The global economic crisis may cause a decline in Brazilian economic growth this year, but it won’t cause a financial crisis. Brazil is well positioned for a rebound once the world economy stabilises. Thanks to sizeable FX reserves, a solid public-sector debt position and a fundamentally sound banking system, its short and medium-term growth outlook has improved relative to many other emerging and developed markets. Brazil will emerge relatively stronger from the global economic crisis.
The world economy is experiencing the worst downturn since World War II and the worst banking crisis since the Great Depression. Brazil won’t be able to escape the economic slump, but various factors suggest it will emerge stronger from the crisis compared to many other emerging and developed markets, many of which will be struggling with substantial debt burdens and debilitated banking systems.
First, net external financing needs are small. The current account should be largely financed by net FDI inflows this year, limiting Brazil’s dependence on net debt inflows at a moment when global financial flows are falling sharply. A low dependence on net non-FDI flows makes Brazil less vulnerable than many other emerging markets. The depreciation of the real exchange rate in Q4 2008 has helped to absorb the shock to the current account. The sharp slowdown in domestic demand and declining profit remittances on the back of lower corporate profitability and a weaker exchange rate will also help limit the current account shortfall.
Second, gross external financing requirements are also manageable even if external roll-over rates remain at low levels. The central bank has built up large FX reserves which shield the economy against the capital account shock. The central bank has announced a programme to provide short-term financing to the corporate sector and its balance sheet looks strong enough to extend these lines into 2010, if necessary. Thanks to large FX reserves and a floating exchange rate, Brazil is well positioned to ride out the external liquidity crunch.
Third, the government’s external debt position is solid. Today, the public sector is a net foreign currency creditor. This means that net public-sector debt declines if the currency weakens. In the past, a high degree of FX-denominated or FX-linked government debt and lower levels of FX reserves represented a major vulnerability, since exchange rate shocks increased government debt and quickly raised concerns about public sector solvency. Today the situation is the reverse, even after accounting for central bank FX transactions (e.g. provision of short-term credit to the private sector).
Fourth, fiscal policy and public-sector solvency are not near-term concerns. While increasing risk aversion and interest rates forced Brazil in the past into a pro-cyclical fiscal adjustment, this time the government can afford to let automatic stabilisers absorb the economic downturn. Whether Brazil can afford to run a fully-fledged countercyclical fiscal policy is more debatable given relatively high public debt. In practice, it probably does have some limited room to introduce a fiscal stimulus due to the fact that the government entered the economic downturn with a 4% of GDP primary surplus. Realistically and sensibly, the primary surplus will fall to somewhere between 2% and 3% of GDP. It is worthwhile noting that a 2-2.5% surplus will be sufficient to stabilise the net debt ratio at its current level.
Last but not least, Brazil has substantial scope to ease monetary policy. Unlike in the past, Brazil is in a position to substantially lower interest rates and stimulate domestic demand without jeopardising economic stability. The collapse in domestic demand and a benign short-term inflation outlook will provide the central bank with plenty of scope to cut interest rates. Unlike in other economies where central bank policy rates are falling (or have already reached zero), Brazilian interest rates have a long way to go before they reach zero. Lower interest rates combined with a fundamentally sound, well-capitalised and liquid banking system will sooner or later “unclog” the credit channel and re-ignite domestic demand. Brazil is not going to fall into a “liquidity trap”.
Brazil won’t escape the economic slump, but it is well positioned for a sustainable rebound once the world economy stabilises. The factors that will constrain economic growth in quite a few developed and emerging markets over the next several years do not apply (or apply less) in Brazil. Solid credit fundamentals, a sound banking system, a manageable public debt burden and a continued commitment to fiscal discipline will help ensure the resumption of sustainable long-term growth. Brazil won’t be expanding at 6% levels, of course, but the medium-term outlook relative to many other emerging and developed markets has improved. Brazil is indeed set to emerge stronger from the global financial crisis.