Brazilian waxing and waning

IN THE past few years Brazils economy has disappointed, and then some.
It grew by 2.2% a year, on average, during President Dilma Rousseffs first
term in office in 2011-14, a slower rate of growth than in most of its
neighbours, let alone in places like China or India. Last year GDP shrivelled
by 3.8%, and is expected to shrink again in 2016. Household consumption
has registered the first drop, year-on-year, since Ms Rousseffs left-wing
Workers Party (PT) came to power in 2003. At the same time, public
spending has surged. In 2014, as Ms Rousseff sought re-election, the
budget deficit doubled to 6.75% of GDP; it has since swelled by another
four percentage points. And now Ms Rousseff is facing her greatest
challenge yet: on April 17th the lower house of Congress voted to start
impeachment proceedings against her over accusations of accounting
trickery to hide the true size of the budget deficit.
This year is likely to be the third in a row when the government fails to set
aside any money to pay back creditors: the target for the primary surplus,
which excludes interest owed on debt, has been cut from an unambitious

0.5% to basically nought, and the government is trying to leave itself

room to post another primary deficit. Brazils gross government debt of
70% may look piffling compared to Greeces 197% or Japans 246%. But
its high interest rates of around 14% make borrowing costlier to service.
Debt payments eat up more than 8% of output. To let businesses and
consumers borrow at less exorbitant rates, public banks have increasingly
filled the gap, offering cheap, subsidised loans. These went from 40% of
all lending in 2010 to 55%.

As the government loosened fiscal policy, the Central Bank prematurely

slashed its benchmark interest rate in 2011-12. This pushed up inflation,

which is now well above the banks self-imposed upper limit of 6.5%, and
way above its 4.5% target. The interest-rate cut has since been reversed.
Since last July the Bank's monetary policy-makers have kept the rate at
14.25%, nearly two percentage points higher than before the decision to
cut. Alongside the lack of macroeconomic rigour, there was a lot of
microeconomic meddling: the government pursued a clumsy industrial
policy and shortchanged the private sector, for example by insisting on
absurdly low rates of return on concessions to run infrastructure projects.
Small wonder confidence slumped among businessmen.

Red tape, poor infrastructure and a strong currency have rendered much
of industry uncompetitive. So consumers have been the main source of
demand. A low unemployment rate pushed up wages. In the past ten
years wages in the cushy public sector have grown faster than GDP
(private-sector workers have fared worse). That allowed consumers to
borrow more, which encouraged still more spending. Now the virtuous
circle is turning vicious. Real wages have been falling since March 2015
(compared with a year earlier), mainly because Brazilian workers
productivity never justified the earlier rises. People are returning to seek
work just as there are fewer jobs to go around: unemployment in the main
metropolitan areas, which has long been falling and dipped below 5% for
most of 2014, increased to 8.2% in February. A broader measure puts it at
9.5%. Economists expect it to exceed 10% this year.

To improve its finances the government has cut spending on

unemployment insurance (which had risen even when the jobless rate was
falling) and on other benefits. Taxes, including fuel duty, have gone up. So,
too, have bills for water and electricity (two-thirds of which is generated
by hydropower). The point was to reduce demand following a record
drought in 2014 and to correct a policy of holding down regulated prices
to keep inflation in check (and voters happy). But these increases have
stoked inflation.

All this is hurting disposable incomes, a big portion of which are spent
paying back consumer loans taken out in the good times. Consumer
confidence has fallen to its lowest level since Fundao Getulio Vargas, a
business school, began tracking it in 2005. The government has no money
to boost investment. Petrobras, the state-controlled oil giant and Brazils
biggest investor, is in the midst of a corruption scandal that has paralysed
spending: the forgone investment may have reduced GDP growth last
year by one percentage point. It is hard to see where growth will come
from.
Worst of all, Ms Rousseffs policy levers are jammed. Failure to rein in
spending already prompted all three big rating agencies to strip Brazil of
its prized investment-grade credit rating. Now economists fret that it may
render monetary policy powerless: as the interest bill balloons, the Central
Bank could be forced to set rates to make it manageable rather than to
keep prices in check. The hawkish former finance minister, Joaquim Levy,
slashed 70 billion reais ($19.5 billion) off the discretionary spending
planned for 2015 (on top of the modest welfare reforms). But that was
trimming around the edges: roughly 90% of government spending is ringfenced and needs congressional approval (or sometimes constitutional
change) to curb.
Nor can the Central Bank ease monetary policy: that would once again
undermine its credibility and risk de-anchoring inflation expectations. If
that were not enough, a depreciating real is adding to price pressures,
though the prospect of Ms Rousseff's fall has cheered markets: the real
and the So Paulo stock market have rebounded as the likelihood of
impeachment has risen. But not before making Brazils $230 billion dollardenominated debt dearer. Ms Rousseff cannot bring Brazils animal spirits
back to life with more spending and lower interest rates. She was hoping a
return to economic orthodoxy would do the trick. Unfortunately, she lacks
the political capitaland possibly convictionto embrace it more fully in
the teeth of opposition to austerity, not least from her own left-wing
Workers' Party, whose support she desperately needs to avert
impeachment. As a result, Brazil's economy will take a while to heal.