Brazilian Economy

Economy:

Historical Perspective

Until the beginning of the 20th century the Brazilian economy was characterised by a succession of cycles, each based on the exploitation of a single export commodity: timber (brazilwood specifically) in the first decades of colonization;

sugarcane in the 16th and 17th centuries; precious metals (mainly gold and silver) and gems (diamonds and emeralds) in the 18th century; and, finally, coffee in the 19th century. During those centuries, enslaved Africans were imported and became the 'basic pillar of the economy' in the most populous areas of Brazil. Slave labour was used until the last quarter of the 19th century. Parallel to these cycles, cattle-raising and small-scale agriculture were also developed for domestic consumption. A first surge of industrialisation took place during World War I, but it was only from the 1930s onwards that Brazil reached levels of modern economic performance. In the 1940s, with US Eximbank finance, the first steel plant in Brazil was built at Volta Redonda in the state of Rio de Janeiro.

The industrialisation process from the 1950s to the 1970s led to the expansion of important sectors of the economy such as the car industry, petrochemicals and steel, as well as the inception of major infrastructure projects. In the decades following World War II the annual growth in Gross National Product (GNP) was among the highest in the world, averaging 7.4% up to 1974. During the 1970s, like various other countries in Latin America, Brazil absorbed substantial amounts of foreign capital from US, European and Japanese banks. Such capital inflows were aimed at infrastructure investments and state enterprises formed in areas that were not attractive for private investment. The result of this capital injection was impressive: Brazil's GDP increased at an average rate of 8.5% per annum from 1970 to 1980, despite the impact of two world oil crises. Per capita income rose fourfold during the decade, reaching US$2,200 in 1980.

In the early 1980s, however, the significant rise in US interest rates began to affect international capital markets, ending the relatively favourable conditions for foreign indebtedness that had existed until then. A substantial increase in interest rates in the world economy forced Brazil, as well as other Latin American countries, to implement strict economic adjustments that led to negative growth rates. The suspension of capital inflows reduced Brazil's capacity to invest. The foreign debt burden affected public finances and contributed to the acceleration of inflation. In the second half of the 1980s, a series of stringent economic measures were adopted that aimed at monetary stabilisation. These included the end of indexation, which was a policy of adjusting wages and contracts according to inflation, and the freezing of all prices. In 1987 the government suspended interest payments on foreign commercial debt until a debt rescheduling agreement with creditors could be reached. Although such measures failed to bring about the desired results, overall economic output and exports were growing again by the end of the 1980s, providing enough trade surpluses to allow the debt to be serviced.

The 1980s crisis signalled the demise of the 'import substitution' economic model in Brazil (a policy that had developed Brazilian industry by prohibiting the purchase of certain manufactured goods from abroad, and imposed very high import tariffs on industrial goods), thereby contributing to the opening up of the country's economy. In the early l990s Brazil engaged in a series of far-reaching economic reforms. They encompassed trade liberalization, deregulation, privatization, and the establishment of a legal and structural framework to promote foreign investment. Economic reforms continued through the 1990s and included measures such as the abolition of state monopolies and, in line with Brazil's obligations as a WTO member, reduction of import tariffs, elimination of subsidies, and reduction of barriers to trade in goods and services.

In 1994, after several frustrated attempts to bring inflation down, the Brazilian government introduced the Real Plan (Plano Real), a stabilisation programme that replaced the currency in use at the time with the real. This new set of economic measures finally succeeded in controlling prices and curbing inflation.

Now, after fifteen years of macro-economic policy based on the three pillars of inflation targeting, floating exchange rate and primary fiscal surplus, the Brazilian economy displays clear signs of stability with regard to external accounts and public finances. Furthermore, since 2003, there has been increasing evidence of improved performance in production, sales, exports and employment. This scenario reveals a benign coexistence between stability and development, and favours the fulfilment of the main objectives of the Brazilian government in its quest for social justice.

In 2007 the Brazilian government created the Growth Acceleration Programme (PAC), a set of measures aimed at improving infrastructure and fostering conditions that allow the private sector to prosper with positive externalities for the Brazilian people.

All the major credit-rating agencies have already granted Brazil investment grade, and it is indeed the case that Brazil has become an extremely attractive destination for foreign investment due to the combination of sound institutional measures and economic stability with a large and dynamic internal market. Among the huge opportunities for foreign investors are the preparations to host major sporting events in the coming years – the World Cup in 2014, and the Olympic and Paralympic Games in Rio de Janeiro in 2016 – and the need to develop the resources required to exploit the vast offshore oil fields that have recently been discovered.

Brazil's current development trajectory requires further public policies aimed at increasing economic efficiency and reducing external vulnerability, along with measures to stimulate investment and savings as proportions of GDP. The government has contributed to the recovery in demand, for example by stimulating credit and temporarily reducing tax rates. Inflation has been kept stable as a result of a sound fiscal policy that has allowed the public debt to be significantly reduced in recent years.

During the recent international economic crisis, sound macroeconomic policies and a well-regulated financial system enabled the Brazilian economy to recover quickly. The construction of a sustainable development path has already demanded both hard work and enormous resources, but challenges still lie ahead. The overarching goal of bringing prosperity to Brazil’s people goes together with broader international engagement, as the domestic and international spheres are increasingly intertwined. A peaceful and developed South America is a priority for Brazilian foreign policy. In addition, the construction of fair and strong international institutions is an opportunity for Brazil.

Gross Domestic Product (GDP)

Brazil's nominal GDP is currently around US$2.5tn. Brazil's economy ranks as the sixth largest in the world when measured by nominal GDP, and is always among the top ten whatever criteria are employed. It is the second largest economy in the Americas after the United States and the second largest in the developing world after China.

With a population of 192 million and a per capita income of around US$12,000 per annum, Brazil has the largest domestic market in Latin America.

Source: Central Bank of Brazil-DEPEC, IBGE and The Economist

Brazil's growing urban areas are home to more than 85% of the population. As a result of urbanisation, services have become the leading sector in the economy, accounting for approximately 68% of GDP in comparison with 26.5% for manufacturing and 5.5% for the agribusiness sector.

Growth and Employment

Since World War II Brazil has shown a great potential for continuous economic growth and development. As mentioned above, this was particularly evident in the 1960s and 1970s, when average annual growth was 6% and 9% respectively. In the so-called 'miracle' years between 1970 and 1974 the annual growth rate exceeded 10% per annum. In recent years annual economic growth has tended to be around 5%. In 2008, for example, the economy grew by 5.1%, and it is expected that a similar rate will be achieved in 2010, following modest growth in 2009 (expected to be around 1%) as a result of the international economic crisis.

With a relatively young population Brazil has to create millions of jobs every year to absorb the new entrants in the employment market, particularly in urban areas.

Monetary Policy

Following the 1999 currency crisis, which led to a dramatic depreciation of the real, Brazil established an inflation-targeting policy (Decree No. 3,088 of 21 June 1999) similar to that used in the UK and other countries. The National Monetary Council (CMN) has ultimate responsibility for formulating and conducting monetary policy. The CMN sets the inflation targets and the main monetary policy goal, and is responsible for coordinating monetary and fiscal policies. The Central Bank of Brazil, an autonomous federal institution that is part of the organizational structure of the Ministry of Finance, is in charge of implementing monetary policy, executing CMN decisions by issuing Resolutions. The Monetary Policy Committee (COPOM) is responsible for setting the monetary policy stance, and establishing the target for the overnight inter-bank loans collateralized by government bonds – the SELIC interest rate, the principal monetary policy instrument of the Central Bank of Brazil. After each meeting of the COPOM a decision is announced with respect to the SELIC rate, i.e. whether to ease or tighten monetary policy. In order to keep the SELIC rate on or around its target, the Central Bank of Brazil conducts liquidity management operations in the domestic money market.

Under the inflation-targeting framework, annual inflation targets for the national Broad Consumer Price Index (IPCA) are set by the National Monetary Council and announced by the Minister of Finance. Monetary policy decisions are based on inflation forecasts, dependent upon alternative interest rate paths, and take into account the state of the economy and the probable future development of exogenous variables. According to a recent IMF study, inflation targeting has increased the responsiveness of inflation levels to monetary policy. The inflation index used for the purpose of setting interest rates is the IPCA (for definition of price indices, see below). The inflation target after the 1999 currency crisis was initially quite high: 8% for the year 1999 and 6% for 2000. Since 2005 the target has been set at 4.5% per year. A variation of 2 percentage points around the target is permissible. The annual rate of inflation fell year after year between 2003 and 2006, but despite the positive effects of the appreciation in value of the real it has been increasing since 2007, caused partly by higher food and oil prices. Although the prices of tradable goods increased, those of non-tradable goods, particularly services, increased more, which according to COPOM indicates the influence of domestic factors over inflationary dynamics.

Source: Central Bank of Brazil

Public finance and fiscal policy

Brazil has undertaken major adjustments in its fiscal policy since the 1997-98 currency crises in Asia and Russia. These have included tightening control over current expenditure, a fiscal 'pact' between the federal government, states and municipalities, and measures to increase revenue, as well as the continuation of institutional and structural reforms aimed at greater fiscal discipline and stability in public finances.

Foreign Direct Investment

Brazil has been one of the world's leading recipients of Foreign Direct Investment (FDI) in recent years; in the developing world it is second only to China. In 2012 Brazil received approximately US$ 65 billion in FDI. This impressive figure reflects the longstanding presence of international companies in prominent areas of the Brazilian economy such as oil and gas, banking and financial services, telecommunications, chemicals, pharmaceuticals, car manufacturing, and various other services.

These large inflows of FDI have been sustained by various factors including the size of the domestic market, political stability and stable macroeconomic conditions (especially in terms of enhanced fiscal discipline), as well as by various economic reforms implemented in the last fifteen years. As well as its very positive financial impact on the balance of payments, FDI has played a major role in expanding industrial capacity and the supply of services, and in boosting competitiveness.

Outward investment has also been growing. The Brazilian companies investing abroad are from several differnet sectors including finance, mining, aircraft manufacturing, construction services, agricultural commodities, and audiovisual and IT services.

Source: UNCTAD/WTO and Central Bank of Brazil