The return to normalcy in Brazil

The economic stress experienced since 2014, which continues to get worse each day, has generated anxiety among society for the country to return to normalcy. Business executives and consumers once again want to be able to plan for the future, leaving behind the scenario of default, bankruptcy and unemployment.

Normality presupposes balancing the macroeconomy, which means being able to envision, over a reasonable horizon, stabilization of the public debt in proportion to GDP, convergence of inflation to the 4.5% target, a downward path of the SELIC rate and actual growth in line with potential growth.

These goals may not seem ambitious, but in reality they are. In view of the current economic climate, the challenges are huge. The saying “change to remain the same”, although shopworn, adequately reflects the current moment. The return to normalcy requires progress in the reform agenda. The old recipe of controlling expenses “at the teller’s counter” and increasing the tax burden will no longer work.

The first steps will be important. The first challenge of the probable next government will be to formulate a courageous and credible economic agenda, to restore the confidence of economic agents. Clear proposals, well-defined priorities, competent policymakers and agile political dealmakers with good reputations are necessary.

Improved confidence can bring benefits in the short run. Besides retreat of inflation expectations and market interest rates, it is also might be possible to see, for example, positive signs from the labor market and private credit market, despite the fragile macroeconomic scenario.

The confidence of consumers and business leaders appears to have stabilized after a lengthy period of decline. But it’s too soon to celebrate. The levels of pessimism is still at record highs, which alone can work against any further decline of confidence. Some factors can act in the short term to stem the hemorrhaging of confidence, such as the end of the adjustment of inventories and costs/expenses of companies/consumers, and the impulse (albeit modest) from the external sector. The impact on confidence of the expectation of impeachment cannot be discarded. However, the fundamentals are still fragile, and in the absence of reforms, the improvement in confidence might not produce material results.

The indicators from the job market, like average number of hours worked in industry and the ratio between the occupied population and GDP, suggest that further layoffs are in store, mainly in the service sector, which is the largest employer. Many employed people are idle or underused. But discharge is a difficult and expensive decision. Besides the high monetary cost to pay severance benefits, the company loses trained and experienced workers, especially in the more advanced stage of payroll adjustment, when less qualified workers have already been laid off. We are seeing indications of this already, such as the increase in discharge of heads of household, who generally are more experienced workers.

This having been said, if business executives, with renewed confidence, decide to remove their finger from the firing gun, giving the benefit of the doubt to the new government, this will contribute to the cyclical recovery of the economy later on. It goes without saying that additional measures are necessary for sustainable recovery to occur.

Regarding the credit market, it is possible that private banks will gradually loosen the credit conditions after the substantial contraction in recent years, with the outlook of a credible economic agenda that reduces the level of economic uncertainties. There would be no cause for a surge in new credit, because the loan default rates are still high, and show no signs of accommodation for the time being. Nevertheless, although conservative (which is understandable in light of the legal insecurity in the country), banks tend to be zealous in preserving their market share. Measures that reduce the risks and costs in the credit market will be welcome.

It should be mentioned that the current levels of new undirected lending to businesses are the same as in 2004, adjusted for inflation, while such lending to individuals is at the same levels seen in 2008. When disregarding credit via check overdraft coverage and credit cards, which are the lines with the least restrictions imposed by banks, the picture is much worse. In other words, there is a veritable credit drought.

In light of the substantial contraction we’ve seen recently, the supply of private credit can be one of the first variables to return to normal. And less restrictive lending will help counteract default by companies facing problems of liquidity and access to credit.

The arrangements made at the outset will thus be essential. If all goes well, they will shorten the path to normalcy and increase the chances of recovery. The good side to all of this is that the team being formed by Temer, apparently, understands this.


Zeina Latif is chief economist at XP Investments. She holds master and doctorate degrees in Economics at University of Sao Paulo (USP).

Previously she worked at Royal Bank of Scotland as senior economist for Latin America, and ING, ABN Amro and HSBC Asset as chief economist for Brazil.

She is columnist at the newspaper Estado de São Paulo and she is counselor at the Social and Economic Development Council of the Republic Presidency.

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