IMD International

James Carville, one of the main campaign strategists for Bill Clinton in the 1992 US Presidential election, coined the message “The economy, stupid,” as one of the key slogans for Clinton’s successful campaign. For anybody trying to understand the Brazilian annus horribilis—with the country mired in its worst economic recession since the Great Depression (expected negative growth of roughly 4% in 2015)—a reference to a revised Carville’s slogan is helpful: “It's the politics, stupid”.

Unsound development model

It remains true that the economic crisis is being driven by a combination of structural and cyclical factors that go well beyond the realm of politics. The structural component of the crisis is, to a large extent, associated with the economic unsustainability of the development model adopted 12 years ago. The model in question was inward-oriented and driven by consumption growth, which was leveraged by income redistribution and credit expansion. It paid only lip-service to productivity growth while distorting investment decisions in favor of “national champions”. The cyclical component reflects the current “headwinds” being faced by Brazil on the international front, including the aftershocks of the global financial crisis, a significant negative terms-of-trade shock—a by-product of the slow-down of the Chinese economy and its implications for the prices of commodities—and the adoption of a more restrictive monetary policy in the USA.

The spark for the crisis, however, was fiscal irresponsibility—particularly in 2014, which was an election year—when the target primary budget surplus became a deficit of 0.59% of GDP. Beginning in 2012, a series of fiscal tricks (the so-called “pedaladas fiscais”) were increasingly adopted to camouflage the real impact of subsidies – e.g., those provided by the National Development Bank (BNDES)—on the fiscal accounts, by postponing their recognition in the governmental accounts. As a consequence, the Brazilian gross public debt increased at a fast pace (from 54.8% in 2012 to an expected 66.1% of GDP by the end of 2015).

Political civil war

These actions came back to haunt the government, as they are being used as the legal basis for the impeachment procedures initiated against President Dilma Rousseff on December 2nd. To make things even more complicated, the current political imbroglio is being leveraged by an open “war” between the Executive branch and the Speaker of the House of Representatives (Eduardo Cunha), amid the reverberations of the Petrobrás corruption scandal, as I previously discussed. The Executive branch’s lack of credibility and the games being played by Mr. Cunha, who is being investigated by an ethics committee of the lower house of the Congress, increase the pessimism about the prospects for a quick political solution.

It is not only a crisis of governance, but also a crisis of ethics. Politicians seem to have fallen in what could be characterized as a Granovetter’s trap—after the name of sociologist Mark Granovetter—in which each “offender” feels that his/her unethical actions are not abnormal since the lowest threshold has already been made public by an earlier offender (e.g., those involved with the so-called “mensalão,” a large-scale vote-buying scandal uncovered in 2004). This tug-of-war between the Executive and the Legislative is being mediated by a Judiciary power that has become more and more pro-active. This activism translates not only in the pursuit of corruption cases (that already involve a large number of politicians and executives of some of the biggest Brazilian companies), but also in the interpretation of the law in ways that suggest a judicial “invasion” of territories that were considered the prerogative of the executive and legislative branches of government.

No end in sight

Those that believe that the beginning of the impeachment procedures against the President will lead to a quick resolution of the political crisis are bound to be disappointed. This will be a protracted and complex process. Political uncertainty is here to stay. The political crisis will further impact domestic and foreign investment decisions and the growth prospects of the Brazilian economy. As I mentioned before, there is a strong correlation among credit rating decisions by the “big-three” (S&P, Moody’s, Fitch). S&P is traditionally a first-mover, both with respect to advanced and emerging economies, in taking negative rating actions and it downgraded Brazil to junk status in September. S&P actions, however, are typically followed by the other agencies in the next three months. And this was exactly what happened on December 16th, when Fitch Ratings joined S&P in downgrading Brazil one notch to BB+ rating, also stripping the country of its investment grade status. These developments will drive additional selling of Brazilian assets by institutional investors, putting more pressure on the Brazilian currency. In short, a “perfect storm” fed by a political crisis will continue to impact the economic prospects for Brazil in 2016.

Carlos A. Primo Braga
is Professor of International Political Economy at IMD, and Director of The Evian Group@IMD. He teaches in the Orchestrating Winning Performance program.

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