Adrift: Brazil’s Crisis of Confidence

Brazil fell to Germany 7-1 in the semi-final of last year’s FIFA World Cup soccer championship held in Brazil. Since then, things have only gotten worse for both FIFA and Brazil.

On the Brazilian side, President Dilma Rousseff, re-elected in October 2014 to a second term, has seen her approval ratings hit rock bottom to around 7% in recent opinion polls (probably just a co-incidence with Germany’s 7 goals!)

The Brazilian currency, the Real, has depreciated by 37% in 2015. The Brazilian economy has contracted or stayed flat in five of the last seven quarters. It is now in recession with no immediate signs of reversal.

Just weeks ago, Standard and Poor’s downgraded Brazilian government debt to a speculative level just above junk bond status. Brazil is now adrift.

The economic malaise is deepened by Brazil’s most pervasive corruption scandal of all time, the Petrobras Lavo Jato (“car wash”) kickback scandal.

It has already led to the conviction of dozens of political operatives and elected officials, including members of the governing Workers Party of President Dilma, as well as corporate executives from Petrobras and its private sector contractors.

According to Brazilian federal prosecutors, electoral politics has been plagued by multi-million dollar bribes offered by some of Brazil’s largest private sector companies to Petrobras executives and politicians in order to secure lucrative infrastructure and procurement contracts.

However intriguing it is to focus on the corruption scandal, and as vital as it is to Brazil’s future to clean house, corruption alone does not explain the country’s economic malaise.

Scrambling for fiscal stability

Recently, Brazilian economists Mansueto Almeida, Jr., Marcos Lisboa and Samuel Pessoa published a critical analysis of Brazil’s federal government accounts.

They showed that current spending levels are not sustainable and contribute to the nation’s recession.

According to the report, Brazilians’ tax burden grew from 25% of GDP in 1991 to more than 35% by 2014. And while per capita economic growth increased by 103%, tax collection increased by 184% during this same period.

In other words, the public sector appropriated some 45% of the country’s per capita economic growth.

On a positive note, much of this increased spending was devoted to education, health and income redistribution programs with the Social Security system generating the largest increases.

However, today these spending increases prevent the government from balancing the budget and investing in future economic growth.

To be sure, some social programs have been very effective and affordable, including the so-called “Bolsa Familia” cash transfer benefit. It has lifted millions out of extreme poverty — at a cost of only 0.5% of the GDP.

Where does the problem lie?

The real problem, as Almeida, Lisboa and Pessoa point out, is the Social Security system. From 1991 to 2014, social security spending increased by 4.3% of GDP.

In Brazil, the average retirement age for women is 52 years and 54 years for men. That is significantly lower than nearly every developed country, which have much higher per capita earnings.

As established, this system effectively redistributes income from the private sector workforce mainly to white-collar public sector retirees.

This ill-advised transfer mechanism places a tremendous fiscal burden on the state, while also lessening the purchasing power of those workers, most likely to stimulate the national economy with consumption of wage goods (many of which can be produced in Brazil).

Under those circumstances, one can see why President Dilma and her Finance Minister, Joaquim Levy, are keen to bring about meaningful reforms.

However, her low poll numbers make it all the more difficult to pass these measures through the Brazilian Congress.

Cutting spending and raising revenues are critical to restoring Brazil’s credit rating, lowering interest rates and attracting greater productive investment for the economy. But that economic logic has little in common with the general policy preferences exhibited by most politicians, whether in Brazil or elsewhere.

No surprise, then, that the Brazilian Congress recently voted to oppose Levy’s package of cuts. However, it also failed to override most of the president’s vetoes, resulting in a savings of $31.5 billion dollars.

The road ahead will be very difficult for Dilma and Brazil. The recession and Petrobras corruption scandal have certainly left Brazil adrift.

Even the president’s own core constituency, the Workers Party (PT) and the country’s largest labor union confederation, the Central Única dos Trabalhadores (CUT), while they defend the president against impeachment, oppose her efforts to repair the public accounts and reduce the budget deficit.

Many of Dilma’s diehard supporters now call for Levy’s ouster. However, it is this growing lack of political coordination between the elected branches of Brazilian government that breeds a growing crisis of confidence.

This threatens to shipwreck the country, while the congress moves toward mutiny.

Some good news

What warrants proper highlighting – and points to an improved future path for Brazil’s political economy — is that the country’s federal prosecutors and judges are conducting a high impact judicial revolution.

There have been successive stages of investigation and prosecution as well as a growing list of convicted business leaders, political operators, Petrobras executives and leading political officials.

This most recently included the former Treasurer of President Dilma’s Workers Party, João Vaccari Neto.

The performance of federal judges, especially the work of Sérgio Moro of Curitiba to advance the Petrobras corruption prosecutions, have a bigger purpose beyond just the judicial one.

They actually limit the crisis of confidence and sense of malaise that generally reeks from the various elected branches of the government.

At the heart of this crisis is the growing partisan divide that affects not only Brazil’s executive and legislative branches but also many of Brazil’s largest political parties.

The Eduardo Cunha factor

Eduardo Cunha, President of the Brazilian Congress’ House of Deputies, plays a particular role in this. Cunha is a survivor of three previous investigations of corruption.

He is now under investigation by the Attorney General for accepting a five million dollar bribe related to the Petrobras corruption scandal.

Cunha opposes many of the executive-proposed fiscal reforms and blames President Dilma for the current bribery investigation. Cunha is actively fomenting the move to impeach the president.

His upcoming decision on whether or not to proceed with impeachment hearings against Dilma may well determine whether Brazil’s crisis of confidence spreads – and then like wild fire — or whether it recedes to allow for economic recovery.

The hope must be that Brazil will rebound from the global downtown and its own excesses to catch a gust of growth before the mutiny spreads to grab the captain’s wheel.