The suggestion that Brazil could be the world’s fifth-biggest power by the next decade would have once sounded far-fetched, but the election of Luiz Inácio Lula da Silva heralded a new era. But how well placed is Brazil to cope with the challenges ahead? Will Jackson reports.
In particular, there are concerns that the country has spent too much money on higher wages and too little on infrastructure to support greater consumption and trade. Wood says Brazil is “notoriously poor” at infrastructure, in contrast to other emerging nations such as China. “Brazil has spent very little in public investment as a share of GDP – it’s only around 1 or 2%,” he says. “During this boom, you’ve had an increased tax take but unfortunately the quality of spending hasn’t been great. In the crisis, it went into civil servants’ pay packets rather than being used to fund projects to increase productivity.”
According to the World Bank, Brazil could significantly reduce its expenditure on logistics through investment in transport infrastructure – at present, it takes twice as long for Brazil to export than America. The government has ramped up spending by introducing the “PAC” accelerated growth programme, which aims to spend up to R40.5 billion on logistics, including R27.7 billion on almost 5,000 kilometres of roads – although Wood notes that only 50%-60% of PAC money has been spent so far.
”Everything is going very well so far, but down the road Brazil does not have the infrastructure to grow beyond 5%, maybe 6% a year”
Investors sense an opportunity. According to Jonathon Ong, a portfolio manager at Macquarie Funds Group, demand for electricity is growing at 1.2-1.3 times GDP a year, while vehicle traffic is rising at a similar rate. He has been overweight Brazilian infrastructure for several months, including investments in electric utilities, toll-roads, railways and ports. Ong points to government estimates that R90 billion will be spent on Brazilian infrastructure in the next five years – much of it related to the country’s hosting of the World Cup in 2014 and the Olympic Games in 2016.
But some commentators remain sceptical on PAC. Fleck recalls that even before the economy slowed during the banking crisis the country’s ports were struggling to cope with increased shipping. He dismisses the programme as “window dressing” but says that better infrastructure is crucial. “Everything is going very well so far, but down the road Brazil does not have the infrastructure to grow beyond 5%, maybe 6% a year,” he adds. “Doing some work on this infrastructure might change Brazil forever.”
Going hand in hand with the uptick in inflation are fears that Brazil could attract speculative capital inflows from overseas. In its April World Economic Outlook, the IMF noted the strong recovery in Latin America and the Caribbean, but also warned that inflation-targeting countries in the region may be vulnerable to short-term inflows as they seek to prevent overheating. “There is [an] argument for keeping interest rates low for a longer period than justified by domestic cyclical considerations, because higher interest rates may attract speculative capital inflows,” it said.
Brazil took measures to limit speculative foreign inflows in 2009, with the introduction of a 2% tax in October. “The received wisdom is that it doesn’t have much effect, but it coincided with the exuberance towards Brazil in the third quarter,” says Wood. “One could argue that the signal sent by policymakers was that they are ready to do something, to throw some sand in the works. Managing the capital inflows will be a challenge, but they’ve done reasonably well so far.” Wood says he does not expect the tax to increase, unless there is further appreciation in the real.
Despite the risks of inflation and speculative capital inflows, Wood says most of the concerns centre around Brazil’s ability to manage growth – a problem that is “a luxury to have”. However, the full realisation of Brazil’s potential is still some way off. “The next period is about consolidating the stabilisation story,” Wood says. “Brazil is well positioned to grow 4.5 – 5%, but even at those rates you’re not going to see a rapid convergence with income levels in developed markets. So although it’s doing well, and the middle class is doing well, the economy will still be lagging behind the developed markets for a while.”
• Will Jackson was a guest of the Association for Real Estate and Tourism Development (ADIT) at the 2010 Nordeste Invest conference in Natal, Brazil.
**Note: This article was updated on June 1. Robert Wood’s comment that “policymakers threw everything but the kitchen sink at the meltdown” referred to countries in the Organisation for Economic Cooperation and Development (OECD) and China – not Brazil. This quote was removed.