Brazil is witnessing a dramatic polarisation of its politics that risks putting foreign investors off the country until the 2022 presidential election – likely to be a straight contest between the right-wing incumbent Jair Bolsonaro and the left-wing challenger and former president Luiz Inácio Lula da Silva – which takes place on 2 October.
While the country still has Latin America’s largest economy, in US dollar terms it has shrunk since the Covid-19 pandemic struck: from $1.88trn (9.88trn reais) in 2019 to an estimated $1.49trn in 2021, according to the International Monetary Fund (IMF) (Mexico is Latin America’s second-biggest economy at an estimated $1.19trn). The Brazilian economy nosedived by -4.1% in 2020 and declined by an average of -2.2% a year between 2015 and 2019 after the last commodity boom ended in 2014. In fact, economists are referring to Brazil’s past decade as a ‘lost one’: GDP growth averaged only 0.27% a year between 2011 and 2020 and in dollar terms annual income per head has almost halved from $13,296 in 2011 to $6,783 in 2020, according to the IMF. Brazil’s per capita income now stands at $7,000, compared with Mexico’s $9,200.
Brazil was in bad shape economically as it entered the pandemic and was among the countries in the world that suffered the most during the Covid crisis. With a population of 213 million people (compared with Mexico’s 129 million), Brazil suffered the second-highest number of Covid-19 deaths (583,866 until 7 September 2021) after only the US (666,559). In terms of deaths per million people, it was the sixth-worst country in the world at 2,767 per million until 8 September, after Peru, Hungary, Bosnia and Herzegovina, North Macedonia and the Czech Republic.
Bolsonaro – aged 66 – assumed office on 1 January 2019 and has been a controversial president, borrowing heavily from the Donald Trump playbook. His populist, straight-talking, nationalistic approach won him wide support, at least at first. He dismissed Covid-19 as “a little flu” and railed against lockdowns. As recently as 4 March he told Brazilians to “stop whining” about the deaths from the virus. He even joked that Pfizer‘s vaccine may “turn people into crocodiles”.
Since then, however, he has signed massive jabs contracts with Pfizer and Johnson & Johnson and the country’s vaccination roll-out has gathered steam. By 7 September, Brazil had administered at least 200,714,744 doses of Covid vaccines, according to Reuters. Assuming every person needs two doses, that is enough to have vaccinated about 47.6% of the population.
Lula in the clear to challenge Bolsonaro
One of the most significant recent political events in Brazil happened on 8 March 2021 when a Supreme Court judge threw out the criminal charges against Lula da Silva (the 75-year-old who was president between 2003 and 2010), freeing him to run against Bolsonaro in 2022. Often known simply as Lula, he had been excluded from the 2018 presidential election because of corruption charges and spent 580 days in jail between 2018 and 2019. He used his first speech after the March verdict to condemn Bolsonaro’s handling of the pandemic. “Do not follow a single one of the president or health minister’s moronic decisions,” he said. “Get vaccinated.”
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In August, at a meeting of evangelical leaders, Bolsonaro raised the stakes by declaring: “I have three alternatives for my future: being arrested, killed or victory.” He later added that the first option is out of question. “No man on Earth will threaten me,” he said. Worryingly, he has also started to mirror Trump in questioning Brazil’s electronic voting system and has threatened not to accept the results of the 2022 election. He called for the adoption of printed receipts, saying that electronic ballots are vulnerable to fraud.
Bolsonaro’s public approval rating reached an all-time low of about 23% in September 2021, as soaring unemployment and inflation hampered the economic recovery. Many voters were also angry at his administration’s record in dealing with Covid-19.
Crime and the natural environment are also significant issues on voters’ minds. Brazil remains the country with the world’s highest number of murders: 50,033 in 2020, according to the Brazilian Yearbook of Public Security. The Amazon rainforest is disappearing at an alarming rate. If all that were not enough, the country is suffering from its worst drought in almost a century, threatening electricity supply and agriculture. It relies on hydropower for two-thirds of its electricity, but crucial dams are at less than one-quarter full, a near-record low.
Brazil has become extremely polarised politically. If Lula wins, he is likely to wreak revenge on the people who sent him to jail. The situation is terrible. Victor Rodríguez, LatAm Alternatives
Can Brazil get out of its rut?
Brazil has had a turbulent past – it has suffered from dictatorships and hyperinflation – and is passing through another tough period now. It has strong economic potential but its structural problems – including graft and suffocating red tape – remain huge constraints. It takes 79.5 days to create a company in Brazil compared with the Latin American average of 30 days.
“As things stands, Lula is the favourite to win next year’s presidential election,” says Victor Rodríguez, president and chief executive officer at LatAm Alternatives, a financial services company based in Miami. “There is now a great deal of political uncertainty around the election outcome and investors attach quite a lot of political risk to a Lula victory. There is now very little appetite to buy Brazilian assets; the risk is just too great.
“Sadly, Brazil has become extremely polarised politically. If Lula wins, he is likely to wreak revenge on the people who sent him to jail. The situation is terrible.”
Otávio Vieira, partner and portfolio manager at Nest Asset Management, a São Paulo-based fund manager, says: “Brazil is not in a good shape at the moment. It has big fiscal problems, inflation is very high, we have the difficult elections coming next year and, to top it all, there is a big issue with energy generation because of the drought that has been taking place. I expect the country to have lower economic growth than other emerging markets during the next few years.”
Brazil's economic woes
Brazil’s economy shrank by -4.1% last year – mainly as a result of the Covid-19 pandemic – according to IBGE, the official statistics agency. It was the worst result since the current IBGE series began in 1996. During the year, only agriculture showed positive growth among the country's key sectors, up 2% from 2019. Services and household consumption fell -4.5% and -5.5%, respectively, owing to the pandemic and social restrictions to combat its spread.
The economy started to rebound strongly in the fourth quarter of 2020. It jumped by 3.2% during the three months (led by 2.7% growth in services, 3.4% expansion in household consumption and a 20% surge in fixed business investment). It also grew by 1.2% in the first quarter of 2021 but surprised economists by declining by -0.1% in the second quarter. The consensus among economists was that it would expand by 0.2% during that quarter, but a severe second wave of Covid-19 cases triggered restrictions in major cities during April and May, hurting household consumption and manufacturing. Goldman Sachs has now downgraded its 2021 real GDP growth forecast for Brazil to 4.9%, from 5.4%. At the end of the first quarter, GDP returned to the level of the fourth quarter of the 2019 pre-pandemic period but was still 3.1% below the highest point of economic activity reached in the first quarter of 2014.
Brazil is also suffering from a jobs crisis, which is one of the key reasons Bolsonaro's support has dropped despite his policy of handing cash transfers to the poor during the pandemic. The country's unemployment rate reached a historic high of 14.7% in April 2021. IBGE said that the number of people officially unemployed in Brazil was 14.8 million in April and that less than 50% of the working population had a job. In April, there were 3.3 million fewer Brazilians in work than before the pandemic struck more than a year before. The number of people entirely out of the workforce held steady at 76.4 million in April, up more than 5.5 million – or 7.7% – from a year earlier. The under-employment rate rose to 29.7% in January 2021, from 29% in November, according to IBGE.
What impact has the government's stimulus had?
The government’s response to the Covid-19 crisis was swift and sizeable. The authorities implemented emergency cash transfer and employment-retention programmes, improved health spending, provided financial support to regional governments and extended government-backed credit lines to small businesses. The emergency cash transfers to millions of poor families helped cushion the country against the impact of the pandemic and lockdowns and totalled about 322 billion reais ($56.5bn), a boost of some 4.5% of GDP.
Lots of economists are concerned that Bolsonaro will now look for other ways to make transfers to the poor in the run-up to the elections next year, that he will attempt to buy votes. Peter Hakim, Inter-American Dialogue
In all, fiscal and quasi-fiscal measures amounted to 18% of GDP, raising the primary government deficit to 12% of GDP in 2020, from 1% in 2019, according to the IMF. Fitch Ratings forecasts the general government deficit to remain relatively large at 7.4% of GDP in 2021. Brazil’s gross public debt ended July 2021 at 83.8% of GDP – down from 88.9% in March – but up from 74% in 2019 and 56% in 2014. The country's public finances have been deteriorating during the past five years and the pandemic made matters even worse.
During the crisis, the Brazilian Central Bank cut the benchmark Selic rate by 225 basis points to a historic low of 2%, where it remained until March 2021 when it was raised to 2.75%. It also announced extensive liquidity and capital relief measures during the emergency.
"Bolsonaro's cash transfers to the poor did a lot of good," says Peter Hakim, president emeritus and a senior fellow at the Inter-American Dialogue, a Washington, DC-based think tank. "They were praised by economists on the right and the left of politics. His approval ratings went up to about 45%, but they have now started to drop a lot. The problem is the federal government ran out of money and could not continue with the transfers.
"The country has had a strict cap on fiscal spending since Michel Temer was president between 2016 and 2018. Lots of economists are concerned that Bolsonaro will now look for other ways to make transfers to the poor in the run-up to the elections next year, that he will attempt to buy votes. The business community does not want to see a huge splurge in spending."
Lawmakers have been working on a new, smaller aid package to the poor, putting markets on edge about an undermining of fiscal discipline. There is concern that the government will not respect a constitutionally mandated spending cap that prevents the budget increasing above inflation.
Brazil's debt headache
Economists are particularly worried about a rise in government borrowing costs. The yield on the ten-year local currency bond recently hit its highest point – above 11% – since the 2018 presidential elections. At the end of August, the debt was trading with a yield of about 10.3%, well above the approximately 7% level from the end of 2020.
The country's annual inflation rate hit 8.4% in June 2021, its highest in almost five years and double the central bank's year-end goal. The monetary authorities have now been forced to rapidly unwind the low interest rates of 2020 and raised the Selic rate by one percentage point to 5.25% in August this year. Market expectations are that it will reach 7.5% by the end of 2021, according to a central bank survey.
“The persistence of inflationary pressure is greater than expected, especially among industrial goods," said the central bank in an August 2021 report. "Additionally, the slow normalisation of supply conditions, the resilience of demand and the implications of the deterioration of the water scenario on electricity tariffs contribute to maintaining high inflation in the short term, despite the recent appreciation of the real."
The price of food and electricity has been soaring in Brazil, made worse by the drought. Reservoirs in the centre and centre-west of the country are almost dry and the government has become increasingly concerned about power outages, which would hammer the real economy. “We have never seen a drought like this – it looks like I am being tested," said Bolsonaro in August. "I appeal to you at home now: turn off a light. This way you will help save energy and water from the hydroelectric dams."
The Brazilian currency's depreciation during the past five years underlines the economic problems the country has faced: in September 2016 it stood at 3.26 reais to the US dollar but had depreciated to 5.32 reais by 9 September 2021. The Ibovespa share index, meanwhile, has had a turbulent year and on 9 September (at 113,412) it remained slightly below the level it started the year at (118,800).
"Going forward, the economy will be jammed by a triple whammy," said Marcelo Fonseca, chief economist at asset manager Opportunity Total, in a recent interview. "The first one is inflation. It will definitely undermine consumer purchasing power. The second is the consequence of inflation – the central bank is now rushing to deal with [interest rate increases]. In order to fight inflation, we will have to hurt the economy. The third is the uncertainty. The fiscal regime is in danger and I don’t think that outlook will change during the electoral period. There will be a lot of turbulence, so some slowdown in investments – which have been driving the recovery – is inevitable.”
Pandemic freezes up Brazil's FDI inflows
Foreign direct investment (FDI) into Brazil boomed between 2009 and 2011 but has been slowing down ever since. According to the UN Conference on Trade and Develepment's (UNCTAD) World Investment Report 2021, FDI inflows into the country plummeted by 62% from $65bn in 2019 to $25bn in 2020. Last year, the pandemic forced the country's privatisation programme and process for approving infrastructure concessions to be paused for a number of months. The most affected industries were transportation (FDI inflows nosedived by more than 85%), financial services (down 70%), oil and gas extraction (down 65%) and the automotive industry (down 65%).
Brazil's stock of FDI has remained stable over the past two years and reached $608bn at the end of 2020. Last year, Brazil was the 11th-biggest recipient of FDI in the world in terms of inflows (it was ranked sixth in 2019) and is the largest recipient in the Latin America and Caribbean region. The main investing countries are the Netherlands, the US, Germany, Spain, the Bahamas and Luxembourg. Investments are mainly oriented towards oil and gas extraction, the automotive industry, financial services, commerce, electricity and the chemicals industry.
Brazil is an attractive market for international investors owing to a number of factors: a domestic market of more than 210 million inhabitants, availability of easily exploitable raw materials, a diversified economy that is less vulnerable to international crises, and a strategic geographic position that allows easy access to other South American countries. However, investment in Brazil remains risky because of several negative factors, including cumbersome and complex taxation, bureaucratic delays, and heavy and rigid labour legislation.
The country has been attracting some major new investors but losing others. In January 2021, US-based New Fortress Energy said it would buy Hygo Energy Transition and Golar, a Brazilian liquefied natural gas producer, in a combined $5bn deal. The transaction will make the company the leading gas-to-power provider in the country. Brazil has plans to open its natural gas industry further to private investors. Other major oil companies, including BP and EIG Global Partners, are considering multi-billion-dollar investments.
On the other hand, Ford Motor Company stated in January that it would close all three of its plants and stop producing cars in Brazil, where it has been operating since 1919. It said that the pandemic had amplified persistent industry idle capacity and slowed sales, resulting in significant financial losses.
Brazil is Latin America's top oil producer and enjoys the largest recoverable ultra-deep oil reserves in the world, with 94% of Brazil’s oil production produced offshore. It is also the largest electricity market in Latin America and the seventh-biggest globally in terms of electricity generation capacity. Renewable energy makes up a large percentage of the energy mix at 45%, and both current and future installed capacity represent an opportunity for foreign investors to provide much-needed solutions within energy storage, transmission and distribution, and efficiency.
Brazil is reliant on China for trade
China has been Brazil’s most important trade partner since 2009; it is its biggest importer and investor. Total commerce between Brazil and China reached $102.5bn in 2020 and that figure could be surpassed this year. Brazil is the main destination for Chinese investment in South America, having received $66.1bn – 47% of the Chinese total invested in the region – in the decade up to 2020, according to the China-Brazil Business Council. In 2020, Chinese investment in the country fell by 74% to $1.9bn, the lowest amount since 2014.
There is a perception in Brazil that corruption had dropped a bit since the Operation Car Wash, or Lava Jato, criminal investigation. Things don't seem quite so bad as before. Otávio Vieira, Nest Asset Management
Between 2007 and 2020, Chinese companies made large investments in Brazil's electricity sector (attracting 48% of the total amount), followed by oil extraction (28%) and mining (7%).
Brazil was ranked in 124th spot out of 190 countries in the World Bank's 2020 Doing Business report, a significant decrease from the previous year, when it took 109th place. In Transparency International's Corruption Perceptions Index 2020, Brazil was ranked in 94th place among 180 countries worldwide, an improvement on its 2019 ranking of 106th spot.
"There is a perception in Brazil that corruption had dropped a bit since the Operation Car Wash, or Lava Jato, criminal investigation," says Nest Asset Management's Vieira. "Things don't seem quite so bad as before."
Operation Car Wash was a huge criminal investigation by the Federal Police of Brazil between 2014 and 2019, which resulted in more than 1,000 warrants of various types. Investigations implicated senior management at the state-owned oil company Petrobras, politicians from Brazil's largest parties (including former presidents of the country), presidents of the Chamber of Deputies and the Federal Senate, state governors and businessmen from big corporations.
Will Bolsonaro's structural reforms bear fruit?
Bolsonaro's administration has been credited by economists for structural reforms at the start of his presidency, in particular in the thorny area of public pensions. The pension reform bill passed in October 2019 was significant, as it required a change in the country’s constitution and a super-majority in Congress. The high cost of the pension programme had long been the major cause of the country’s large fiscal deficits. The measures were expected to result in savings of $195bn over the next ten years.
Led by Economy Minister Paulo Guedes, the Bolsonaro government has also been active on other economic fronts, including privatisations, selling in excess of $23bn in state assets in 2019. To strengthen its business environment, the country also introduced electronic certificates of origin, which reduce the time required for import documentary compliance.
The IMF has urged the authorities to press ahead with other structural reforms to boost potential economic growth and improve living standards. These would make the economy more competitive, open to business and trade and attractive to investment. It stresses the need to pass comprehensive tax reforms, to accelerate the pace of new concessions and privatisations and to finalise trade agreements. It also emphasises the importance of labour market reforms – as well as education and reskilling – to make it easier for people to find new jobs. It says that it is also important to stop legal and institutional setbacks to combatting corruption and to implement effectively anti-money laundering procedures. Measures to ensure the integrity of public procurement are also needed.
However, the government delayed sending its proposals for tax and public service reforms to Congress in 2020 and commentators now think they are unlikely to be passed before the 2022 elections.
The destruction of the Amazon
One of the areas where Bolsonaro has faced the severest criticism concerns Brazil's natural environment. Ecologists say that the president has steadily dismantled or discredited the mechanisms that helped protect the Amazon, including satellite monitoring, personnel on the ground and legislation to punish offenders and demarcate indigenous land and conservation areas. Between August 2020 and July 2021, the rainforest lost 10,476km2 – an area almost seven times bigger than greater London or 13 times the size of New York City, according to Imazon, a Brazilian research institute tracking Amazon deforestation since 2008. The figure was 57% higher than the previous year and the worst since 2012.
Brazil contains extremely rich mineral reserves that are only partly exploited, including iron ore, tin, copper, pyrochlore (from which ferroniobium is derived) and bauxite. There are also significant levels of asbestos, china clay, gemstones, gold, granite, manganese, quartz and tantalum. Most industrial minerals are concentrated in the states of Minas Gerais and Pará, including iron ore, bauxite and gold. Mato Grosso and Amapá have most of the known manganese ore deposits.
The country could benefit from the rising price of raw materials since the start of 2021. A number of the minerals it produces are 'transition minerals' and important to the green energy revolution taking place throughout the world. According to UNCTAD, the price of minerals and metals has risen by 53.3% since the start of the pandemic. Brazil tends to do well economically when an upturn in the commodity cycle takes place and this could happen during the next few years.
The past few years have been very tough for Brazil and the pain is not over yet. The country's politics have become extremely polarised and are likely to remain so until the outcome of the presidential election is known. Lula is the favourite to win but Bolsonaro could still be victorious. A lot depends on what happens to the economy between now and then. Foreign investors are likely to enter a 'wait and see' mode. Whoever wins must embark on a series of structural reforms, so that the economy can become more competitive and more productive in the future.