According to an investor survey by Franklin Templeton Investments in Toronto, the two most bullish countries right now are India and Brazil. Investors there expect year-ending returns on equity funds of more than 13.5%.
This is also an election year, so the country finds itself at a political crossroads too. Dilma is expected to win, but her re-election will not be as easy as once thought. If she is re-elected, Brazilians and the market will be expecting changes in economic policy. Middle class citizens will expect Dilma to make good on promises to improve infrastructure and public services, like health care and education. The market will expect stability on macro-economic policies, rather than Dilma’s preferred method of short term tax breaks in hopes to spur consumption and job creation.
Since 2005, Brazil has relied on a consumption-driven growth model that was made possible by a favorable global environment of high commodity prices and ample liquidity. This liquidity allowed consumption to expand without Brazil “hitting the wall” against possible external constraints, Volpon said during the 2014 Brazil Summit in New York at the Harvard Club on Monday.
Brazil managed to avoid its boom-bust cycle of old, but did not avoid a serious correction to its economy pre-Dilma. Or as the Financial Times put it this year, Brazil’s “go-go” economy has become a “so-so” economy under Dilma. Some of the fault lies in the external landscape beyond her control. But a chunk of it also lies with Brasilia.
Today’s model — the “Lula model” — has many now well-recognized deficiencies. However, it allowed a large section of Brazilian society to become participants in society. Lula made this a goal of his first term in the early 2000s, and delivered on the promise to diminish poverty in the northeast and keep poor children in school.
The Lula model began to show its limitations in 2009. Specifically, the low growth in industrial production seen after 2010 and the persistent increase in service sector inflation were signals of severe supply-side constraints, and it is because of these that we have seen low growth ever since, Volpon said.
Brazil’s President Dilma took over the “Lula Model”, but changes to the world economy post-2008 made that model difficult to continue. Despite solid wage growth and low unemployment, Brazilians are less happy now than they were four years ago. Disdain over lackluster public services, high taxation and Dilma’s economic policies threaten her shot at re-election in October.
“One way to understand the errors made by the Rousseff administration during 2011 and 2012, the years of the new economic matrix, is that the government made a fundamental mis-diagnosis of why Brazil was seeing low growth, which emphasized demand-side factors at the detriment of the supply side of the economy,” he said.
Brazil will have to reverse course to some extent, and that is making some analysts pessimistic about a true turnaround. Punishing demand means higher interest rates, or higher unemployment, or stagnant wage growth. This worries investors as much as it does everyday Brazilians.
But like the new currency plan in the mid 1990s that saw Brazilians throw away Cruzeiros for Reals, and like the Lula model of stable inflation and wealth redistribution, Brazil is ready for its third act. The Central Bank has shown more interest in defeating inflation and keeping it under 6%. The market likes Central Bank governor Alexandre Tombini. It’s not so sure about Dilma and Guido.
In poll after poll, Brazilians of all social classes have expressed concern over volatile inflation. It’s made them overlook historically low unemployment and solid gains in real income, which continued under Dilma even as the economy weakened.
“What I see here is a manifestation, like in 1994 and 2003, of Brazilian society holding economic stability as a core value,” Volpon said. In Brazil, playing with inflation is a losing proposition for presidents.
“This political reality will go a long way to push the current economic debate in the right direction, regardless of who wins in October,” Volpon said.
Year-to-date, the iShares MSCI Brazil (EWZ) exchange traded fund is up over 3.8%, beating the benchmark MSCI Emerging Markets Index, plus the S&P 500, MSCI Europe and MSCI Japan.
Not bad for a core member of the “Fragile Five.”
-Kenneth Rapoza for Forbes