Brazil: the Recession is Over, the Crisis is Not
by Mário Braga
BRICS leaders in Hangzhou, China, September 3, 2016. Left to right: Temer, Modi, Xi, Putin and Zuma.
Photo by Beto Barata
Eduardo still has no job. It has been a year since he got his bachelor's diploma. No concrete opportunity laid ahead. By April 2017, the Brazilian engineer was more than worried. In a desperate attempt, he decided to add as many people on LinkedIn as he could. An e-mail with his CV would always follow. The 10,495 contacts he currently has on the platform are the result of over 100 daily requests carried out month after month. By then, his routine was surgical: wake up, have breakfast, turn on the computer. The "add connection, send e-mail" cycle would go on until 5 pm. "It was like a job for me," he describes. The 24-year-old would receive no more than two or three replies. Per week. Mostly some demonstration of support. Not a job offer.
Eduardo Intrieri was not alone. In March 2017, unemployment in Brazil hit a record high of 13.7%, affecting 14 million people. The lack of jobs was a consequence of the country's worst recession in 30 years. Inflation skyrocketed to 10.6% in 2015. The Gross Domestic Product (GDP) shrank 3.5% in the same year and another 3.5% in 2016. Investments collapsed.

Relief came in 2017 when the economy grew 1%, consumer prices accelerated only by 2.9%, and the unemployment rate began to fall. The recession is officially over. But believing that the country is back on track and that the economic recovery will hit full force is being naïve.

The impacts of the economic depression that lasted for 11 quarters will not simply vanish and make way for prosperity. The question economists, policymakers and citizens should be asking themselves is: why isn't Brazil's economic recovery guaranteed?

"Mayday, Mayday! We Lost an Engine"

The flight of the Brazilian economy was going well so far. The pilot managed to avoid the turbulence caused by the 2008 financial crisis. The country's GDP barely felt the strong winds and fell only 0.1% in 2009, while the world economy dipped 1.7%.

The maneuver, however, would prove costly. Direct interference in microsystems and demanding too much from the public investment turbine led to a generalized breakdown. The aircraft lost altitude, as growth slowed down from 3% in 2013 to 0.5% in the following year. Then, it just nosedived. A recessive freefall pulled down the economy by 8.2% between the second quarter of 2014 and the end of 2016.

The 1% rise registered in 2017 indicates that the plane has been stabilized. However, a critical area was damaged during the plunge: investments dropped 27%. As a major motor to keep the economy going, it is as if the hypothetical plane of Brazilian economy had lost an engine. No way the captain will be able to take the flight back to its previous conditions. The alarming situation here is that this context will not change any time soon, and here is why.

Trying to get the country out of its second-worst crisis in history, the federal government attempted to ensure economic growth by injecting money into the economy: vast public investment, widespread subsidized credit, generous tax breaks. And these are only a few examples.

Since 2014, the federal government spends more than it earns. Brazil's annual primary deficit deepened from R$ 20.5 billion (US$ 6 billion) in 2014 to R$ 159.5 (US$ 48 billion) in 2016. The situation is so critical that for the past years the Ministry of Finance does not even try to achieve positive results by making primary surpluses, as the economic jargon defines it. The country's fiscal target is set to be negative from the start.

In this scenario, government debt spiked from 60% of the GDP in 2013 to 74% in 2017, a peak since 2002. The country has the highest indebtedness among emerging markets, according to the International Monetary Fund (IMF). And the trend will persist in the years to come. The institution forecasts such ratio to reach 91.7% by 2021.

But Who Is to Pay the Bill?

In society, if someone spends more than they earn, creditors go after them, and banks no longer loan them money. Something similar happens at the national level. When a country is clearly incapable of managing its budget efficiently, flags are raised.

In the financial markets, the credit rating agencies are the ones pointing fingers. Yes, the same ones blamed for the 2008 financial crisis. Their work, however, is still closely watched by investors worldwide. Especially the ones at pension and hedge funds, who deal with — literally — trillions of dollars. For they not to take chances with people's "big money", most statutes bind them to invest only in countries accredited with "investment grade" ratings. That is why the decisions made by the three largest credit agencies are so crucial for emerging economies.

In that front, however, Brazil is lagging. The critical fiscal imbalances had the country downgraded to speculative level back in 2015. In the following year, the outflow of dollars topped the inflow by US$ 15,8 billion, as investors sold local assets and moved onto better-rated markets, according to the Central Bank's data.

Until the country rearranges its public accounts and regains international trust, financial investment will be limited. At Standard & Poor's rating, Brazil is three steps below investment grade. By Moody's ranking, two degrees below. The latter however improved the country's outlook from negative to neutral in April 2018 in the first positive note in that front since 2015. Climbing up the credit rating ladder will take time, though.

On average, downgraded countries took 7,2 years to regain investment-grade status, a study by Brazil's largest bank ItaúUnibanco reveals. However, for a group of countries with high debt and low saving rates, it took longer: 10 years. With similar economic conditions, South America's largest economy will have to say "goodbye" to institutional investors for about a decade.

"At Least We Tried"

When faced with this situation, Brazil's government did not stand still, it must be said. This does not mean it made the right choices, though. In 2016, Senate passed a spending cap proposed by president Michel Temer.

The constitutional amendment limits for two decades the increase of the federal budget to the inflation rate of the preceding year. It was meant as a strong sign for the international markets that the country is committed to fiscal discipline and will be able to control the expansion of its public deficit.

The decision, however, is controversial — not to say questionable. Vox classified it as the "harshest austerity program in the world", highlighting that government's expenses on health care, education and infrastructure will be stuck in real terms until 2037.

But that's not all. Brazil has a bomb-clock pension system that will increasingly demand more resources if no reform is passed. An IMF study estimates that pensions, which currently account for 11% of the country's GDP, will represent 18% by 2030.

With the public spending ceiling, the federal administration will have no other choice to comply with the law but to defund other components of its budget, including public investment.

The Invisible Hand

If the potential for financial and public investments is clearly compromised, business enterprises could be a viable solution for economic recovery. But that is not likely to happen.

Brazil has undergone a drastic process of deindustrialization. The sector's share of the GDP hit 11.8% in 2017, the lowest level since 1996, when it started being recorded by Brazil's statistics agency, IBGE.

The recession made matters worse. People and businesses were buying so little that factories countrywide started simply shutting down part of their machinery, letting employees go and working at a slower pace.

To be precise, as of March 2018, Brazilian industry was using only 76.1% of its existing capacity, according to a monthly survey by FGV, ranked Latin America's leading think-tank for eight years in a row. This number means that even if economic activity spikes and demand increases, factories can increment their production in 30% with no need to invest in new machinery.

This is directly linked to the country's extremely low level of investments, aggravated by the 27% decline over the past four years. The Gross Fixed Capital Formation (GFCF), the term economists use for investments, accounted for only 15.6% of the GDP in 2017, the lowest rate since it started being tracked, in 1996.

Against this backdrop, it is clear that there are no conditions for private investments to play a role in the country's upturn. The first researches on the topic already show that productive investments have been recovering at a slower pace than usual. A study developed by Aloisio Campello, a head researcher at FGV, indicates that GFCF grew 3.9% in the 12 months following the end of the recession. That is less than half the average rate of 8.8% registered after the previous eight recessive periods in Brazil's history.

"I Have a Job! No, Wait…"

Eduardo's job-seeking efforts paid off in June 2017. After a year and a half of fruitless attempts, a call for an interview at a company in a neighboring city was his big shot. When he sat for a talk with the Human Resources director, however, Eduardo thought there was a misunderstanding. The company was seeking an intern — or at least someone willing to take an intern's pay.

"I was shocked," he remembers. "It was confusing, but I had to make a decision right there". He ended up following the HR professional's advice. In the application form, when faced with the "salary expectation" field, he wrote down what the company was prone to pay: R$ 1300 (US$ 390) per month.

The sum is six and a half times lower than the base pay for engineers in Brazil. As a contractor, he is also not entitled to paid leave, pension savings or any labor right a regularly hired employee has. On his way back home, Eduardo did not feel like celebrating. "I had to accept such terms because I needed the job. There's no better way to put it", he says.

Again, Eduardo Intrieri is not alone. Unemployment is still high, but it slightly fell in 2017. The reason? A sharp rise of low-quality positions. When investments are low, and companies don't hire, people find a way to work somehow — but they make little money.

Such situations became so ordinary that those working on their own or with no formal contract have outnumbered regularly employed workers. The number of Brazilians properly hired — and entitled to labor rights — keeps falling despite the end of the recession. The figure reached a record low of 33.1 million in the quarter finished in February 2018, the most recent data reveals.

Meanwhile, self or underemployed workers sum 33.9 million people. On top of that, another 13.1 million Brazilians are unemployed. Both groups account for 45% of the country's labor force. With almost half of the working age population making less or no money at all, there is no reason to count on families' consumption — a factor that could generate demand and boost production — as a drive for recovery.

To put in perspective how the decaying labor market can undermine this process, it is a must to understand how such dynamics impact people's wage and the amount of money in circulation.

For starters, the sum of the wages earned by all Brazilians employed under the country's labor legislation declined 9.3% between its historic peak, in July 2014, and October 2017, the most recent data shows. This means that each month R$ 10.5 billion (US$ 3.1 billion) are no longer being injected into the economy, according to a monthly data gathering by Fipe, the Institute of Economic Research Foundation, linked to the University of São Paulo.

However, unemployment is not the only way a weak labor market affects the potential for economic recovery. Poorer employment conditions also play a role. On average, an employee with no formal contract earns 42% less than a regularly hired worker. Those working on their own, 24% less, according to IBGE data.

Even if the economic activity rehearses a comeback in the short-term, the conditions in the labor market will remain sour for a long period. "When a recession starts, the working conditions are the last aspect of the economy to be affected. However, when the economy is growing back again, they are the last to rebound," explains professor Hélio Zylberstajn, the researcher coordinator at Fipe who has studied Brazil's labor market for decades now. "Due to their high cost, hiring and firing are considered last resort measures for employers in Brazil", he adds.

This should serve as a warning: better-quality-higher-paying-jobs are vanishing while precarious-low-paying-positions are on the rise. Both mean less income for workers and are not likely to change any time soon. Tighter budgets in their turn indicate a lower level of household expenditure. Little consumption inhibits production. Again, we are looking at another significant obstacle for economic revival.

Can It Get Any Worse?

Unfortunately, it can. On the top of all this, Brazil is set to face a bumpy political road ahead. The presidential elections set to occur in October are considered the most unpredictable since the redemocratization of the country, in the late 1980s.

In the eyes of business leaders and investors, the scenario comes down to one word: uncertainty. And this is the most effective investment-repelling component known to the markets. If anything, these elections will translate into a decision paralysis until ballots give their verdict. After that, Brazil can be set on the path of a weak and slow recovery due to all the reasons discussed above or worse: in the hands of a populist, face an additional decline of its current already pale economy.

As Eduardo puts it, the longer his career crisis lasts and the more he falls behind competitors, the harder it gets to achieve his goals. The same goes for Brazil. The longer the country takes to define its political future, establish a transparent business environment, and balance its public accounts so government and foreign investors can return, the weaker and slower the upturn will be. Despite overcoming its worst crisis in 30 years, Brazil has no guarantees the page is turned, and growth awaits. If something is certain here is that the economic recovery is not a sure thing.
About the author: Mário Braga is a journalist from São Paulo, Brazil. He is currently a contributor for "The Brazilian Report", publishing stories in English mostly about the Brazilian economy. He has previously worked at Broadcast/Agência Estado, Brazil's leading financial newswire, at InfoMoney, covering stock markets, and as a TV reporter at local affiliates. He also had an experience as an information assistant at the United States Consulate General in São Paulo.

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