Brazil’s dark cloud over the global economy
For the global economy, it would never be a good time for an economy as large as that of Brazil to have a political and economic crisis. But now is a particularly inopportune time for such a crisis. The world is in its deepest economic recession in the past 90 years, and other major emerging market economies too are facing severe coronavirus-induced economic challenges that would be exacerbated by a Brazilian crisis.
Brazil is not just another emerging market economy; rather, it accounts for around half of South America’s overall output, and it currently ranks as the world’s eighth largest economy. It also is a highly indebted country with a government debt that now totals around $2 trillion. With Brazilian debt being a major component of most emerging bond portfolios, a Brazilian economic crisis has the potential to roil world financial markets.
Even before the coronavirus crisis, the Brazilian economy was in the midst of a lost economic decade as its economy struggled to recover from its very deep 2014-2016 economic recession. Despite initial hopes that Jair Bolsonaro’s ascension to the presidency in October 2018 might bring much needed economic reform to the country, last year the Brazilian economy grew by barely 1 percent. That left Brazilian output well below its level some 10 years earlier.
Brazil’s sclerotic economy, coupled with its long delay in addressing its chronic public pension problem, has not been good for its public finances. Already before the pandemic, the persistence of large budget deficits raised serious questions about the country’s public debt sustainability. By the end of 2019, Brazil’s public debt had reached 80 percent of GDP, which is a very high level for an emerging market economy.
It would be a gross understatement to say that the coronavirus pandemic has considerably darkened an already gloomy Brazilian economic outlook. This has not least been because of the total state of denial in which Mr. Bolsonaro finds himself as to the seriousness of the pandemic and because of his gross incompetence in meeting this major health challenge.
Lacking any plan to address the pandemic’s spread, Brazil has now become the country with the third-largest number of coronavirus fatalities in the world with every indication that matters will get a lot worse before they get any better. It is also troubling that the pandemic seems set to further delay any meaningful economic reform in Brazil as the country’s domestic political crisis deepens and as calls for Bolsonaro’s impeachment grow ever louder.
All of this has heightened market doubts about Brazil’s ability to meet its debt service payments and has led to a 30 percent plunge in the Brazilian currency since the start of the year. It has also led the IMF to substantially downgrade its forecast of the Brazilian economy. The IMF now expects that the Brazilian economy will contract by more than 5 percent in 2020. That in turn will cause the Brazilian budget deficit to balloon to almost 10 percent of GDP and will contribute to a rise in the public debt to GDP ratio to almost 100 percent by the end of 2020.
A full-blown Brazilian debt crisis would be the last thing that a fragile global economy now needs. This would especially seem to be the case at time when other emerging market economies like Argentina, Ecuador, Lebanon and Venezuela have either defaulted or are well on their way to defaulting on their debt. It would also seem to be the case at a time when serious questions are being raised about debt sustainability in Italy, South Africa and Turkey.
With Brazil’s coronavirus pandemic showing every sign of spinning out of control and with Bolsonaro’s government showing every sign of crumbling, global economic policymakers would ignore Brazil’s troubling political and economic outlook at their peril. A Brazilian economic and financial crisis has the real potential of triggering a very much broader emerging market crisis by accelerating the rapid pace at which capital is already being withdrawn from the emerging market economies.
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.