International Finance

Brazil takes a $27 billion hit

That’s the cost of the Petrobras scandal to the world’s seventh largest economy Kamilia Lahrichi April 8, 2015: The Petrobras oil scandal, which sparked massive protests across Brazil against the government’s corruption and the economic slowdown, has cost $27.1 billion to the GDP of the world’s seventh largest economy, according to an April 2015 study released by Fundação Getúlio Vargas, a higher education institution in...

That’s the cost of the Petrobras scandal to the world’s seventh largest economy

Kamilia Lahrichi

April 8, 2015: The Petrobras oil scandal, which sparked massive protests across Brazil against the government’s corruption and the economic slowdown, has cost $27.1 billion to the GDP of the world’s seventh largest economy, according to an April 2015 study released by Fundação Getúlio Vargas, a higher education institution in Brasília.

The organisation’s Environmental Solutions and Infrastructure Group found that Brazil lost over than 1% of its GDP — estimated at $2.2 trillion — as a consequence of this colossal corruption scandal.

Former employees of Petrobras, the national oil company, shed light on a kickback stratagem to inflate the value of projects and channel bribes from contractors into the pockets of political figures and to President Dilma Rousseff’s 2010 election campaign.

Mysterious payments amounted to $3.7 billion, according to the Brazilian police. The Supreme Court approved in March 2015 a probe into top political figures — mostly from the ruling Workers’ Party coalition — who are allegedly involved in the scheme.

Billions lost

Although Petrobras has not yet gauged the financial impact of the bribes, it is today the most indebted publicly traded oil company on the planet. It faces threats of default with $52 billion of bonds outstanding.

The state-run company has until the end of May 2015 to release its financial statements from last year’s third quarter.

The sweeping Petrobras scandal is dragging the country’s economy down, especially the construction, oil and gas industries, engineering and consumer spending.

Construction, in particular, is a key sector in a continent-size country lacking adequate infrastructure.

The Fundação Getúlio Vargas report assesses economic loss based on the company’s plans to reduce investments this year.

For example, the international ratings agency Fitch downgraded its ratings for the Brazilian construction companies Construtora Queiroz Galvão, Mendes Júnior Trading Galvão Participações, Engenharia and Galvão Engenharia. They are allegedly involved in the Petrobras bribery scheme.

Construtora OAS, one of the largest construction companies in Brazil, and Galvao, filed for bankruptcy.

Ultimately, construction workers are paying the price, according to the study’s estimates.

Petrobras “had to expand outside its core business – from infrastructure to shipbuilding, to chemical markets. As the nasty connections are now revealed and Petrobras moves away from these projects, several sectors and regions will experience losses,” says Glauco Oliveira, economist and policy analyst at Brazil’s Administrative Council for Economic Defense, a governmental agency that investigates economic power abuse, in Brasilia.

For instance, he refers to “dire prospects” for the shipbuilding industry with the fall of Petrobras’s demand. “Several municipalities, especially those that rely on royalties, are already experiencing difficulties,” explains Mr. Oliveira.

Notwithstanding Brazil’s enduring fight against impunity, the Petrobras saga is one of the biggest corruption scandals in the nation’s history.

“Corruption has been impacting the Brazilian economy deeply at all levels of the (local and regional) government,” says Guillermo Alborta, economist at the Inter-American Development Bank in Washington D.C.

“Taking into account that Petrobras represents about half of total investment for the economy, a large share of the BOPESVA index and [is] a large (almost unique) energy player for the Brazilian economy,” he explains.

Besides the urgent need to restore confidence among investors and the public, “lowered petroleum investments and challenging managerial reforms will cost them dear economic growth points,” said Alborta.

On the edge

Confidence is indeed lost. On March 15, 2015, almost a million Brazilians took to the streets across the country to voice their ire at rampant corruption, the inert economy and rising prices in Latin America’s largest economy. They also called for the impeachment of the left-wing president.

In reaction, the government vowed to tackle economic hardships and corruption. Yet, a wide majority of Brazilians disapprove of the narrowly re-elected president – as GDP contracted by 1.01% at the beginning of this year, according to a weekly central bank survey of 100 economists released in April 2015.

Demonstrations broke because the Brazilian economy has fared poorly and hurt the middle-class – although Brazil’s economy is doing better than its neighbour’s, namely Argentina.

Inflation has reached a 10-year high, according to Bloomberg, and 7.7% based on data from the national statistics agency, the Brazilian Institute of Geography and Statistics (IBGE), in February 2015. In both cases, it is the highest rate in a decade.

As oil and gas prices rose sharply and consumer confidence collapsed, Brazil’s Central Bank tried to rein in inflation by raising benchmark interest rate – the SELIC rate.

Meanwhile, the real dropped to a 10-year low. In February 2015, the local currency fell to the weakest level since September 2004 – 1.3% to 2.9 per US dollar.

In addition, IBGE estimated that the unemployment rate in January 2015 reached the highest level in a decade – 5.3%.

“The economic policies of the last years were incorrect and misconceived, provoking several distortions,” says Mr. Oliveira. “The excess of fiscal stimulus, such as tax breaks and subsidies for selected sectors, coupled with protectionist measures and populist energy price caps, misaligned relative prices and distorted economic signals, which are now being corrected.”

President Rousseff’s administration intervened heavily in the economy to expand infrastructure and social programs to end extreme poverty in a highly discriminatory society. Brazil’s budget deficit almost tripled during her first term.

The government introduced capital controls and developed loose monetary policies to keep prices low, which put Brazil at risk of an investment credit rating downgrade.

The country recently focused on exporting raw materials, thereby exposing the economy to market volatility. Last year, raw products amounted to half of all exports, according to 2014 data from the Brazilian Trade Balance.

In fact, its average growth exceeded 4% during the decade before President Rousseff took office in 2011.

Yet, the protectionist measures and widespread corruption of the Workers’ Party are not the only factors to blame: the vagaries of the commodities market sapped the vitality of the economy too.

On the other hand, the devaluation of the real has boosted the competitiveness of industrial goods, in particular. For instance, it benefitted non-commodity exporters, such as meat producers and exporters.

“To Petrobras, the devaluation might be good, since the company exports part of its production,” says Mr. Oliveira.

Endorsing austerity?

In the end, “Petrobras was chosen by the Workers’ Party’s governments to be the spearhead of a development model based on state intervention and investments, and commodities windfall. The demise of Petrobras might be the beginning of the end of that model,” says Mr. Oliveira.

In January 2015, President Rousseff appointed Joaquim Levy, a former banker in favour of orthodox economic policies, as Finance Minister to promote pro-market measures and get public spending under control.

He recently said that economic growth has worsened at the beginning of 2015 and stressed the need for austerity. He is trying to convince senators to implement radical fiscal adjustment measures, namely cuts in labour and pension benefits and to stop subsidising utility rates.

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