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Brazil, a Giant with Too Much Fat and Too Little Muscle

The Economist's coversBrazil, the largest economy in Latin America, is in dire need of structural reforms and reduced government bloat to fuel sustainable growth, according to analysts. And this will not happen overnight and will take massive political will. A giant but it carries “a lot of fat and not much in the way of muscle”.

“Brazil’s problem is that it carries a heavy load: the State,” said economist Pedro Tuesta of the 4Cast consulting firm in Washington. “There needs to be a radical change in the role of the State. Prioritize the country’s infrastructure more than control the private sector,” he argued.

In 2010, the economy posted 7.5% GDP growth after contracting 0.2% in the wake of the 2008 sub prime crisis. In late 2009, influential British weekly The Economist, projecting a Brazilian economic rebound, posted a picture of Rio’s iconic Christ the Redeemer statue on its cover, taking off like a rocket.

But two years later, the country grew a paltry 2.7% and an anemic 0.9% last year. This year the economy is projected to expand by only 2.5%.

The world’s top producer of coffee, sugar and orange juice and one of the biggest producers of meat, soybeans and iron ore, Brazil has benefited from high commodity prices on world markets.

“This price increase was artificial, fueled by zero interest rates in the United States and the huge demand from China,” said economist Enrique Alvarez of New York-based IdeaGlobal.

Brazil, now the world’s seventh largest economy, also boosted domestic demand. Its middle class expanded and improved its purchasing power amid a continuing low jobless rate. With the domestic currency, the real, appreciating against the dollar, Brazilians increasingly traveled and shopped abroad, a trend that is continuing although now the real is depreciating.

Yet now the commodity price boom is over. And stimulus packages could be phased out at any time in major economies.

Faced with chronically inadequate domestic infrastructure, Brazil is now trying to stimulate private investment to finance ports, highways and multi-million-dollar oil projects by state-run energy giant Petrobras to tap the country’s huge deep-water oil reserves.

“We see positive initiatives, infrastructure concessions (…). But for the country to grow 2.5%, we need structural reforms. We need to reduce the tax burden, have more competitive (interest) rates, huge investment in infrastructure,” André Gerdau, president of the steel group Gerdau, told the economic daily Valor.

The government recently held two auctions for highway construction, but one did not attract any bidders. In a recent meeting with entrepreneurs in New York, Rousseff vowed to respect the rules of the game for investors.

But analysts believe that the so-called “Brazil Cost,”the excessive operational costs associated with doing business in this country, is a barrier to increased growth through private sector investment.

For Alvarez, the issue is still how to restructure state machinery and in turn stimulate business creation and job creation.

The World Cup, which Brazil will host next year, can provide a welcome boost, with market analysts expecting a 2.2% expansion of GDP as a result. But in the short term, the country will still reel from problems associated with the global economic instability.

“Brazil is a giant in terms of natural resources. And being a giant, it can move powerfully at times. But it carries a lot of fat and not much in the way of muscle,” Alvarez said.

Down to Stable

Brazil’s currency real declined from its highest level in two weeks after Moody’s Investors Service cited rising debt and weak growth in lowering its outlook on the country’s credit rating to stable from positive.

Brazil’s government debt will probably stay at about 60% of GDP, higher than the 45% median for its peers, Moody’s said in reducing the outlook on the nation’s Baa2 rating, the second-lowest investment grade. The central bank trimmed its 2013 economic growth outlook to 2.5% from 2.7% this week.

The economy expanded less than forecast by analysts in five of the past six quarters. Industrial output unexpectedly stalled in August as factories reduced output of consumer goods. Annual inflation has twice broken the 6.5% upper limit of the central bank’s target range this year.

Moody’s also cited the recurrent lending by the Treasury to Brazil’s public banks as well as the “deterioration in reporting quality of the government accounts” for its decision. The credit rating is the same level as Peru, Italy and Kazakhstan, and one step below that of South Africa, Mexico, Thailand and Russia.

“Even though there are signs that the Brazilian economy may be starting to recover, Moody’s view is that, if and when the upturn materializes, it is unlikely that it will be strong enough to restore a positive trend in Brazil credit metrics,” Moody’s said in a statement.

In June, Standard & Poor’s reduced its outlook on Brazil’s rating from stable to negative, citing sluggish growth and expansionary fiscal policy. S&P rates Brazil BBB, the second-lowest investment grade.

Brazil’s efforts to lure private investment for infrastructure projects and a pledge to reduce lending by state banks help support a stable outlook on the rating, said Mauro Leos, a sovereign analyst at Moody’s.

“The first step is to restore growth to the trend of above 3%”, Leos said. “We’re not sure how successful it is going to be” in attracting foreign investors to infrastructure.

The Real has rallied 11% since August 22, when the central bank announced a 60 billion dollars program to bolster the currency and curb inflation. But Brazil has also raised the target lending rate by 1.75 percentage points to 9% from a record low 7.25% in April. The central bank is next scheduled to meet October 8 and 9.

Policy makers will work to bring inflation as close to target as possible next year, central bank President Alexandre Tombini anticipated in an interview in London.

Mercopress

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