Robust growth despite skepticism on the financial markets

The Brazilian economy is once again performing significantly better than expected. Nevertheless, financial investors remain cautious in the face of rising government spending.

by Alexander Busch, Latin America correspondent for Handelsblatt and Neue Zürcher Zeitung

The Brazilian economy surprises with its dynamism for the third time in a row

Growth forecasts for 2024 have been raised significantly following a strong second quarter. Latin America’s largest economy will grow by around three percent this year. This is in line with the trend of recent years: gross domestic product has been rising by around three percent annually since 2021.

This is primarily due to domestic consumption, but for the first time, investments are also on the rise again: Government and private demand increased by almost five percent by the middle of the year – and thus more strongly than the economy as a whole. Rising imports, which were almost 15% higher in the second quarter than in the previous year, closed the gap between supply and demand on the domestic market.

Unemployment stands at just under seven percent. This is almost full employment by Brazilian standards. It is the lowest unemployment rate in ten years. Capacity utilization in industry is also higher than it has been for a decade.

In the meantime, inflationary pressure has increased due to higher growth and the largely empty labor market. The weak real is also contributing to rising inflation. The inflation rate for the last twelve months is 4.5 percent. As the economy is thus moving away from the central bank’s inflation target (3 percent), the monetary authorities are likely to raise interest rates this year or leave them at the current high level. The Selic prime rate currently stands at 10.5 percent.

Brazil’s foreign trade balance is also solid: a clear export surplus was achieved until August, although imports grew more strongly than exports for the first time again. The foreign exchange balance is well filled at USD 370 billion.

According to a report by the Organization for Economic Cooperation and Development (OECD), Brazil is the second most important destination for foreign direct investment worldwide. Last year, 64 billion US dollars flowed into the country. Only in the USA did foreign companies invest significantly more. The Brazilian central bank expects a similarly high inflow of foreign investment this year. This means that Brazil’s economy is stable by global standards.

Financial investors are currently skeptical about Brazil

This year, more capital has been withdrawn from the stock and bond markets than at any time in the last 40 years. This year, the Brazilian share index has not only brought up the rear in Latin America alongside Mexico – in a global comparison, hardly any other stock market has performed as badly as the one in São Paulo. The dollar has appreciated by around 15 percent against the real this year. Investors are demanding higher interest rates (spreads) for Brazilian bonds because the risk is increasing from the perspective of the financial markets.

There is one main reason for the discrepancy between the positive economic reality and investor restraint: investors and many entrepreneurs are concerned about the government’s lack of budgetary discipline, which automatically leads to high interest rates. In addition, the planning horizon for entrepreneurial decisions is shortening, as it is unclear whether the government will react to possible declining growth figures with an expansive spending program towards the end of the legislative period.

Government spending has already increased significantly. The government’s primary deficit (i.e. excluding interest payments) is currently around 2.5% of gross domestic product (GDP). The primary budget is the decisive indicator of whether a state will increase or reduce its debt in the medium term.

Under the Lula government, the debt ratio rose from around 70 percent to the current 76 percent of GDP. The independent Fiscal Institute (IFI) estimates that Brazil’s debt will rise to over 100 percent by 2034. This is not worrying for an industrialized country, but too much for an emerging country like Brazil. This is because the state has to repay more and more debt without being able to invest in infrastructure, healthcare or education.

But there are other reasons why financial investors and entrepreneurs are skeptical about the economy’s development potential. They are bothered by the government‘s state-dominated economic policy. They fear that Brazil will remain stuck in unambitious mediocrity and fall further behind along the way. In fact, the economy’s productivity is hardly increasing at all. The average labor productivity of Brazilians is stagnating at the level of the 1980s.

It is unclear where the necessary productivity growth in Brazil will come from – apart from modern agriculture and mining. This is because Brazil’s population growth is declining. Brazil will no longer benefit from the demographic bonus – if the economically active population grows faster than the number of inactive people (pensioners and children).

At 16% of gross domestic product, the investment ratio is also very low. Brazilian companies do not play a significant role internationally in the growth areas that are currently important worldwide, such as artificial intelligence, data science, semiconductor technology or IT.

Contrary to expectations, Brazil has so far benefited little from the nearshoring taking place worldwide. Until recently, the economy was confident that Brazil would benefit from the global shift of economic value chains away from China and towards Western countries. However, unlike in Mexico, for example, hardly any new industries have set up in Brazil to benefit from access to the US market.

Only Chinese car manufacturers and suppliers have launched an investment offensive. Several companies are currently building factories and are focusing on the local market and Brazil as a location for exports to South America. This applies in particular to electric cars. European car manufacturers in particular will come under pressure in one of their traditionally important markets as a result.

Nevertheless, Brazil has important strategic advantages in international comparison

Brazil will continue to expand its position as a global supplier of food in the future. Brazil is one of the world’s leading suppliers of soy, meat, sugar, corn and coffee. Suppliers for the agricultural and food industry have a large market there.

Brazil also has great potential when it comes to industrial raw materials: in addition to iron ore, the country supplies many important mining products, from niobium to lithium. And as an oil producer, Brazil’s importance in the world will increase. Today, Brazil is the eighth largest oil-producing country in the world. Further deposits off the coast are to be developed.

At the same time, Brazil already obtains a significant proportion of its electricity from sustainable sources. This makes the country an attractive location for industries that want to produce with green energy.

Another locational advantage is the geopolitically neutral positioning of the country by the Lula government: the country maintains equidistance from the geopolitical power poles of China and the USA. It trades and negotiates with both world powers.

The distance to Europe has also grown

The country’s new neutrality is criticized above all in Europe. But Europe has also lost importance for Brazil. Trade is shrinking. European companies are reluctant to invest in Brazil. In public perception in Brazil, Europe is moving further and further away from Latin America and is also fully occupied with a multitude of its own unresolved problems.

The recently resumed EU-Mercosur negotiations on a common economic zone could therefore bring a new dynamic to relations between Europe and South America. They could do with such a boost.