beyondbrics

The inexorable climb of a latent global superpower: last year, Brazil’s economy outstripped Italy’s for the first time; this year, it will be bigger than the UK’s. So crowed local Brazilian newspapers recently. But how much of this triumph is real, and how much is an optical illusion? Judging by finance minister Guido Mantega’s latest measures to boost the economy, not as real as it might have seemed.

Brazil’s economy has indeed been growing at a ferocious pace – when measured in nominal, dollar terms. Since the global financial crisis first erupted in 2008, Brazilian nominal GDP has increased by an astonishing 52 per cent. In real inflation-adjusted terms, however, the performance is more modest: Brazil has grown just 10 per cent. Go back further, say to 1990, and the difference is more dramatic. In nominal dollar terms, Brazil’s economy is now five times bigger. But in real terms, it has “just” doubled since then.

Why does this difference matter? The short answer is because Brazil’s apparently fantastic growth rate hinges on its exchange rate. This has been pumped up by two factors. First, because of the startling climb in commodity prices, which has produced some real improvements in the economy. And second, because of capital inflows, which have produced some nominal improvements. Again, the difference matters. As Andrew Hunt economics points out, Brazilian nominal GDP has doubled since 2000 but employment has only grown by 10 per cent. Queer, no?

The apparent oddness of this discrepancy points to one of the vulnerabilities of Brazil’s investment story. The economy is now slowing, and interest rates are falling. But as interest rates fall, so too does the attractiveness of Brazilian capital markets – and also the exchange rate. If commodity prices should drop as well, then the exchange rate would fall further still – possibly by a lot.

Mantega’s removal on Wednesday of some of the taxes on portfolio capital will help inflows, a bit. But perhaps only at the margin – if Bank of America’s decision to shut its Brazilian private banking unit is anything to go by.

Of course, all this has happened before in Brazil. In 1998, foreign investors made a similar “round trip” into and then out of Brazil. Now it might be about to happen again. If it did, Brazil’s economy would not appear quite as beefy as many thought it was.

Related reading:
brics at 10, beyondbrics