By Martin Kaufman and Mercedes García-Escribano,
14th April 2014
Since the early 2000s, Brazil’s economy has grown at a robust clip, with growth in 2010 reaching 7.5 percent—its strongest in a quarter of a century. A key pillar of its hard-won economic success has been sound economic policies and the adoption of far-reaching social programs, which resulted in a substantial decline in poverty.
In the last couple of years Brazil’s growth slowed down. Although other emerging market economies experienced a similar slowdown, the growth outturns in Brazil were particularly disappointing. And the measures taken to stimulate the economy did not produce a sustained recovery. This is because unleashing sustained growth in Brazil requires measures geared not at stimulating domestic demand but at changing the composition of demand towards investment and at increasing productivity.
Home-grown woes
Inadequate infrastructure and imbalances in demand are hampering Brazil’s growth process. During 2011-13 private consumption in Brazil has been strongly supported by very low unemployment, broad gains in real wages (partly owing to large increases in minimum wages), and buoyant credit expansion.
But investment has been disappointingly weak. Global uncertainties played a role, especially in 2011, but the main factors behind the sluggish investment have been home-grown, including the steady loss of competitiveness. Restarting growth To address this situation, the recent report on Brazil’s economy prepared by IMF staff recommends solidifying Brazil’s macroeconomic policy framework and adopting measures and reforms geared at increasing the economy’s productive potential and improving competitiveness.
The tightening of monetary conditions initiated by Brazil’s central bank in April is a step in the right direction that has helped lower inflation expectations and contain inertia. Sustained fiscal consolidation, through adherence to a fiscal primary surplus of about 3 percent of GDP, would also be important as it would keep domestic demand in check, lower public indebtedness, and bolster a recovery in confidence and investment.
The government’s renewed focus on policies to alleviate constraints on the economy’s productive capacity, in particular infrastructure concessions to the private sector, is also welcome. The near-term outlook Staff projects that Brazil will grow by about 2½ percent this year and next. Although higher than the growth rate of 2012, this performance will keep Brazil below its potential growth. Moreover, the outlook is subject to many risks.
The recovery could prove more unbalanced—that is, excessively dependent on consumption—and sluggish than envisaged. The factors underlying weak investment and supply constraints may be more severe than anticipated. Or investor confidence may not be restored. If those risks materialize, the response should not be further demand stimulus. This response would exacerbate domestic demand imbalances, widen the external current account deficit, reignite inflationary pressures and weaken confidence.
There are also external risks to the outlook stemming from Brazil’s reliance on foreign savings, and its highly integrated financial markets. However, the flexible exchange rate, strong monetary policy framework and large holdings of international reserves would provide protection against those risks.
Reaching full potential Brazil can do better. To get the Brazilian economy close to potential growth—currently estimated at about 3½ percent—the government should focus on enhancing productivity and stepping up investment, including in infrastructure. As noted, the government’s renewed focus on policies to alleviate constraints on the economy’s productive capacity is welcome.
These efforts should be complemented with an overhaul of the minimum wage indexation mechanism and reforms to keep labor costs in check and prevent further erosion in competitiveness. Lowering and simplifying taxes and improving business conditions to lower what has become known as the custo Brasil should also be part of the agenda.