Brazil’s Economic Policy Lurches Right

Free-market practices are put in place to fix the economy.

Brazil managed to pull off the Rio Summer Olympics and silence the naysayers. Now the country has a bigger act to manage—approve a painful austerity package to help bring on an economic rebound.

Michel Temer, the provisional president who was sworn in after Dilma Rousseff was impeached on Aug. 31, is aiming to halt the interventionist economic policies and fiscal recklessness pursued by Rousseff’s Workers’ Party. His economic team has won praise on Wall Street for formulating policy less like disastrous Venezuela and more in line with the region’s emerging-market darlings, Chile and Colombia. In Argentina, President Mauricio Macri has gained investor confidence by unwinding regressive economic policies, including currency controls, providing a model for Temer and his advisers as they struggle to lift Brazil from a two-year recession, its deepest on record. The country’s budget deficit as a share of gross domestic product is 10 percent, compared with 3 percent in 2013, the peak of the commodities boom.

“There is a shift toward neoliberal policies again. It is happening all over Latin America, with the exception of Venezuela, maybe Ecuador,” says Carlos Langoni, a former central bank governor who’s director of the Center for World Economy at the Getulio Vargas Foundation in Rio de Janeiro. “It is no longer an ideological choice. It’s a pragmatic matter. The state is broken; there are no funds for the state to lead this new stage of growth.”

While restarting an economy through spending cuts sounds counterintuitive, Brazil is in no position to execute a stimulus package after years of operating in the red. Brazil’s debt as a share of GDP reached 69 percent in June, up from 52 percent in 2011, when Rousseff first took office. Generous social benefits put in place by Rousseff’s party brought millions of Brazilians out of poverty. They also stoked inflation and left government coffers bare when the economy went into a downturn. Now the government needs to limit spending. Otherwise, Brazil will face a debt crisis similar to Greece’s, according to Dyogo Oliveira, interim minister of planning, development, and management.

Confidence among Brazilian consumers and industry has been returning, as the worst of the recession passes, offering hope that the economy will follow in 2017. The Brazilian real is the world’s best-performing major currency this year, and the stock market recently touched its highest level since late 2014. Temer has appointed what many consider to be the most market-friendly economic team in Latin America. He wants to change the constitution to keep the budget at 2016 levels plus inflation. The word “privatization” is no longer taboo among policymakers.

The risk is that Temer’s political coalition will start to fray after achieving the common goal of removing Rousseff, leading to compromises and watered-down reforms. There’s no “clear support” in Congress to approve his agenda, says Samar Maziad, a senior analyst at ratings company Moody’s.

What happens in the coming few months will either set the stage for one of Temer’s advisers to win the presidency in 2018, or turn Brazilians leftward again. Temer, 75, has said he has no ambitions to join the campaign.

The good news is that it won’t take much to show progress, because the economy has been so decimated, says James Gulbrandsen, a Rio de Janeiro-based partner at NCH Capital, a money manager. Temer needs only to accomplish part of an ambitious package of entitlement reforms and spending caps. Even a partial legislative victory can propel the market recovery that gained speed leading up to Rousseff’s impeachment. “It’s Brazil. They’ll never get everything they want,” Gulbrandsen says. “They’ll get part of what they want, and if they get most of what they want, it’s amazing. When you’re going from the fourth subbasement to the ground floor, there’s a lot of money to be made.”

The commodities downturn showed Brazil, like fellow exporters Ecuador and Venezuela, was overly dependent on Chinese demand. It also exposed the flaws of having the entire Brazilian oil industry hinge on a single player: state-controlled Petroleo Brasileiro, or Petrobras. Temer is backing legislation to open the industry to more competition to accelerate extraction from deep-sea oil fields. It’s one of the first bills Congress is expected to send to his desk for a signature, and the oil industry is watching closely. The state of Rio de Janeiro stands to benefit the most as it pumps 68 percent of the country’s oil and natural gas, and the industry is a big employer. “With the right regulatory model, the exploration and production-services industry will come back,” says Lincoln Guardado, chief executive officer of QGEP, a Rio-based explorer and partner with Petrobras. “Brazil will return as a global hot spot.”

The fallout from a 2½-year corruption investigation will lead to more participation in major industrial projects from foreign construction and engineering companies as the economy revives, says Langoni, the former central banker. A group of Brazilian conglomerates allegedly colluded to bribe executives at the oil producer and also politicians to win contracts and limit competition. The scandal has led to the arrests of leading businessmen and politicians and contributed to Rousseff’s downfall, even though she hasn’t been directly implicated. “This monopoly was broken down by a legal process, and that opened up space for new players,” Langoni says. “That is very positive for the competitive economy that Brazil must be.”

For Adelmo Emerenciano, a corporate lawyer in São Paulo who represents foreign companies that want to invest in Brazil, the shift is under way. With Temer’s government pledging to make toll roads and power-generating plants more profitable for private investors, buyers are showing plenty of interest. “It’s very clear the policies are pro-industry, a different model,” says Emerenciano. “Clients are looking at assets, looking at concessions that are cheap.”

They’re cheap for a reason. The number of Brazilian companies filing for bankruptcy protection jumped 88 percent, to a 10-year high, in the first half of 2016, and many more will go under in the next six months, before any recovery takes hold, Emerenciano says. Just how many depends on Temer’s success at shifting the lopsided economy away from the state-centered model favored by Rousseff.

The bottom line: Brazil is in the peculiar spot of being in deep recession while investors have bid up stocks in anticipation of recovery.