Foreign Capital Returns to Brazil. Will Growth Follow?

Dressed in the national colors of green and yellow, a flood of Brazilian protesters washed over the streets of the country’s cities this spring, calling for President Dilma Rousseff’s impeachment. Brazilians have grown tired of their head of state, who squeezed into a second term with 51.6 percent of votes last October. Fernanda de Lima, CEO of São Paulo–based Gradual Investimentos, reckons that Rousseff would have lost had the polling been held three months later.

People have good reason to complain. Growth in South America’s largest economy has weakened since Rousseff’s first term began in 2011, slumping from 7.5 percent in 2010 to just 0.1 percent in 2014 and slipping into recession this year. The end of the global commodities supercycle and the oil market collapse explain much of the decline, but domestic policy problems — including a growing deficit and accelerating inflation — are also to blame. Inflation has risen to 8.9 percent, nearly double the central bank’s target rate. Meanwhile, a burgeoning corruption scandal at state-controlled oil giant Petróleo Brasileiro has also dampened the economy and undermined confidence in Rousseff, who chaired the company from 2003 to 2010.

International credit rating agencies have been threatening to strip the country’s investment-grade status, which would stifle investment and jack up borrowing costs. In April, Fitch Ratings changed its outlook for Brazil to negative; it rates the country’s debt at BBB, two notches above junk status. In March, Standard & Poor’s had lowered its long-term debt rating on Brazil to BBB–, its lowest investment-grade rating.

Rousseff’s constituents blame her for many of these shortfalls. The president ended 2011 with a 72 percent approval rating. Nine months after the 2014 election, Rousseff’s popularity has crumbled to 10 percent, the lowest presidential approval level since 1992, just before then-president Fernando Collor de Mello was impeached for corruption. Yet GI’s de Lima sees a silver lining in the slide: “Essentially, this has forced her to share her power and make changes.”

Rousseff has loosened her grip on politics and economics. She made Joaquim Levy her new Finance minister in January and has given him more or less free rein in necessary economic policy decisions, says Alex Wolf, Edinburgh, Scotland–based emerging-markets economist at Standard Life Investments. “This was somewhat of a positive surprise,” he adds. Pro-austerity budget hawk Levy promises to turn last year’s deficit of 0.4 percent of GDP into a primary surplus of 1.1 percent of GDP by year-end through tax hikes and spending cuts. Brazil’s congress has postponed a vote on the measures, however, and an ever-slowing economy has diminished tax returns so far, sending the real into a tailspin. The currency plunged by nearly 30 percent against the dollar in the 12 months ended July 13. Senator Romero Jucá of the Brazilian Democratic Movement Party has proposed reducing the primary surplus target to a modest 0.4 percent of GDP this year.

“Levy knows what needs to be done and how to do it,” de Lima insists, noting that the “driven to results” minister left a successful position as president of Bradesco Asset Management, a unit of Brazil’s second-largest private bank, to revamp Brazil’s economy. Foreign investors were net buyers in April on the BM&F Bovespa, the Brazilian stock market, signaling the return of confidence, she says.

The near-term outlook remains challenging, though. De Lima expects the Banco Central do Brasil, which has raised its benchmark rate by 2 percentage points since December, to hike it another 75 basis points, to 14.5 percent, by December to bring inflation under control. The International Monetary Fund forecasts the economy will contract by 1.5 percent this year and grow by just 0.7 percent in 2016.

More needs to be done to diversify exports beyond commodities, argues Standard Life’s Wolf. Brazil also needs to boost productivity, he adds, but two areas that could provide a lift — education and investment — are being cut by the government to fix the twin fiscal and current-account deficits.