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Brazil -- unsustainable spending, still-high inflation [ClearOnMoney]
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Brazil -- unsustainable spending, still-high inflation

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Commentary

Brazil -- unsustainable spending, still-high inflation

25 Aug 2012 by Jim Fickett.

It is not just the developed countries that have a problem with living beyond their means. The top three problems in Brazil are

  • Lula, the previous president, maintained his popularity by greatly growing the government budget, in part by awarding unsustainable pay raises and pensions to public workers
  • The household sector discovered credit and roughly tripled its debt load in less than a decade
  • The country assumed the commodity export boom, which was in large part driven by an unsustainable investment boom in China, to be the new normal, rather than the bubble it was

The country has been trying to keep the good times rolling rather than adjust, so inflation has not been brought under control; though it is down in the last few months, the trend over the last few years seems to be a rising one.

Here are excerpts from a few recent overviews of Brazil that substantiate the main points above:

From Business Week in March:

Operating costs in Brazil are now higher than in many developed countries, says José Velloso, vice president of the association of machine builders. “If you were to take a factory by helicopter from Germany to Brazil, your costs would jump 48 percent as soon as you touched down,” says Velloso. “Those of us producing in Brazil are doomed not to be competitive,” he adds. Bank loans at double-digit rates are much more expensive than in Germany, and steel costs 30 percent more in Brazil, says Velloso. Because of wage inflation, a treasury director at a multinational company in Sao Paulo earns 285,000 reais, compared with 185,OOO in New York and 249,000 in Shanghai.

The government has granted tax credits and low-cost loans to boost domestic production and promote research in such areas as digital tablets, automobiles, and offshore oil production. It also intends to cut payroll taxes in up to five industries to push down labor costs. Julio Gomes, economist at the industry-funded think tank Iedi, thinks manufacturers will still struggle. In a worst-case scenario, Brazil’s industry could lose another 20 percent share of its market and 1 million jobs, Gomes says.

The decline of its industry could force Brazil to reassess its strengths—and that could be a good thing, says Alberto Ramos, chief Latin America economist at Goldman Sachs (GS). “What is the comparative advantage of Brazil? I doubt it is industry. It’s services, agribusiness, and commodities,” says Ramos. “The economy needs to redirect resources to where it’s competitive. That’s actually a healthy process.”

From the Economist in March:

Uniquely among large economies, Brazil is a young country with the pensions bill of an old one (see chart). It has just ten over-65s for every hundred 15- to 64-year-olds, fewer than anywhere in the G7. And yet it spends 13% of GDP on pensions, more than any G7 member except Italy, where the share of old people is three times higher than in Brazil. In fact, so few Brazilians pay for pensions, and so many get them, that the country has 35 pensioners for every 100 contributing workers, a higher ratio than in the United States.

… most Brazilians retire startlingly early: at 54 on average for a man in the private sector, and just 52 for a woman. Survivors' benefits have no age limits. Families inherit pensions in their entirety, meaning young, childless widows never need work. A tenth of all 45-year-olds are already receiving a pension. …

The price for such distorted priorities is already high. But soon it will be unpayable. Payroll taxes for pensions are already greater in Brazil, at 32% of gross salary, than in all G7 countries except Italy. According to Bernardo Queiroz of the Federal University of Minas Gerais, without reforms, by 2050 they would have to reach a crushing 86% to keep the system going.

From the Financial Times in May:

The stubborn slowdown [in GDP growth to Q1] comes despite rate reductions that have cut 350 basis points off the Brazilian central bank benchmark lending rate, the Selic. The central bank is expected to cut the Selic from 9 per cent to 8.5 per cent, a 15-year low, when it meets this month.

Brazil’s economic troubles have yet to dent the popularity of Ms Rousseff, however, who is presiding over a period of record low unemployment and solid pay increases.

But while consumer demand remains strong, domestic industry is feeling the brunt of the weakness in the economy, as the strong currency has attracted a flood of cheap imports, undermining Brazilian manufacturing.

The car industry is also reeling from a rise in auto loan defaults, which has slowed sales and is leading to a build-up of stocks among major suppliers.

From the Financial Times in June:

economists are beginning to question whether the old economic system, known as the “Lula” model, which relied on salary increases, social welfare transfers, a credit boom and fiscal stimulus to boost domestic demand, is broken.

Brazilian consumers seem to have borrowed as much as they can for now. Non-performing loans are stubbornly high, particularly in the important automotive sector.

In this environment, private banks have been refusing to lend more aggressively until the bad loan cycle turns downwards.

From the Economist in August:

For much of the past decade the country enjoyed faster growth because of China’s demand for its iron ore, soya beans and oil, and because higher wages and newly available credit boosted the purchasing power of tens of millions of Brazilians. But now the economy has stalled. Having slashed interest rates, intervened to weaken an overvalued currency and offered tax breaks and cheap loans to favoured sectors, officials insist that GDP will grow by 4.5% next year. In 2008, when the world economy tanked, the government engineered a quick recovery by stimulating demand. But now its lever-pulling seems to be having less effect. …

Taxes take around 36% of GDP, a European-sized chunk. But Brazilians get nothing like European public services in return. Almost half of them lack sewerage connections. Although public investment has risen, it remains paltry. A disproportionate share of tax revenues is gobbled up by insiders. Under Luiz Inácio Lula da Silva, the former trade-union leader who was president between 2003 and 2010, the public-sector wage bill more than doubled in nominal terms, whereas inflation was less than 50%. Lula also pushed up both the minimum wage and pensions much faster than inflation. …

The decisions that Ms Rousseff is taking this month will be a critical indicator of where her presidency is headed. Her Workers’ Party derives much of its support from public-sector unions.

(See the Reference pages Brazil inflation and Brazil household credit for more background and sources.)