Brazil is hot now what?

Global Finance, Jun 2001 by McCrary, Ernest S

Brazil has earned the respect of economists and the favor of foreign investors by clawing its way out of chronic inflation and repeated backsliding over the past 40 years. Now, with external problems clouding the horizon and the election of a new government next year, another testing point is at hand. Can Brazil keep its act on track?

For more than 40 years Brazil's economy has been "on the verge" of taking off-but repeatedly has been held back by entrenched inflation, spurts of nationalism, and a weak political system.

Today, though, there is ample evidence that the world's fifth-largest country in population (170 million) and ninthlargest in GDP ($600 billion) has turned the corner once and for all.After five consecutive years of outstanding performance that has brought economic and political stability-plus a literal flood of foreign direct investment-- there's no denying that Brazil is flying high. Foreign investors have more than doubled their stakes in Brazil since 1995, to nearly $100 billion. Thus, more direct investment has entered the country in the past five years than all investments in previous years combined. The macro picture, relative to an increasingly gloomy world outlook, is downright bullish.

"Last year GDP was up 4.5%, and we had anticipated about 4% growth for this year," says Banco do Brasil's chief economist Uilson Melo Araujo in Brasilia,"We're still evaluating what the impact of a domestic energy crisis might be, but it's hard to see GDP going below 3% this year, even with the most pessimistic scenario."

That energy crisis, caused by drought that is crippling the country's mostly hydroelectric-based power systemand a California-style rate-fing issue that has gutted investments in recent years-could be an unwelcome surprise. Already the government is imposing rationing and electricity cuts of up to 20% as of June 1 will take a big bite out of industrial production in coming months.

"Either Saint Peter will have to save us again with a lot of rain to refill our reservoirs," says Fernando Quartim Barbosa Figueiredo, adviser to private Brasilian power company Rede, "or Brazil has to build a lot of new gas-burning thermal power plants soon."

Ironically, perhaps the biggest threats to Brazil's continued short-term growth today are external. Neighboring Argentina, a key trade partner with many ties to the Brazilian economy, continues to wobble along in a debt crisis and prolonged recession that taint the whole region. More important, the abrupt slowdown in the US economy and the looming prospects of a global slump can only bode ill for Brazil and its big export markets.

Yet, in a country whose favorite phrase is deixa comigo (leave it to me), these challenges pale in comparison to the systemic gridlock that has kept Brazil tangled in a spiral of inflation and debt for most of its modem history.

Helping the country break out of that debilitating cycle is the primary accomplishment of President Fernando Henrique Cardoso. He laid the foundations for today's outstanding performance as finance minister in 1994-bringing inflation down from 1,100% in 1994 to 14.8% within a year. He then rode the popularity borne of that success to two consecutive terms as president. Barred by the constitution from seeking reelection again in October next year, Cardoso's imminent departure from Brazil's political stage-and the absence of an obvious successor-introduces another element of doubt about the country's ability to continue its winning ways.

Brazil is hot. But should investors be concerned that another chill is just around the corner?

"We are more optimistic than at any time since the return of democracy in 1985;' says Paulo Ferraz, executive director of Brazil's Bozano Group and chairman of Invest-- shop.com, an online investor portal he founded in 1999.

"The foundation of the reform process here is strong. Unlike other countries-like Chile or Mexico-Brazil pursued a political solution first, and then a solution to its economic problems.We're the first country to do that, and it gives me great faith in our system."

Looking ahead, Ferraz says: "Will there be stress? Sure. But that's how the world works. In the midst of that, Brazil will continue to grow, and inflation will stay under control. Period."

Francisco Gros, a former central bank president and ex-Morgan Stanley Dean Witter executive who now heads the national development bank, Banco Nacional de Desenvolvimento Economico e Social (BLADES), has a similar view."Brazil made absolutely tremendous progress throughout the 1990s, and there have been extraordinary changes in the economy," he says. "We've finally put inflation behind us, from a technical point of view, and people understand this issue is resolved.This is absolutely fundamental. Our Law of Fiscal Responsibility holds the line on public finance.

Today's conservative monetary policy should stand, even with the arrival of a new president next year. "The risk of having a candidate who would change things is low," says Osanan Lima Barros, executive superintendent and head of international operations for Banco do Brasil. "Brazilian society would not accept it. There is no space to trade inflation for growth."