Dynamism can help Brazil navigate almost unscathed through the stormy crisis raging abroad, economist says
Alexandre de Ázara — Foto: Silvia Zamboni/Valor
The dynamism of Brazil’s spending has helped create a stronger economy in Brazil. With an investment rate comparable to the best periods of the Workers’ Party (PT) administrations, the country has a potential growth – without generating inflation – of 2.5% in the coming years, said Alexandre de Ázara, the chief economist of UBS BB.
The confidence in this accelerating effect of investment on the Brazilian economy shapes the bank’s optimistic view about the country’s macroeconomic scenario. UBS BB was among the first to bet on stronger growth and lower inflation in 2022. The scenario for 2023 is the same. Mr. Ázara foresees 1.4% growth next year and put Brazil’s official inflation index IPCA at 4%. The medians of the Central Bank’s Focus survey with economists are, respectively, 0.6% and 4.9%.
Such dynamism can help Brazil navigate almost unscathed through the stormy crisis raging abroad, the economist said. In a world very concerned about inflation in the United States and the slowdown in China, “Brazil became the darling, but in a relative ‘ugly contest’.”
However, it is key to know from the winner of the presidential election what the fiscal policy will look like. “If a proposal comes out to take items out of the spending cap and a R$200 billion waiver, I think the reaction will be very negative.”
Read below the main excerpts from the interview:
Valor: What supports UBS’s more optimistic view on Brazil’s economy?
Alexandre de Ázara: At the worst moment in 2020, we projected that GDP would contract 6% to 7%, and the most pessimistic analysts were talking about 10%. In 2021, we expected growth close to 2%, it ended up at 4.6%. For this year, we started with something between zero and 0.5%, and it will end up close to 3%. In other words, for three years now, we, the economists, have been consistently underestimating Brazil’s GDP growth. I wanted to make this introduction to answer the question. I looked at the longer-term perspective, breaking down factors of production by capital, labor and productivity. We know that productivity growth was very high during the Lula administration. Between 2003 and 2013, it was 1% and 2% all the time, but it collapsed during the Rousseff administration and never recovered. My longer-term reading is that this increase in productivity, which made us imagine potential GDP at 4% or even 5%, was the effect of the creation of the credit market in Brazil. Until 2003, companies were not able to get a loan running for more than a year. Only the big ones could. Apart from that, we had the demographic dividend [when an economy grows as a result of a change in the age structure of its population], which peaked at that time. In 2014 and 2015, the economic policy led Brazil into a crippling recession, of 7%. There was then an uncoordinated but common economic policy response of classifying the country’s capital stock as excessive. And the only way to destroy excessive capital, without war or natural disaster, is to have depreciation. Then in 2014 the investment rate fell to close to 10% of GDP, which did not change despite the lower interest rates. One theory to explain that is that the interest rate had lost the power to drive investment. The other theory, which I like better, is that the power is the same, but there was a much higher capital stock than desired. It is difficult to demonstrate this in practice, but I can use this as a backdrop for my scenario. The economic recovery from the second half of 2016 onward brought a 1.7% GDP growth. Why wasn’t it higher? Because the capital stock was still excessive. But at some point between 2018 and 2019 that process must have ended. Then the pandemic hit and we could not realize that.
Valor: Does investment made GDP growth surprise to the upside?
Mr. Ázara: After breaking down GDP growth by consumption, investment, and government spending, the only component of GDP that is above pre-pandemic levels is investment, and by a lot. Investment is now close to 18% of GDP. This is the highest investment rate in Brazil since 2010, when the Economist magazine made that cover with Christ the Redeemer taking off. This increase in the ratio of investment to GDP, and also a higher-quality investment, has a very important accelerating effect, and that is why GDP has been surprising to the upside for two years now. This was not clear to anyone. Economists look at these numbers often because they don’t change all the time, but they tell a compelling story. That is why we have 1.4% GDP [projection] for next year. Another thing is that in order to calculate GDP in the short term, one thing many do is use data from China as a kind of proxy for world trade. Before the lockdowns [because of the zero-Covid policy], that proxy served well. That has changed. A lockdown in Macau, China, causes a contraction of demand and supply of services in that country that doesn’t necessarily impact the world in the same way.
Valor: But shouldn’t this investment rate fall with the rise in the Selic rate?
Mr. Ázara: There was a prevailing view that if interest rates went up, the investment would slow down, but this didn’t happen. Investment grew in this period only because a high rate of return was expected, and this only occurs because productivity will be good. And there is no public spending, this is the beauty of it, the greatest proof that we don’t need public spending to grow. [Former President] Dilma Roussef’s economic policy [2011-2016] focused on public spending, and I understand that she had the best of intentions, but it doesn’t work. The GDP fell by 7% and unemployment increased, creating uncertainty for families.
Valor: You are also more optimistic about inflation.
Mr. Ázara: I am more optimistic about inflation next year. There is a relative price of goods to be adjusted because of the normalization of world supply. It is not a permanent move, but it is likely to help to smooth out dynamics in the next 12 months. That is why I have a more optimistic projection than the market for this. My projection for services inflation, on the other hand, is closer to the consensus.
Valor: What is the potential GDP projection UBS works with for Brazil?
Mr. Ázara: We think the country can grow close to 2.5% in the next two or three years. For the long term, however, this number is closer to 2%. In order to improve, we have to make structural reforms that I don’t think either of the two candidates in the runoff vote will be able to do.
Valor: And what are these reforms?
Mr. Ázara: To grow above 2% a year, there is a list. But I think two are more important. The first is a new pension reform. Brazil still has very privileged civil servants. The rules that apply to them do not apply to the private sector. The second is to make a tax overhaul together with a spending overhaul, and a fiscal overhaul. This is my vision. If this is done, I think Brazil can grow by 3%, maybe even 4% a year.
Valor: You don’t believe in relevant reforms in either scenario?
Mr. Ázara: The taxation of dividends is the only measure likely to pass. Discussion in Congress is ripe, it is likely to be voted on. I think it is the only one. There is, in fact, an asymmetry, where business entities don’t pay taxes. Journalists, the financial market, lawyers, and engineers are the ones who most fit into these special tax situations. I worked for years in asset management and did not pay income tax because I received everything as dividends. I think it is a fair discussion.
Valor: Tax collection has been surprising along with economic activity, and has given the government room to maneuver. Can this situation persist in 2023?
Mr. Ázara: I believe so. We need, obviously, that the initial fiscal conditions are not bad. The winner of the runoff vote will have to ask for a fiscal waiver for next year’s target. If it is something north of R$100 billion, I think we will start off on the wrong foot. I like the idea of starting with R$50 billion, leaving more R$50 billion contingent on the approval of a new fiscal rule. But if this new rule keeps things out of the spending cap as if there was no limit, the market will misread it. It has to be a consistent rule that embraces everything: it can have some flexibility, and it can allow some additional spending contingent to the level of debt/GDP – if debt drops, for example, the government can spend more. This discussion is likely to last for the first six months of the administration.
Valor: To what extent can this more pessimistic scenario for the economy abroad affect Brazil?
Mr. Ázara: I was this month at the meeting of the International Monetary Fund (IMF) and the consensus is that Brazil has become the darling but in a relative “ugly contest.” The world is very concerned about a recession caused, mainly, by an excessive monetary tightening in the United States and a slowdown in China. The main reason Brazil suffers less is that Brazil always suffers less because it is a large and closed economy. We only export 10% of what we produce, we only import 10%. Besides this, the percentage of debt in the hands of foreigners is at a historic low, and the Central Bank, starting the year with fiscal and elections challenges, normalized the monetary policy earlier. Another question is whether the risk premium on the fiscal policy dominates the external risk.
Valor: Doesn’t growth fueled by the services sector, while industry and retail are falling, signal a worse quality GDP?
Mr. Ázara: I believe not. We spent a long time with a greater demand for goods. It was reasonable to have this adjustment. I don’t think it means a forecast of worse growth ahead. Investment is a very positive story. It is what rules the rest. Everybody is a little concerned and thinks that the situation is bad, but is investing. The general perception is worse than the sectorial situation, specific to each company. I believe that investment can be maintained for a while longer, contingent upon responsible fiscal choices. If it is irresponsible, it will fall to 10%, the same as it was during the Dilma Rousseff period. It has nothing to do with the ruler, but his choices will determine this.
*By Marcelo Osakabe — São Paulo
Source: valor International