ISSUE BRIEF 02.17.17 The Lengthy Brazilian Crisis Is Not Yet Over Sergio Fausto, Contributing Expert, Latin America Initiative Since the first quarter of 2014, Brazil has funds, which were controlled by unionists been living in “crisis mode.” September affiliated with the PT; and a relatively 2016 marked seven consecutive quarters of restricted but powerful group of companies negative economic growth that resulted in a that were the primary beneficiaries of cumulative negative variation in the GDP of federal government-subsidized credit and more than 7 percent, the greatest recession contracts. With resources diverted from ever registered in the country. In the state-owned companies, these private same period, investigations conducted by companies provided electoral funding public attorneys and Brazil’s federal police for the dominant political coalition (the uncovered the largest corruption scheme opposition also received funding, but on in Brazilian history. The scandal was rooted a smaller scale). Intellectually speaking, in the largest state-owned company in the it is an interesting case of an attempt to country, Petrobras, but had widespread develop state capitalism in a competitive ramifications. By the end of December 2016, political environment. The lesson to be nearly 200 people had been indicted or learned is that this kind of experiment imprisoned. Most were businessmen and ends up undermining democracy by politicians, including the former president giving the incumbents an extraordinary of Brazil, Luiz Inácio Lula da Silva, who was electoral advantage and compromising a defendant in five judicial inquiries. At the the system of checks and balances, and/ confluence of the economic and political or generating fiscal disarray and financial crises, President Dilma Rousseff, a member crisis. In the case of Brazil, the experiment of the Partido dos Trabalhadores (PT) and was interrupted before democracy mutated reelected in October 2014 to a four-year into a semi-democratic regime. That it fell term, was removed from office in April 2016 short of causing a mutation in the nature and permanently impeached the following of the political structure can be explained September. She was replaced by Vice to a great extent by the strength of some President Michel Temer, who is affiliated institutions: the independence of the judicial with the Partido do Movimento Democrático branch, the autonomy of public attorneys, do Brasil (PMDB). and the freedom of the press, all of which The economic crisis and the corruption are guaranteed by the Brazilian Constitution probe (called Operação Lava Jato, or and upheld by society. Operation Car Wash) destroyed the The destruction of the party’s system power system that had been expanding that was dominant between 2003 and throughout the PT administrations from 2015 turned into a crisis of the entire 2003 to 2016. This system was composed political system, as the opposition parties of an ideologically heterogeneous alliance also became involved in the criminal of parties under the PT’s hegemony; trade investigations carried out by the Lava Jato unions; state-owned companies’ pension operation. This picture is similar to the RICE UNIVERSITY’S BAKER INSTITUTE FOR PUBLIC POLICY // ISSUE BRIEF // 02.17.17 one that prevailed in Italy in the wake of commodities-producing countries led to the Mani Pulite investigation in the mid- Brazil’s long-term sovereign credit rating 1990s. Conducted by public attorneys, being raised to “investment grade” in this investigation revealed the existence 2008. In this context, Lula’s government of widespread and systematic corruption felt emboldened to distinguish itself from schemes involving businesses and political its predecessor. Second, in 2006 Petrobras parties. As a consequence, the Italian announced the discovery of reserves in the political party system that had developed pre-salt layer located in ultra-deep waters since the end of World War II collapsed. In within the country’s maritime territory. Brazil, however, the political crisis came in They were estimated to be large enough conjunction with a deep economic crisis. to double the proven petroleum and gas In the short span of this issue brief, I reserves of the country. Thus strengthened, analyze both the anatomy of these mutually Brazil responded effectively to the impacts This kind of experiment reinforcing crises and the challenges that of the global financial crisis of 2007-2008 ends up undermining Brazil faces in overcoming them. by adopting counter-cyclical fiscal and democracy by monetary policies made possible by the giving incumbents economic gains obtained during Lula’s first FROM THE PRE-SALT TRIUMPHALISM term. The resulting economic contraction an extraordinary TO THE PETROBRAS TRAGEDY was intense but short-lived. Much deeper electoral advantage and longer-lasting, however, was the Lula’s first term in office (2003-2007) ideological impact of the financial crisis. and compromising demonstrated continuity with the economic It seemed to confirm the long-held belief the system of checks policies adopted by his predecessor, of most of the Latin American left in the Fernando Henrique Cardoso. During his and balances, and/ unsustainability of liberal capitalism, as two terms in office from 1995 to 2003, or generating fiscal well as in the superiority of state capitalism Cardoso brought decades of chronically as an instrument of national development disarray and financial high inflation to an end and liberalized the for developing countries (now rebranded crisis. Brazilian economy, ending state monopolies “emerging countries”). These three factors on oil and gas and telecommunications, resulted in the introduction of fateful policy among other infrastructural sectors. He changes in Lula’s second term, which were also created independent agencies to to be deepened under Dilma Rousseff’s regulate competition in these sectors and administration. eliminated legal discriminatory treatment Petrobras played a major role in the against foreign direct investment. Long- “national development” venture that took term commitments with sustainable public shape almost in tandem with the global accounts and low inflation were translated financial crisis. To that effect, in 2010 into new institutions such as the Fiscal the government used its super-majority Responsibility Law, which was approved in in Congress to approve a package of 2000. These commitments, as well as the interrelated bills changing the regulatory general framework of Cardoso’s economic structure established to govern the oil and policy, were kept by Lula in his first term gas industry after the end of Petrobras in office. This started to change during his monopoly under Cardoso. The bills were second term (2007-2011). approved with much nationalistic fanfare Three factors produced this change: in the midst of a presidential campaign First, by maintaining his predecessor’s that would lead then-Chief of Staff Dilma economic policies and even tightening fiscal Rousseff to the presidency. This legislation policy in his first year, Lula’s administration created a new regulatory structure for the rapidly dissipated initial market distrust and pre-salt region. benefited hugely from the commodities Under the new structure, all exploration boom that started in 2004. The combination and production activities in the pre-salt of consistent macroeconomic policies region were to be conducted exclusively domestically and an extremely favorable by Petrobras. Foreign investment was economic atmosphere abroad for permitted only as long as Petrobras held at 2 THE LENGTHY BRAZILIAN CRISIS IS NOT YET OVER least a 30 percent share in any consortium Between 2011 and 2015, the Petrobras formed to bid in the region. A new local investment program quadrupled in content policy—much stricter and more comparison with the previous five years. To detailed than the prior one—was applied finance this unrealistic program, Petrobras to the oil and gas productive chain. A started to rapidly acquire debt. At the production sharing agreement (PSA)—used same time, it lost revenue due to the almost exclusively in authoritarian regimes— government-dictated policy of deterring was substituted for the concessions inflation by controlling the price of fuel and program that had been adopted with great saw its expenditures rise as a result of the success after the end of Petrobras monopoly excesses of the national content policy. (the old structure remained in place for Between 2009 and 2015, Petrobras’ debt areas outside the pre-salt region). increased five-fold—becoming the largest Such a major policy change can only be corporate debtor on Earth—and its capacity After the pre-salt explained by the confluence of ideological for cash-flow generation was considerably and more practical factors. To increase the reduced, bringing the company to the brink discovery, the participation of the Brazilian state in the of financial ruin. expansion of future revenue stream that would come out investments in the of this new source of wealth, adopting a petroleum and gas higher level of taxation for the pre-salt region THE DOOMED INHERITANCE FROM would have sufficed. But Lula’s government DILMA ROUSSEFF sector became, all insisted that changing the regulatory at once, one of the The Petrobras disaster is the most prominent structure was the only way to ensure that case in a general process of deterioration main gears of the the oil coming out of the pre-salt region affecting Brazil’s economy and