Dec 23rd 2014

Why Brazil Is Its Own Worst Enemy

by Daniel Wagner

Daniel Wagner is CEO of Country Risk Solutions, a Connecticut-based cross-border risk advisory firm and author of the book Managing Country Risk. CRS provides a range of services related to the management of cross-border risk. He is also Senior Advisor with Gnarus Advisors.

Many common perceptions foreign investors have about Brazil are misplaced. By all rights, given its size, location, and natural resource base, Brazil should be an economic juggernaut. But the truth is that Brazil should never have been designated a BRIC because it is a poorly managed economy that has rarely lived up to its potential. In 2001, when the country was designated a BRIC, it was $200 billion in debt and spent 38% of its GDP servicing that debt. The following year Brazil took out of $40 billion loan from the IMF. The country's average GDP growth rate since 2000 has been under 2%, and Brazil has consistently underperformed its BRIC counterparts. So, what's all the fuss about?

Not a Great Place to do Business

As an investment destination, Brazil scores poorly in the World Bank's Doing Business rankings, with an overall score of 167 out of 189, and ranked in the lowest third in 6 of the 10 categories. Its best ranking is in providing electricity (55) -- and even that is under threat because of the persistent drought. According to HSBC, only in 2014 did Brazil return to its pre-Crisis level of foreign direct investment, having never attracted more than 3% of global FDI. Its inward investment as a percent of GDP is just two-thirds of what it was in 2008. In other words, Brazil has failed to attract a large percentage of FDI, or to invest in itself.

There are a number of reasons for this, ranging from a failure to control government spending, to poor economic management, to low labor productivity. According to the Conference Board, Brazil's labor productivity is half of Mexico's and less than a third of South Korea's.

Like many of its counterparts in Latin America, Brazil has also fallen into the trap of export dependency on China. Approximately 80% of Brazil's basic goods exports went to China between 2000 and 2010, while less than 20% of its manufactured and semi-manufactured goods were purchased by China. That's fine when times are good, but as China's growth rate continues to decline, Brazil is finding it difficult to find buyers to take up the slack, as are many other China-dependent countries.

Another source of concern is Brazil's increasingly dilapidated infrastructure, which impacts everything from production logistics to basic transportation needs. A number of large infrastructure projects were approved during the 'boom' years under Lula da Silva, and remain unfunded and unfinished. The country's balance of payments deficit continues to rise while inflation continues to push up against the Central Bank's ceiling.

A combination of government complacency, an inadequately developed regulatory framework, and a host of infrastructure bottlenecks prevent Brazil from achieving its full potential. Rigid labor laws, a byzantine tax system, and government domination of long-term credit markets conspire to prevent Brazil from breaking out of its well established pattern of low economic performance.

Too Big for Its Britches

Politically, Brazil has simply gotten too big for its britches. The country's obvious regional importance and special status among global policy makers gave President da Silva the confidence to leap on to the global political stage. Lula naturally sought to project Brazil's power globally, but based more on his popularity as a friend of the global worker than as a skilled statesman. Although Brazil has admittedly been a pivotal player in forming the G20 and played a significant role in WTO and climate change talks, it appears to have bitten off more than it can chew.

Brazil's foreign policy since 1985 has been based on three pillars of achieving autonomy: through diversification of relations with other nations, by maintaining a distance from the liberalizing international order, and participation in international forums. For Brazil, independence is paramount, and in foreign policy, it wants to be all things to all people. As a result, a tendency to 'double deal' with its international partners in order to protect itself has become endemic in Brazilian foreign policy over the past 25 years.

By embracing Iran and attempting to broker with Turkey the low-enriched uranium swap to France in 2010, Lula chose to give priority to Brazil and Iran's $2 billion trade relationship over Brazil's decades-long relationship with Washington. As a result, Lula burned a lot of political capital with Brazil's second largest trading partner (the U.S.). The attempted exchange with Iran demonstrated clearly that Brazil will pursue its own path, even though it is clearly not yet ready to assume a leading role in superpower politics.

Brazil's attempts to play a broker role in Honduras, when former Honduran President Zalaya was thrown out of power in 2009, and between the Israelis and Palestinians, also both failed -- the result of the Brazil overstepping its bounds and sticking its nose where it didn't belong. In his desire to be all things to all people and maintain a diverse range of bilateral relationships, Lula got himself caught on a slippery slope, causing potentially long-term damage with some of Brazil's most important allies, and likely impacting what his successors will be able to achieve in the foreign policy arena. President Rousseff certainly has achieved little in the foreign policy arena.

Its Own Worst Enemy.

In spite of all the hoopla over Brazil as one of the world's globalization poster boys, its worst enemy is itself. Brazil has yet to sustain mid-to-high single digit GDP growth rates as the other BRIC countries have done, and looks no better poised to do so in the second decade of the 21st century than it did in the first. Brazil's inexperience on the global stage, combined with Lula's desire to project Brazilian power, has led to a series of mistakes that are perhaps best described as reckless. By trying to shape the world to reflect its own world view, Lula succeeded in ringing alarm bells in Washington and the capitals of Europe. That cannot help its objective of gaining a permanent seat on the UN Security Council. The Brazilian government would be well advised to steer clear of the established powers' neighborhood until such time as it is genuinely accepted as a member of the club, and can demonstrate that it has something meaningful to offer by becoming engaged in the most sensitive diplomatic issues of the day.

So, given that President Rousseff has presided over the continuing decline in Brazil's basic economic and business indicators, business as usual is not what Brazil needs in the future. In order to come close to its potential, Brazilians should have rejected her failed economic policies and elected Aecio Neves. Having done the opposite, the global investment community should expect more of the same. It may indeed be a long time until Brazil proves itself worthy of the BRIC designation. It will certainly not be in the next 5 years.



Daniel Wagner is CEO of Country Risk Solutions and author of "Managing Country Risk". For Country Risk Solutions, please click here.

You can follow Daniel Wagner on Twitter: www.twitter.com/countryriskmgmt



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