Despite economic uncertainty, there are still reasons to back Brazil

Despite economic uncertainty, there are still reasons to back Brazil Photo: MJgraphics/Shutterstock

The Covid-19 pandemic has caused levels of economic unpredictability to skyrocket in Brazil. The Brazilian Economic Uncertainty Index (IIE-Br), compiled by the Brazilian Institute of Economics at think tank Fundação Getúlio Vargas (IBRE-FGV), has hit its highest mark in history, far above measurements recorded amid previous 21st-century crises. In April 2020, the IIE-Br reached 210.5 points. In its previous peaks — at the 2002 presidential election, the 2008-2009 financial crisis, and Brazil’s loss of investment-grade rating by S&P in 2015 — the index hit 132.1, 132.4, and 136.8 points, respectively.

The so-called “standardization window” of the IIE-Br came between January 2006 and December 2015, where the average uncertainty hit 100 points, considered ‘normal.’ Therefore, the 210.5 points seen in April 2020 is extremely high for the index’s standards. July saw the IIE-Br retreat to 163.7 points, but this is still much higher than previous peaks.

</p> <p>In a recent article published on VoxEU, entitled “<a href=",measures%20reached%20all%2Dtime%20peaks.&amp;text=The%20stock%20market%20volatility%20measures,by%20the%20end%20of%20June.">Economic uncertainty in the wake of the Covid-19 pandemic</a>,” several aspects of Covid-19-related uncertainty are highlighted.</p> <p>In epidemiological terms, there are lingering doubts about the degree of contagion and lethality of the virus, the efficacy of social distancing, as well as the time that will be required to produce a vaccine and successfully inoculate populations. With regards to the economy, there is uncertainty over the short-term economic impacts, the effects of reactive public policies, the speed of post-pandemic recovery, and the persistence of changes in habit, such as consumption patterns, business tourism, and remote working.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/3470765"><script src=""></script></div> <p>As the numbers make clear, Brazil was hit squarely between the eyes by the Covid-19 pandemic, being one of the countries with the highest number of cases and deaths from the virus. Therefore, Brazil not only has to deal with the enormous and undeniable short-term consequences of <a href="">Covid-19</a>, but also the unpredictability over the medium and long-term post-pandemic period.</p> <p>What indexes such as IIE-Br show is that merely pushing the current bleak scenario to the future is a form of self-deception, <a href="">similar to excessive optimism</a>, yet working in the opposite direction. On the one hand, it is true that uncertainty in itself weighs heavily on economic activity, reducing investments and spending on more expensive consumer goods, as has been addressed by the economic literature. However, as the word &#8216;uncertainty&#8217; suggests, the future is up in the air, and there are very few visible elements to forecast &#8216;trustworthy&#8217; scenarios. In other words, we cannot rule out any possibility, be it pessimistic or optimistic.</p> <p>However, this heightened uncertainty cannot be used as a justification for economists and other analysts to give up on making projections, even though this task has become much more challenging. And, when working with the future, we cannot rule out a direct consequence of the crisis, seen all around the world: the increase of public debt, which evidently has not spared Brazil.</p> <h2>Soaring public debt</h2> <p>A <a href="">recent article</a> by economists Victor Gaspar and Gita Gopinath, on the IMF Blog, indicates that global public debt is set to reach 101.5 percent of global GBP this year — the highest level ever, surpassing the peaks seen after World War II. In the case of advanced economies, public debt as a ratio of GDP is forecast to jump 26.5 percentage points, to 131.2 percent. In the same comparison, emerging economies should see their indebtedness climb to 63.1 percent of GDP, an increase of 6.8 percentage points.</p> <p>Brazil is expected to see an increase in its debt/GDP ratio of around 20 percentage points, putting it closer to richer countries than emerging markets. The absolute value of Brazil&#8217;s public debt in relation to GDP could reach between 95 and 100 percent by the end of this year, which is also above average for emerging countries.</p> <p>As it happens, monetary policy around the world has dunked global markets into a never before seen level of liquidity. This phenomenon creates different conditions for countries to adjust their public accounts after the necessary explosion in spending in the face of the pandemic. Brazil is drastically increasing its public debt, but the vast majority of major economies are doing the same thing. What we have seen is a form of exceptional tolerance linked to the extraordinary shock of the coronavirus. After severe panic in March, when the western world was rocked by the pandemic, markets began to cool off, including those comprising Brazilian assets. Today, the country&#8217;s stock exchange, risk level, and interest curve point toward a stable macroeconomic scenario.</p> <p>While it is true that the Brazilian Real has suffered a severe loss in value, this appears to be in part down to a fundamental repricing of the U.S. Dollar, coupled with an adjustment of relative prices in Brazil that is potentially more structural. Inflation and inflationary expectations in Brazil remain at record low levels, which causes the <a href="">devaluation of the currency</a> in a completely distinct way to previous BRL slides.</p> <p>This situation of a &#8216;truce&#8217; in the markets does not mean, however, that there are no risks. In fact, returning to the leitmotif of this article, the current times are ones of heightened uncertainty. For some analysts, the massive injections of liquidity and fiscal expansion in rich countries, added to the possibility of &#8220;financial repression&#8221; to reduce the burden of global indebtedness, could lead to a return of global inflation in the medium term. In this case, almost everything mentioned here about tolerance and extended deadlines for the adjustment of macroeconomic inequalities comes undone. A scenario of sudden rises in inflation and international interest rates would certainly bring almost insurmountable difficulties for emerging countries such as Brazil, with significant fiscal vulnerabilities.</p> <p>In the socio-political sphere, the polarization of recent years could be boosted by the inevitable short- and medium-term consequences of the pandemic. <a href="">Unemployment and precarity of labor</a> are tipped to hit record levels, and the potential end or reduction of emergency aid — impossible to fund for any significant length of time — could see social tensions become more acute.</p> <p>All over the world, since 2019, the spores of social revolt and popular movements are in the air. We covered this issue in a <a href="">July article</a>, highlighting the global protest wave caused by the death of George Floyd, a black U.S. citizen killed by the police. The extremely adverse conditions ahead for the Brazilian labor market as a result of Covid-19 — which are likely to worse once the federal government&#8217;s mega income and job support programs expire — could in theory create a socio-political confrontation between the most vulnerably strata of the population and the capitalist elite, potentially threatening the integrity of the country&#8217;s socio-institutional tapestry.</p> <h2>Reasons for optimism?</h2> <p>As we have seen, there is no shortage of reasons to be concerned about Brazil in the coming years. However, despite this warning and the veracity of the risks detailed herein, we also believe it to be appropriate to outline a moderately optimistic vision for the country&#8217;s medium-term future.</p> <p>First of all, it is necessary to mention the important role played by modern science in the fight against the coronavirus. Herculean efforts have been made in several countries to understand and confront Covid-19. In less than a year, countless aspects of the disease have been discovered, medications have been tested and analyzed, tests have been mass produced, and medical protocols have been developed and optimized. Above all, <a href="">several projects seeking a vaccine have advanced significantly</a>, signalling that this immense scientific and humanitarian feat may come to pass much faster than we had expected was possible. In other words, we can already see the horsemen of science on the horizon, galloping in our direction to provide a definitive solution to the pandemic, which could be rolled out gradually throughout 2020/2021.</p> <p>In terms of the international financial environment, advances made by economic and monetary authorities in crisis management is also notable. Regarding the prior mention of <a href="">inflationary risk</a>, the majority of analysts and the current literature support the idea that the future scenario, for some time, should remain one of high liquidity and low interest rates and inflation. Indeed, the challenge of low growth will remain, already affecting most of the developed world and a part of emerging markets such as Brazil. Regardless, it is unlikely that a sudden eruption of inflation and interest rates will shorten the &#8220;sunny&#8221; period in which nations are expected to make adjustments to their public accounts. This doesn&#8217;t mean that the risk does not exist, as mentioned above, but it must be adequately measured.</p> <p>Meanwhile, in terms of socio-political risk, Brazil&#8217;s institutional maturity since returning to democracy plays in its favor. While the distribution of income remains terrible, Brazil has built a reasonable social security network in recent years for a country with its level of income per capita, which cushions tensions during this disruptive moment in the economy and labor market. The pandemic also created a moment of &#8216;solidarity&#8217; in the relationship between actors of Brazil&#8217;s extremely unfair and unequal social life.&nbsp;</p> <p>With the advent of the emergency aid, though it is temporary, the Brazilian economic elite tacitly or explicitly supported that an additional 0.7 percent of GDP be spent each month on an enormous legion of vulnerable families. Even with the potential of a <a href="">primary deficit</a> of 12.4 percent of GDP that is set to fall 5.5 percent, the financial market agreed — with a reflection on the price of assets — that massive assistance be given to the country&#8217;s neediest people. In a way, the distributive tension behind the political polarization of recent years may have evened out.</p> <p>Evidently, these moments of social harmony do not last long. Once the pandemic has passed, the distributive tension is likely to return, and the big question will be how those with the economic and political power will lead. Concrete dilemmas will have to be faced, such as that between creating a new comprehensive social program, in the space created by the emergency aid, or returning to a strategy strictly focused on Bolsa Família. It seems that the &#8220;invisible&#8221; members of Brazilian society have become much more visible during the crisis. The debilitated labor market will also require actions from the public sector so that the working class may overcome the damage caused to the economy by Covid-19, with the least amount of suffering possible. Furthermore, there will be a demand for governmental actions of economic stimulus, such as a new public investment program, for instance.</p> <p>Faced with this scenario, increased fears over the fiscal situation become inevitable. Some questions are already lingering: how long will it take for the market to demand that the <a href="">primary deficit</a> returns to 2 percent of GDP? Will there be a need to increase the tax burden to make fiscal adjustments? If so, which sectors will foot the bill?</p> <p>There are no easy answers for any of these questions, and they make up the backdrop of widespread uncertainty upon which this article is based. While the moment is difficult, it&#8217;s not time to throw in the towel just yet. There is no reason to fall into radical pessimism or absolute skepticism. We must take Brazil&#8217;s unquestionable institutional maturity into account, which is not always appreciated in the predictions and constant murmuring during turbulent times. In recent years, there has been notable institutional progress with regard to the fiscal situation, as was made clear by the legislative approval of tough measures such as the public spending ceiling — though not a perfect initiative — and last year&#8217;s sweeping pension reform.</p> <p>These Brazilian advances — often dismissed by the country&#8217;s own intelligentsia — appear in the latest report from J.P. Morgan, which suggests that Brazil should not rush into fiscal adjustments after the pandemic, under risk of grinding activity to a halt. This type of recommendation is a clear signal that important foreign actors have noticed that the management of Brazil&#8217;s public finances has evolved to a level of integrity that did not exist until recently.</p> <p>Additionally, international liquidity — combined with some gains of credibility of Brazilian policymakers — helps to prolong the situation of very low domestic interest rates. The result is that, even with higher debt, the service is contained and the debt-to-GDP ratio may become more favorable.</p> <p>There are, therefore, several elements, from the most different scopes of Brazilian life — from the albeit momentary increase of social solidarity to the environment of low interest rates and advances in macroeconomic governance — that indicate that it is possible for the multiple actors of Brazil&#8217;s spirited democracy to reach agreements that will gradually remove the obstacles to the resumption of the country&#8217;s socio-economic development.&nbsp;</p> <p>Though the current dimension of uncertainty brings a lot of anxiety, there are still rational reasons to bet on Brazil.&nbsp;</p> <hr class="wp-block-separator"/> <p class="has-text-align-center"><em>This op-ed was </em><a href=""><em>originally published</em></a><em> in the August 2020 edition of the Conjuntura Econômica magazine, by think tank Fundação Getulio Vargas.</em>

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Luiz Guilherme Schymura

Luiz Guilherme Schymura is the director of IBRE-FGV, Fundação Getulio Vargas' Brazilian Institute of Economics. He is a postdoctoral researcher in economics at The Wharton School of the University of Pennsylvania.

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