward social mobility seen in seven years (2006-2012) could be obliterated in three (2015-2017), according to the study.

It will take a great deal of effort to regain investor confidence and put the economy back on track. Robert Abad, founder of California-based EM + BRACE consultancy for emerging markets, believes Brazil's new government will have to start from scratch and persuade the market that the proposed economic policy is sound, which can hardly be achieved overnight.

“It took years for Brazil to be given an investment-grade rating from credit rating agencies and for the market to believe a miracle was happening,” Abad said. With the crisis, Brazil was downgraded by the three leading international agencies (Standard and Poor's, Moody's and Fitch) and saw its credit worthiness reduced to junk, which scared foreign investors away.

The economic framework presented by vice-President Michel Temer in October was welcomed by the financial markets, but criticized by trade unionists. A document titled Ponte para o futuro (“A bridge to the future”), released by his PMDB party back then, advocated reforming the pension systems and labor laws, and changing the Constitution to make deeper cuts in government spending possible. It also proposes further opening Brazil's market to foreign capital. The goal is to create conditions for the country to achieve sustained annual growth rates of 3.5%-4% over the next decade, an ambitious challenge for an economy that is headed towards a 3.8% downturn this year.

Many analysts, however, prefer taking a more cautious approach. “There is going to be some willingness at first, something like a honeymoon. But, as seen by the people on the streets, Temer is no promise of change. We do not know if protests will cease anytime soon,” says Anthony Pereira, a political scientist and head of King's Brazil Institute in London.

A recent survey found that the acting president faces high rejection rates. Among those who disapprove of suspended President Dilma Rousseff, 54% of respondents said they also favored removing Temer. Among Rousseff's supporters, disapproval of Temer stands as high as 79%.

In Pereira's view, whatever happens to former president Luiz Inácio Lula da Silva is likely to influence the future of the country. “I'd like to believe that the left wing would calmly take up a role as opposition, but that is not the way things happen. We can expect more social unrest,” he said.

Lula, who may run for office in the 2018 presidential elections, is under investigation as part of the Petrobras scandal probe known as Operation Car Wash. So are at least 34 members of Congress across the political spectrum.

Along with Rousseff, Temer also faces charges with the Superior Electoral Court for alleged campaign noncompliance, which could lead to the pair's entire 2014 winning ticket being invalidated, and Temer losing his post as vice-president.

With so much pressure coming from different sides, analysts think the PMDB leader will not be able to complete significant reforms and revive the economy. “I see a slow recovery, as the foundations of growth crumble before our eyes. The pension system is unsustainable, public debt continues to mount, and the productive sector is stalled,” said Marcos Casarin from Oxford Economics.

Casarin argues that the main challenges to restoring fiscal balance is social security. The Brazilian population has barely begun to age—Brazilians' average age in 2015 was 31.1 years, compared to 47.5 in Germany, for example—and spending on pensions have already engulfed 44% of the government's total expenditures.

On average, Brazilians retire at age 55. In Germany, the minimum retirement age is 65 years old. “We need to raise the minimum retirement age in Brazil. Furthermore, pensions should not be indexed to the minimum wage, but to inflation,” Casarin said.

The Fiscal Monitor 2016 report, published by the International Monetary Fund (IMF) in April, predicts that Brazil will not be able to achieve a primary surplus before 2020. The IMF expects a primary deficit of 1.7% of GDP this year. This will be the third consecutive time the government should fail to save money to pay its creditors.

In the opinion of Carlos Primo Braga, former World Bank director and assistant professor at Fundação Dom Cabral, Brazil has many competitive advantages and will not plunge into depression. “I have no doubt that once we get rid of uncertainties, we will gradually start to pick up growth pace again. This won't be a lost decade,” he says.

Daniel Hamilton, a UK senior director at FTI Consulting, is more pessimistic. He believes Brazil will never be able to implement the reforms necessary for development unless it has fewer political parties. “There are nearly 40 parties in Brazil. At least nine of them were represented in the PT government, asking for political favors and concessions here and there,” he criticizes. Political reform has been the subject of much debate in Brazil for over 20 years.

After witnessing so many opportunities slip away over the years, Hamilton has little hope that Brazil will be able to tackle the problems that have always prevented the country from taking off. Asked about what lies ahead for Brazil, he mentioned an aphorism questionably attributed to French leader Charles de Gaulle: “Brazil is the country of the future, and always will be.”

Translated by Mayra Borges / Fabrício Ferreira