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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Kamilia Lahrichi

October 27, 2014: Left-leaning president Dilma Rousseff won the election in recession-hit Brazil on October 26 after one of the most dramatic electoral campaigns.

The country’ first female president turfed out the centrist contender Aécio Neves with about 52% of the vote against 48% for her rival during the second round of voting.

Nearly 100 million people casted their vote in this close race. About 3.5 million assistants oversaw the elections in the world’s second biggest emerging market after China.

The presidential campaign revolved around tacking sluggish growth and high inflation. With a US$2.246 trillion gross domestic product (GDP) in 2013, the world’s seventh largest economy grew by only 2.5% last year.

In late August, Brazil slid into recession for the first time since the financial crisis. Its GDP decreased by 0.2% in the first quarter and by 0.6% in the second one. The rating agency Standard & Poor’s thus lowered the country’s credit rating in March 2014.

Former Economy Minister Guido Mantega claimed that weak global recovery from the economic downturn as well as a surplus of public holidays during the 2014 World Cup led to the recession.

Notwithstanding that exports to China suffered a setback, other factors, namely poor macro-economic policies, are to blame too. Indeed, Brazil’s growth has mainly relied on domestic demand.

In addition, consumer prices keep rising quickly in Latin America’s largest economy. Official figures set the number at 6.5% in August 2014, despite the government’s target of below 4.5%.

A bitter contest

Just like a Brazilian telenovela (television drama), multiple twists added turmoil to this mercurial election.

First, Eduardo Campos, a presidential candidate, died in a plane accident about two months before the election.

Marina Silva, his running mate and a popular environmentalist, replaced him three weeks before the poll. Although she was supposed to be Brazil’s next president according to most surveys, she came third – with 22 million votes – and endorsed her rival Mr. Neves.

Finally, an ex-executive of the national oil company Petrobras shed light on a nationwide bribery scheme one week before the election. It involved President Rousseff’s top political allies and a key figure in Mr. Neves’ Social Democratic Party.

Ms. Rousseff acknowledged for the first time wrongdoings in the company.

Brazil is not foreign to corruption scandals. In 2012, in what was coined “the trial of the century,” about 40 prominent legislators, businessmen and high-level policy-makers, including senior members of President Rousseff’s Workers Party (PT), faced prosecution over alleged vote buying.

A legacy of state interventionism

President Rousseff vowed to carry on with her social programs to boost economic growth whereas Mr. Neves, the business-friendly contender, had pledged to focus on trade and fiscal austerity.

Supporters of the newly re-elected president came from the north of the country where most Brazilians receive the government’s financial aid. They were instrumental to her victory.

In contrast, Mr. Neves’ backers belong to the upper strata, especially around Sao Paulo.

Regardless of the popular discontent with President Rousseff’s handling of the World Cup, she “was never out of the game,” explained Glauco Oliveira, an economist in the capital Brasilia and a civil servant with a government’s agency.

“Her approval rates never felt too much even at the peak of the [2013 anti-government] manifestations, though her governmental policies were indeed blamed for bad timing and a lack of priorities,” he said.

President Rousseff’s popularity stems from her significant headway in expanding social welfare programs to the most disadvantaged.

She increased public investment in social services, such as Bolsa Familia (family scholarship in Portuguese) that help financially 14 million low-income households.

Official statistics estimate that 22 million Brazilians have been lifted out of poverty since President Rousseff took office in 2011. Besides, the income per person grew by 2.3% annually during the years her political party led the country.

The middle class significantly expanded to about 40 million in the past decade – a majority for the first time in this election.

The failure of free market

Mr. Neves’ proponents have pointed the finger at President Rousseff’s state interventionism and protectionism. For instance, the government has managed fuel subsidies and electricity through state-owned companies Petrobras and Eletrobras, the electric utilities company.

Equally emblematic of the government’s intrusion in the economy, public banks have grown since the administration of former president Lula, which sparked much debate between the presidential candidates.

The public banking system has boosted public investments and granted credit subsidies to the lower classes.

Yet, investors have been eager to end President Rousseff’s heavy-handed economic policies. “The truth is that this government failed,” said Mr. Neves, in reaction to the country entering in recession. “And it failed principally in its steering of Brazil’s economy.”

The centrist candidate claimed he would tackle the economic lethargy by bringing back the “tripod” of economic policies, namely substantial primary surplus, inflation targeting and floating exchange rate. Brazil relied on this program 20 years ago to give stability to investors.

“The most unpopular economic policies Rousseff [took that] it is worth stressing is the rejection of the macroeconomic tripod which were substituted by lenient fiscal policy, exchange rate controls and loosening of the inflation target,” explained Mr. Oliveira.

Instead, Mr. Neves wanted to make the central bank more independent of the executive power. He developed a reputation for fiscal austerity.

Yet, President Rousseff’s camp has accused Mr. Neves of siding with bankers and industrialists and cutting back social programs for lower classes.

“It is not true that economists that support Mr. Neves are socially insensible,” said Mr. Oliveira. “The candidate made clear that – if elected – he would not extinguish social programs, but he would reformulate and improve them.”

Challenges ahead

Despite the election’s results, boosting economic growth in recession-hit Brazil requires a change of policy.

“In the short run, the government should restore the confidence about its ability to keep the economy stabilised,” said Celso Toledo, Director at LCA, a consulting firm in Sao Paulo.

This involves breaking with the tradition of state interventionism.

“Non-orthodox macroeconomics, protectionism in trade, fiscal profligacy and interventionism in energy policies can be cited among the most unpopular policies from the perspective of investors,” said Mr. Oliveira.

For instance, the government’s regulation of the price of energy prevents from spurring investment in power grids and transmissions, he explained.

“In the long run, we need measures to boost productivity and to reduce the ‘Brazil Cost’,” said Mr. Toledo, in reference to the complex tax system, the rigidity of the labour market and the poor infrastructure.

In particular, fiscal measures to reduce the public debt are key. The next government needs to cut down public expenditure, which accounted for 37.2% of Brazil’s GDP – a high percentage in South America.

“We need more competition, a trustworthy government that does not use the public infrastructure as a means to defend the interests of a special political party,” said Mr. Toledo.

“Brazil was too complacent during the boom years provided by Chinese demand. Now the challenges are bigger,” he pointed out.

Mr. Oliveira forecasted that growth will be weak in 2014 and 2015 will be a year of adjustments – another economic challenge for President’s Rousseff new administration.

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Sao Paolo, July 9: Brazil’s dalliance with  fiscal instability continued in May, data released by the country’s central bank on July 1 shows, sinking hopes that the ongoing FIFA World Cup would lift it from the morass that has forced funds to flee Latin America’s largest economy.

Alongside, an independent survey report said business conditions in Brazil’s manufacturing sector in June deteriorated at the sharpest pace since July last year.

Banco Central do Brasil, or the Central Bank of Brazil, said state-owned enterprises totted up a primary budget deficit of 11.046 billion reals (or $5 billion), topping analysts’ prediction of a shortfall of 9.25 billion reals.

In simpler terms, this means that these public sector companies did not earn enough in May to cover their expenses, including interest payment obligations for the month. This is, of course, a theoretical calculation, as loans are squared off with the financial accounts of the year concerned in mind.

This was also the second biggest deficit after a shortfall of 20.951 billion reals notched in December 2008, soon after the collapse of Lehman Brothers that triggered a global meltdown, goading analysts to say President Dilma Rousseff would struggle to meet the budgetary targets of her government.

The government aims to save at least 99 billion reals in primary surplus, or 1.9 percent of the GDP.

“It will be very difficult for the government to meet the 1.9 percent of GDP fiscal target in 2014 unless it is able to count on significant extraordinary non-recurrent revenue,” said Goldman Sachs senior economist Alberto Ramos in a client note.

The report reflected a continuation of the situation in April, when the once-bustling economy went on a sloth mode with business activity showing only moderate upswing despite the imminent FIFA World Cup.

According to official data released in June, the IBC–Br index of economic activity – the Brazilian central bank’s gauge for country’s performance in the farming, industry and services sectors – crept up 0.12 percent in April, registering a sluggish start to the second quarter.

Meanwhile, a survey report of Brazil’s manufacturing sector by HSBC said sectoral output dipped at the quickest rate in over two-and-a-half years in June, “reflecting an ongoing weakness in domestic demand”.

“Business conditions in Brazil’s manufacturing sector deteriorated in June at about the same pace as in May,” said Andre Loes, HSBC’s chief economist in the largest Latin American region.

PERVADING GLOOM

Reuters quoted Tulio Maciel, Banco Central’s head of economic research, as saying it was too early to say whether the Dilma Rousseff government would be able to meet its target.

Between January and May, the government has been able to meet 32 percent of the primary surplus target of 99 billion reals for the whole of 2014, with April accounting for 16.896 billion reals, primarily due to concession bonuses and dividends of public sector enterprises

According to Maciel, May’s deficit was due to an increase in public investment and a drop in revenue, which he said would get a boost from dividends of public sector firms.

Despite Maciel’s optimism, Banco Central said on June 26 that it is paring down its growth forecast for the current year. It also said the ongoing inflationary pressures were likely to ebb after a temporary peak this year.

In its quarterly inflation report it released on the day, the central bank lowered its growth forecast from 2 percent in its previous estimate to 1.6 percent, which it said would improve slightly in the first quarter of 2015 to 1.8 percent.

Alongside, the bank upped inflation forecast from 6.1 percent to 6.4 percent.

Reuters quoted Pontifical Catholic University professor Waldemir Quadros saying he feared the government would once again resort to alternative accounting methods or obscure operations to meet the target.

The Sao Paolo-based academician was referring to the government’s move to make transfers from a sovereign fund to boost its accounts before the year-end in 2012. The Rousseff administration had given tax breaks to a slew of industries in an effort to stoke the economy, but has in the process caused public finances to deteriorate rapidly.

In May, Brazil’s net debt spiralled up to 34.6 percent of GDP, the highest since last October. In late June, the government gave its consent to the sale of offshore oil rights to state-run oil company Petrobras, which will fetch 2 billion reals this year alone. However, it is feared that the move will strain the company’s finances.

JUNE OUTPUT

Meanwhile, HSBC’s June data indicated that business conditions in the Brazilian manufacturing sector deteriorated at the sharpest pace since July 2013. Output dipped at the quickest rate in 33 months, “reflecting an ongoing weakness in domestic demand”.

Adjusted for seasonal factors, the HSBC Brazil Purchasing Managers’ Index, or PMI, fell from 48.8 in May to 48.7 in June. Though the fall was slight, the latest reading was the lowest since July 2013 and indicated a third successive monthly deterioration in operating conditions.

Moreover, the latest drop in production was the third in as many months. All three market groups recorded lower output, with the quickest contraction seen at intermediate goods producers. The reduction in output was linked to a third successive monthly decline in order book volumes.

Reflecting subdued demand conditions, the quantity of inputs purchased by Brazilian manufacturers decreased in June. Although slight, the contraction in quantity of purchases was the second this year so far.

Brazilian manufacturers indicated that staffing levels were reduced in June, stretching the current period of job shedding to three months. Nevertheless, the pace of contraction was slight and little-changed since May.

Anecdotal evidence highlighted cost-cutting policies. Despite accelerating since May, input cost inflation was muted in the context of historical data. Where purchase costs increased, this was attributed by survey participants to the dollar-real exchange rate resulting in higher prices paid for imported raw material.

Brazilian manufacturers reported the pass through of higher input costs to clients, with prices charged rising during June. The rate of charge inflation was, however, only modest. By sector, the fastest increase in tariffs was registered in the capital goods category.

“Firms reported that output fell at the fastest pace since September 2011,” said HSBC chief economist Loes. “But while there is a lot of evidence that the economy as a whole is slowing, it seems likely that this decline also reflects disruptions related to the World Cup.”

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