After years of economic stagnation and heightened political uncertainty, Brazil finds itself on a more stable and predictable economic path; however, the country’s medium-term economic growth will remain modest despite government efforts to accelerate it, including by developing the country’s abundant offshore oil reserves. Over the past decade, Brazil’s economy has largely stagnated. A decade ago, a major corruption scandal coincided with the end of a more than decades-long commodity boom, which weighed on investment and economic growth. This was followed by the COVID-19 pandemic, which caused a sharp recession. In economic terms, the past decade thus differed sharply from the Lula years (2003-10), which were characterized by solid economic growth and increased macroeconomic stability in the context of increasing commodity prices and stability-oriented macroeconomic policies. Absent renewed exogenous shocks and barring a major change in savings and investment, which is unlikely, Brazil’s economic growth rate will return to its long-term average and potential of 2.0% in the next few years.
Real GDP growth in Brazil averaged 2.5% over the past four decades, but only 0.6% in the past decade. The ten-year average is inconsistent with Brazil’s medium-term growth potential of 1.5-2.5% on account of its investment levels. In 2023, real GDP growth is forecast to have increased nearly 3%, though this level of growth will be unsustainable due to continued low investment. Brazil ‘s savings ratio is a mere 14% of GDP and its investment ratio 16% of GDP. This is low by international standards and helps explain Brazil’s modest economic growth compared to many of its emerging economy peers. Historically, such a low investment rate is consistent with real GDP growth rate of around 2%.
Brazil’s economic outlook is stable, but its growth potential will remain modest. The risk of serious macroeconomic instability is low. Although Brazil’s has a high level of government debt and large public sector deficits, the bulk of government debt is denominated in local currency and the public sector is net foreign currency creditor, which sharply limits the economy’s vulnerability to external shocks. Moreover, Brazil continues to run trade surpluses and modest current account deficits, which are easily financed by non-debt foreign direct investment inflows. A flexible exchange rate, combined with an independent central bank, allows Brazil to absorb even severe external shocks. In the medium term, Brazil’s greatest economic challenge are a high level of government debt and limited economic growth. But the government has committed to eliminate the primary deficit, which has helped maintain investor confidence in the short term. Medium- to long-term, however, the government needs to make a greater effort if the debt-to-GDP ratio is to be stabilized. As long as the real interest rate exceeds the real growth rate of the economy, the government will need to run primary surpluses, sooner or later. Although the Lula government has loosed some of the restrictions that were meant to curtail real public sector expenditure, the risk of a fiscal crisis will remain manageable in the near-term, as public debt will increase only gradually over the medium term. Five-year sovereign credit default spreads, an important measure of sovereign default risk, are trading at less than 150 basis points, pointing to a very low level of sovereign default risk.
Institutionally, the Brazilian state has proven resilient in the face of political polarization, but resilience and stability also mean inertia in terms of economic reform, particularly in the context of an improving economic outlook through productivity-improving structural reform. An independent judiciary and a strong, or at least obstructive congress limit the Brazil’s ability to generate radical policy change. But the relative stability of the institutional framework is also responsible for the relative policy and reform inertia. While large-scale reform is difficult in all political systems, it is particularly difficult in Brazil due to the high number of veto players. Congress is highly fragmented and party discipline is low. Ideology barely matters, and presidents need to carefully build diverse and heterogenous presidential majorities, which limits the president’s ability to implement wide-ranging reform due to the need to reconcile politically divergent interests. The constitution is very detailed and many important economic reforms require super-majorities in both houses of congress, which are difficult to construct. The judiciary is very independent and both willing and able to constrain government action. In addition to institutional constraints, the relatively stable economic outlook also militates against growth-enhancing structural reform. Significant economic reform typically occurs during times of significant economic stability or after devastating economic crises. Relative economic stability limits the incentives of the government to pursue wide-ranging economic reform, often leading it prioritize smaller, less significant reform. Instead, the Lula government relies on fiscal spending to accelerate economic growth. But this will sooner or later run into the budget constraint and will do little to increase productivity, judging by the success of similar growth programs under the previous Lula and Dilma governments.
The government’s plan to develop its energy exports is welcome, which would boost export revenues, but it will not fundamentally alter the economy’s medium-term growth outlook. Even if the government succeeds in implanting its energy plan, the boost to medium-term economic growth will be limited, if welcome. First of all, the government would need to convert higher export revenues into savings and investment. But political-electoral pressures makes it likely that at least part of the windfall will be consumed. Second, not the entire increase in domestic oil and energy production will translate into increased net exports. Third, even though Brazil may become the fifth-largest oil exporter a decade from now, oil exports as a share of GDP will remain small compared to other major oil exporters, which will limit the impact of expanding production, exports and higher prices on Brazil’s medium-term economic outlook. In addition, increased government investment focused on other sectors, which often revives projects abandoned more than a decade ago under a similar growth program, will only boost aggregate investment marginally. Therefore, Brazil’s long-term economic growth will be highly unlikely to exceed 3% over the medium term, and this assumes that the underlying growth potential will not deteriorate in the next few years. But higher economic growth will help keep a lid on public debt, provided the government manages to eliminate the primary fiscal deficit. But it will be insufficient to raise aggregate investment to a level where it would make a significant difference to the medium-term economic growth outlook.