One has to hope that Brazil’s presidential candidates in that country’s October elections are listening to the clear signals coming first from the markets and now from the International Monetary Fund about Brazil’s troubling economic prospects.
If not, we should brace ourselves for a major economic crisis in the world’s eighth-largest economy that could send ripples through the global economy.
Over the past few years, in a global environment of very easy money, markets chose to turn a blind eye to Brazil’s shaky public finances and to its poor economic growth record. They did so as investors stretched for yield.
However, this picture seems to have changed abruptly since the start of this year. It did so as U.S. Treasury yields approached 3 percent and as the U.S. dollar began to appreciate in response to clear indications that the Federal Reserve was intent on normalizing U.S. monetary policy and reducing the size of its bloated balance sheet.
With attractive returns now on offer on low-risk U.S. financial assets and with a strengthening U.S. dollar, investors have become more discriminating in their investments, particularly toward the emerging market economies.
The capital that had earlier flooded those latter economies in the easy global money times also started to come back to the U.S. As a result, along with the currencies of Argentina, South Africa and Turkey, the Brazilian real has been pummeled by almost 20 percent since the start of the year. At the same time, its government bonds and its equities have taken a beating.
If Brazilian policymakers might be excused for not fully grasping the clear signal that the markets are now sending them about the need for economic and public financial reform, they have no excuse for not understanding the explicit message about the urgent need for economic reform coming out of the IMF.
At the conclusion of its recent annual economic review, the IMF noted that the Brazilian economy has been underperforming relative to its potential, its public debt is high and increasing, and, more importantly, medium-term growth prospects remain uninspiring, absent further reforms.
The IMF went on to warn that especially against the backdrop of tightening global financial conditions, placing Brazil on a path of strong, balanced and durable growth would require a committed pursuit of fiscal consolidation and ambitious structural economic reforms.
A well-founded concern of both the markets and the IMF is the explosive path on which Brazil’s public debt now seems to be set. Since 2014, Brazil’s public debt as a share of GDP has jumped some 20 percentage points to its present level of around 75 percent.
More troubling yet, on present policies and on rather optimistic assumption about future economic growth, the IMF is projecting that over the next few years, Brazil’s public debt will increase further to 90 percent of GDP. That would take its public debt level well beyond that which in the past has got the country into deep economic and financial trouble.
Against the backdrop of the prospective continued tightening in the global liquidity cycle, one has to be concerned about troubling signs that Brazil might not have the political will to address its poor public finances in a timely manner.
One such sign was that following the recent crippling truckers’ strike against high fuel prices, the current Brazilian government was forced to increase fuel subsidies and to soften its economic policy stance.
More disturbing signs of the lack of political will are the strong showing of populist candidates in the polls for October’s presidential election and the fact that even mainstream candidates are shying away from a discussion of what the country needs to do to turn around its public finances and to jumpstart its economy.
Hopefully, in their setting of monetary and trade policies, U.S. policymakers are taking note of the dangerous path on which the Brazilian economy now finds itself as well as of how Brazil can impact the U.S. and global economies. Unlike Argentina and Turkey, which are already enmeshed in major economic crises, Brazil is South America’s largest economy and is a highly indebted country of systemic importance.
One would think that the last thing that Brazil’s already fragile economy now needs is a further intensification of U.S. import protection or a more rapid increase in U.S. interest rates.
One would also think that at a time that the Chinese economy is slowing and Italian developments are raising the prospect of a return of the U.S. sovereign debt crisis, the last thing that the U.S. economy needs is a full-blown Brazilian economic and financial crisis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.