By Richard Lapper and Jonathan Wheatley
Published: February 22 2007 02:00 | Last updated: February 22 2007 02:00
Ever since Goldman Sachs coined the term "Brics" towards the end of 2000, Brazilians have taken pride in a perception of their country, by investment banks and others, as an emerging power of equal status to Russia, India and China. But of latethat ranking has begun to look questionable.
This has been especially disappointing given the encouraging start made by Luiz Inácio Lula da Silva when the centre-left president took office in 2003. Then, buffeted by turmoil on international markets - which itself was heightened by fear that the former firebrand leftwinger would lead Brazil towards debt default - the most pressing need was financial stability.
Mr Lula da Silva surprised markets and his own supporters by delivering it. Sticking to many of his centrist predecessor's policies - keeping inflation in check with high interest rates and running large primary budget surpluses to pay down debt - while also extending targeted income transfer programmes, Mr Lula da Silva delivered a bonanza to the poor that was enough to get him re-elected with a commanding majority last October.
But there is one big problem: a stubbornly sluggish economy. Mr Lula da Silva has failed to deliver the "spectacle of growth" he promised in 2002 and Brazil is lagging behind its higher-octane peers. Average expansion of about 2.7 per cent since 2000 compares with 6.7 per cent in Russia, 6.5 per cent in India or 9.4 per cent achieved by China. In the words of Ricardo Amorim, head of Latin American research at WestLB in New York, Brazil is looking more like a "submerging economy" than an emerging one.
Hence the importance of an accelerated growth plan announced last month by Mr Lula da Silva, who began his second four-year term in office on January 1. The president has left investors in little doubt about his economic priorities. By increasing spending on roads, ports and other infrastructure and introducing new investment incentives, he says, annual expansion of 5 per cent is within reach.
Key ministers say this can be achieved without upsetting economic and financial stability. "We in the Lula administration believe that the hard work done over the past four years to create a stable macroeconomic environment allows us now to go after faster economic growth," Dilma Rousseff, the president's chief of staff and de facto prime minister, tells the Financial Times.
New spending must be funded, of course. The government plans to divert the equivalent of up to 0.5 per cent of gross domestic product away from debt repayment and into infrastructure investment. It argues that even with a reduction in its primary budget surplus it will be able to continue to reduce the ratio of net public debt to GDP, currently at about 50 per cent. Nevertheless, many economists see this as a dilution of the government's fiscal resolve that makes vigorous market reform less likely.
An emphasis on infrastructure is central to the new strategy. In recent years, with the government desperate to stabilise its accounts in order to control its debt burden, public investment has declined markedly. Even including spending by Petrobras, the giant state-controlled oil company, capital investment has totalled less than 3 per cent of GDP, well below the commitments being made by more rapidly growing countries in Asia.
The government hopes its new expansion plan, known as the PAC, will provide the necessary boost. Extra spending has been earmarked for roads and electricity generation, drivers of economic growth which, it says, will bring extra private investment in their wake. Private-sector investment will also be stimulated by tax breaks for construction and much-needed spending is also planned on water and sanitation.
Guido Mantega, finance minister, says in a separate interview: "All this will mobilise a construction industry that was paralysed for a number of years. This can dynamise the economy."
But shortage of investment capital is not Brazil's only barrier to growth. Many economists point to restrictive labour laws that have forced about 60 per cent of the workforce into the informal sector, cutting public revenues in the process. In the public sector, inflexible pay scales based on age deny managers the kind of performance-based incentives that might otherwise, for example, help improve standards of public education. Other obstacles include a bewildering tax system and a dysfunctional judiciary.
Mr Mantega says the government is aware of the need to remove bureaucratic impediments to growth and points to recent innovations such as a new law for small and medium-sized companies that simplifies the hugely time-consuming process of paying corporate taxes. He is also optimistic about the impact of a planned broader tax reform. Brazilians pay an extraordinary amount in taxes - about 39 per cent of GDP, more than many developed nations and twice the amount of many of Brazil's peers. The burden is unevenly distributed and the quality of public services often lamentable.
"We will merge all our indirect taxes into a single national value-added tax," Mr Mantega says. "We have a schedule of work whereby all these things are to happen and on March 6 we have our first meeting with the state governors."
Getting the powerful governors on side is fundamental because the present VAT system is state-based and reforming it will inevitably produce winners and losers among the states. Previous attempts have fallen at just this hurdle and Ms Rousseff is less optimistic than Mr Mantega about the outlook this time. "This [reform] demands deep and complex discussions with the states," she says, adding that the government has learnt from past mistakes and is now "building a new political situation that may lead to approval".
Yet critics say these efforts do not go nearly far enough. Many have concluded that the government is becoming less convinced that orthodoxy offers the way forward. Mr Lula da Silva seemed to say as much in his speech launching the PAC. "When I talk about a change in attitudes," he said, "I am not saying that we were on the wrong path, but that we have created the time and the environment to change and move on."
Indeed, the government appears to be losing the fiscal discipline it maintained during Mr Lula da Silva's first term. Then, under Antônio Palocci as finance minister, the government consistently exceeded its own target of a 4.25 per cent primary budget surplus.
One of Mr Palocci's last acts before being toppled by a corruption scandal a year ago was to propose annual reductions in the government's current expenditure (mostly on payroll in the vast state bureaucracy, pensions, health and education) as a percentage of GDP. Public funds would thereby be released for investment in Brazil's crumbling infrastructure.
Yet the reverse of this has taken place since Mr Palocci fell, as the government has granted generous pay rises to public employees and agreed to an increase in the minimum wage of significantly more than inflation. The PAC sets ceilings on such increases but they are above inflation and risk becoming lower rather than upper limits.
Instead of cutting spending or addressing other reforms, the PAC makes it clear that the government has put all its faith in the power of investment to spur economic activity. Ms Rousseff says the plan takes "the variable of investment as the determining variable for increasing the rate of economic growth".
The impression that the government believes it can spend its way into growth is strengthened by the PAC's reluctance to address fundamental issues such as pensions and labour reform. The government says it recognises the need for change in the pensions system and a forum to discuss the issue has begun six months of deliberations. But restrictions placed on what it may discuss suggest no radical proposals are likely to emerge.
On labour reform, Ms Rousseff is categorical. "This is noton this government's agenda.We believe there are biggerpriorities."
There are other causes for concern, critics say, in the way militants in the president's Workers' party (PT) have taken over much of Brazil's civil service. "Other parties are made up of members of various elites," says Luciano Dias, a political analyst in Brasília. "But the PT has tens of thousands of militants and has changed the way government is run." Mr Dias estimates that the PT has put 30,000 to 40,000 of its members in public service jobs. "It feeds resentment and incompetence," he says.
In the struggle for ministries among the parties that make up Mr Lula da Silva's coalition - especially between the PT and the catch-all PMDB, which has slightly more members of Congress - it is skill at horse-trading that counts rather than policy formulation or being able to offer the right person for the job. Mr Lula da Silva's struggle to unite his coalition leaves his second mandate at risk from the problems of governability that dogged his first, when Congress was paralysed by vote-buying and other scandals.
Perhaps the greatest doubts over the second Lula administration concern its true priorities. Mr Lula da Silva has put growth at the centre of public debate. But he has made it clear that growth alone is not worth having. As he stressed while launching the PAC: "Growing in the right way means reducing inequalities between people and regions, it means distributing income, knowledge and quality of life."
Indeed, if stubbornly slow overall growth was the failure of Mr Lula da Silva's first term in office, its outstanding success was in income distribution. Cheap, highly targeted welfare programmes and, above all, low inflation and high export prices for commodities (driving down the relative cost of imports) helped produce improvements in the living standards of the poor that has made Mr Lula da Silva the most popular president in Brazilian history.
It was largely by sticking to the tight monetary policies of the previous government that he was able to do this. But in refusing to implement conflicting policies that he championed during years in opposition, he was denounced by many of his supporters for betraying his constituents.
This, says WestLB's Mr Amorim, is a misreading. "Lula hasn't betrayed the poor at all; on the contrary," he adds. "What he has betrayed is the promise of growth."
The fear expressed by Mr Amorim and other commentators is not that the second Lula government will veer off course into populism. It is that by failing to grasp the opportunity offered by benign global conditions to overhaul the state, it will condemn the country to many more years of mediocrity.
Copyright The Financial Times Limited 2007
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