The BRAZILIAN ECONOMY Economy, politics and policy issues • MAY 2012 • vol. 4 • nº 5 FGV A publication of the Getulio Vargas Foundation

Foreign policy Foreign trade Brazil and the U.S.: The bankruptcy of Mercosur A lot to talk about Argentina Domestic policy Argentina: On the slippery slope How should the State Participation to full nationalization? Fund be shared? Mexico Interviews Reinventing itself Rubens Ricupero: Brazil, environmental power

José Júlio Senna: Interest rates and growth Cloudy waters After 15 years there’s not much to show for Brazil’s national water policy. F O U N D A T I O N

The Getulio Vargas Foundation is a private, nonpartisan, nonpro- Economy, politics, and policy issues fit institution established in 1944, and is devoted to research and A publication of the Brazilian Institute of teaching of social sciences as well as to environmental protection and sustainable development. Economics. The views expressed in the articles are those of the authors and do not necessarily represent those of the IBRE. Reproduction of the Executive Board content is permitted with editors’ authorization. President: Carlos Ivan Simonsen Leal Letters, manuscripts and subscriptions: Send to Vice-Presidents: Francisco Oswaldo Neves Dornelles, Marcos [email protected]. Cintra Cavalcanti de Albuquerque, and Sergio Franklin Quintella. Chief Editor Vagner Laerte Ardeo IBRE – Brazilian Institute of Economics The institute was established in 1951 and works as the “Think Managing Editor Tank” of the Getulio Vargas Foundation. It is responsible for Claudio Roberto Gomes Conceição calculation of the most used price indices and business and consumer surveys of the Brazilian economy. Senior Editor Director: Luiz Guilherme Schymura de Oliveira Anne Grant Vice-Director: Vagner Laerte Ardeo Assistant to the Editor Louise Ronci Directorate of Institutional Clients: Rodrigo de Moura Teixeira Editors Directorate of Public Goods: Bertholdo de Castro Vagner Laerte Ardeo Claudio Accioli Solange Monteiro Directorate of Economic Studies: Márcio Lago Couto Art Editors Directorate of Planning and Management: Ana Elisa Galvão Vasco Medina Coeli Marcelo Utrine Comptroller: Sonia Goulart Célia Reis de Oliveira Contributing Editors Kalinka Iaquinto – Economy Address João Augusto de Castro Neves – Politics and Foreign Policy Rua Barão de Itambi, 60 – 5º andar Thais Thimoteo – Economy Botafogo – CEP 22231-000 Rio de Janeiro – RJ – Brazil Contributing writer Tel.: 55 (21) 3799-6799 Email: [email protected] Lia Valls Pereira Web site: http://portalibre.fgv.br/ Marcia Carmo - Argentina IBRE Economic Outlook Coordinators: Regis Bonelli and Silvia Matos Team: Aloísio Campelo André Braz Armando Castelar Pinheiro Carlos Pereira Gabriel Barros Lia Valls Pereira Monica de Bolle Rodrigo Leandro de Moura Salomão Quadros IN THIS ISSUE 3 The BRAZILIAN ECONOMY

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Ne w s Br i e fs Finance and Environment, explains to than 50% of Argentines approve the 4 Company defaults and jobless rates Kalinka Iaquinto why investing in the move, which reversed President Kirchner’s rise … industrial output falls … CPI soars green economy is necessary for Brazil to recent fall in popularity, investors and cor- … private roads get more investment … achieve competitiveness, productivity, porate executives are far less enthusiastic, Amazon anticrime operation launched and efficiency and the unique strengths seeing it as part of a series of controversial … Congress defies Rousseff on land law on which Brazil can build. He also dis- moves. Brazilian investors are wary. … Cardoso on the current state of cor- cusses how economic and environmen- Fo r e i g n Tr a d e ruption … Obama-Rousseff talks produc- tal concerns might be balanced, and tive … Clinton says Brazil’s anticorruption what the government’s role should be. 38 The bankruptcy of Mercosur efforts are a model … benchmark rate Lia Valls Pereira looks at what Argentina’s Do m e s t i c Po l i c y falls … primary budget surplus posted. recent nationalization move portends for 22 How should the State the region and explains why Brazil can Fo r e i g n Po l i c y Participation Fund be shared? only lose by being identified as belong- 8 Brazil and the U.S.: A lot to talk about The Supreme Court has given Congress ing to the same group as Argentina. A succession of high-level meetings until January to set new criteria for how While Brazil has been active in promoting highlights the growing economic impor- states will share in the Participation investments in the region, any economic tance of the relationship between the Fund. Taking into account the history of discipline Mercosur created over the two largest economies in the Western the fund, Claudio Accioli discusses the years has been virtually abandoned. Hemisphere. The two share a mutuality resources at stake and what the options Recent events are reinforcing this trend. of interests not only bilaterally but in the are, and explains why Congress is not In t er v i e w global arena as well. Yet the U.S. is unwill- likely to meet the deadline. ing to endorse a seat on the UN Security 41 Interest rates and growth Council for Brazil. João Augusto de Castro La t i n Am er i c a José Julio Senna, former director of the Neves examines the reasons. 26 Mexico reinvents itself central bank, describes to Claudio Accioli Not long ago the largest economy in the context for some recent central bank Cov er St o r y Latin America was Mexico, not Brazil, but and government decisions related to 11 Cloudy waters when China joined the World Trade Orga- interest rates and the trade-offs they may In passing the National Policy of Water nization, Mexico lost U.S. markets and imply; he predicts “a long period of low Resources (the Water Law) in 1997, Brazil investment. Solange Monteiro describes interest rates.” He also makes recom- acknowledged that water is a valuable how Mexico has since been diversifying mendations about what Brazil can do to but limited natural resource. However, its economy and sees the dim future improve its growth prospects. 15 years later the results fall short. for Pemex. José Gerardo Traslosheros Solange Monteiro consults experts to Hernández, Mexico’s consul general in Ec o n o m y determine where there has been prog- São Paulo, compares the two economies. 44 IBRE Economic Outlook ress and what still needs to be done. Recovery of the Brazilian economy Thais Thimoteo describes the even 33 Argentina: On the slippery slope continues to be slower than expected. worse situation of sanitation treatment. to full nationalization? The industry decline in March was a Now that Argentina has almost com- cold shower, dampening prospects for a In t er v i e w pletely nationalized energy producer YPF, stronger second-quarter recovery. Hopes 18 Brazil: Environmental power where will it go next? Marcia Carmo in for improved economic activity must Rubens Ricupero, former Minister of Buenos Aires reports that though more now turn to the second half of the year.

May 2012 Ÿ The Brazilian Economy 4 BRAZIL NEWS BRIEFS

ECONOMY POLITICS Brazil jobless rate rises in March Trade balance in surplus in April, Brazil land law a defeat for Although Brazil’s jobless rate rose but imports rise Rousseff slightly more than expected in The Brazilian trade balance had a Congress has eased rules on March, the local labor market remains surplus of US$881 million in April, the the amount of forest farmers strong. Unemployment rose to 6.2% Ministry of Development, Industry must preserve, a victory for the in March from 5.7% in February, and Foreign Trade reported. This powerful agriculture lobby and the government’s statistics agency was 53% lower than in April 2011 a political defeat for President IBGE said. Real wages, or salaries (US$1,861 billion). April imports Dilma Rousseff, though the bill still discounted for inflation, rose 1.6% totaled US$18,685 billion compared requires that millions of hectares month-on-month to R$1,728 (US$919) to US$18,312 billion in 2011; exports of cleared land be replanted. and gained 5.6% from a year earlier. were US$19,566 billion, 8% less than Farmers have been responsible (April 26) in 2011. (May 2) for much deforestation in the Amazon and other swaths of Domestic credit grew in March March industrial output falls environmentally sensitive land. Domestic credit growth increased Output of Brazil’s mines and factories Rousseff may still veto the bill, from 17.3% year-on-year in February fell unexpectedly in March as they one of the most controversial to 18% in March as central bank rate struggled with high inventories and in recent years. The bill made it cuts stimulated corporate lending. increased competition from imports. through the lower house despite (April 26) Production declined by a seasonally adjusted 0.5% in March compared Rousseff’s overwhelming majority Company defaults rise with February, and by 2.1% compared there because of pressure from In the first quarter of 2012, the to March 2011. (May 3) powerful agribusiness interests. corporate default rate was 21.1% (April 25) higher than it was a year earlier, Inflation soars according to Serasa Experian. The Offical IPCA inflation was 0.64% Corruption higher than under 18.8% default growth rate in March month-on-month and 5.1% year-on- Cardoso? compared to the same month last year in April. The main contributors to In an interview with Folha year was the highest increase for rising prices were personal expenses, newspaper, Fernando Henrique March in two years. (April 30) apparel, and housing. (May 9) Cardoso said corruption has increased since he was president. INFRASTRUCTURE DEFENSE AND SECURITY President Dilma Rousseff’s “housecleaning” is important, 43% more investment in private Amazon anti-crime operation Cardoso says, but warrned that “she roads than public launched may not be assessing the political According to IPEA (Institute of More than 8,500 Brazilian troops risk that she is running.” Applied Economic Research), in in Operation Agata 4 are tackling He also complained about 2011 R$253,900 per kilometer were drug trafficking, logging, and illegal Brazil’s aversion to long-term invested in private roads compared mining in the Amazon, patrolling planning: “What do we do with to just R$177,200 invested in public an area of about 5,000km (3,100 the money from deep-sea oil? roads, though that represented an miles) along the northern border. You have to put it into science, increase in government investment. The Brazilian government says it is technology, education … Qatar Last year the National Confederation keeping concerned neighboring has goals for the year 2030. countries informed. (May 2) of Transport rated just 34% of They have a long-term strategic public roads as good or great vision.” (May 1) compared with 87% of private roads. (April 19) Photo: Antonio Cruz /ABr.

Defense Minister Celso Amorim.

May 2012 Ÿ The Brazilian Economy BRAZIL NEWS BRIEFS 5

FOREIGN POLICY Obama-Rousseff talks productive Barack Obama expects the recovery of the U.S. economy to be “slower

than seen so far,” he told President Photo: Wilson Dias/Abr. Rousseff in Washington, and expressed great interest in Brazilian oil and ethanol. The two indicated that a partnership in biofuels could be announced soon. The conversation was dominated by the global economic crisis. Rousseff blamed the U.S. for the cheap dollar, and was told that the problem is China. U.S. Secretary of State Hillary Clinton and Foreign Minister Antonio Patriota during press conference after meeting at the Itamaraty Palace, Brasília. Although Iran’s president, Mahmoud Ahmadinejad, noticeably Clinton categorizes draining resources.” The U.S. and bypassed Brazil on a recent Latin governments as open and Brazil are leading an initiative America tour, and Brazil voted closed establishing a commitment to open recently in the United Nations to In Brasilia at the 1st High Level government, which 55 countries censure President Bashar al-Assad Conference for Open Government have already formally signed. of Syria, there are still qualms in in April, U.S. Secretary of State Clinton also said that the key to Brasília about intervening in Middle Hillary Clinton said that the world economic success for both Brazil East conflicts. will soon be divided between open and the U.S. is innovation coupled Meanwhile, Washington has and closed governments, rather with concern for the environment. been reluctant to explicitly support than between north and south. She Between the two, she said, “There Brazil’s bid for a permanent seat on also said that President Rousseff’s are opportunities and potential for the Security Council, even after it fight against corruption can serve more investment, more trade, more backed India’s bid two years ago. as a model. Corruption, she said, jobs.” (April 17) (April 12) “kills the potential of countries,

ECONOMIC POLICY Interest rates falling Benchmark interest rate drops Primary budget surplus posted In response to calls from Finance to 9% in March Minister Mantega and President The central bank Monetary Policy Brazil’s consolidated primary Rousseff to boost growth, state- Committee announced a 0.75 budget surplus was R$10.4 billion controlled banks announced plans percentage point reduction in in March, the central bank said. This to lower interest rates on loans to the policy interest rate, dropping figure measures a country’s ability consumers and small and medium it to 9% a year. The unanimous to service its debt. In the 12 months companies. Caixa Economica committee decision justified the through March, the primary surplus, Federal, the country’s fifth largest drop because of the “fragility of the which excludes debt servicing, bank, will also offer more credit to global economy.” (April 18) was equivalent to 3.22% of gross small companies. (April 10) domestic product, down from 3.33% in February. (April 25)

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razil’s domestic economy is faltering. that an aggressive protectionist policy will make What can be done? Brazilian industry more competitive, though B For one thing, we can look around the history of protectionism is not promising. us, as we do in this issue. Argentina has Ozires Silva pointed out that Chinese and just effectively nationalized a major oil South Korean companies are successful because company, YPF. How much is that likely to “government and business interests are working help its economy? Not much. Starting in 2003 together to create a competitive direction for Christina Kirchner and her predecessor as those countries,” yet in Brazil bureaucrats president Nestor Kirchner nationalized the seem to actively distrust entrepreneurs. postal service, the railways, a radio spectrum Moreover, in Brazil, “The government is in operation, a shipyard, a water company, every corner of human activity … we cannot Argentina’s private pension funds, and its take a step without a government permit.” flagship airline. The results have been described He added that “what the government does is by economists as “mediocre crucial in determining whether to dismal.” In 2011 alone the Brazil is at a defining Brazilian businesspeople government spent nearly US$3 moment where it must manage efficiently,” which billion to prop them up. in turn is crucial to Brazilian Meanwhile, the economy stop dithering and competitiveness. of Mexico, which was the commit to a direction Brazil is at a defining largest in Latin America until … such a commitment moment where it must stop Mexico lost U.S. markets dithering and commit to a and investment to China, comes down to a direction. As the recent choice is surging ahead. Last year choice between of themes and articles suggests, Mexico’s GDP grew 3.9% going backward, like such a commitment comes compared to Brazil’s 2.7%, down to a choice between going and the outlook for this year Argentina, or forward, backward, like Argentina, is similar. Perhaps recognizing like Mexico. or forward, like Mexico. that the government is not Plodding along after Argentina, great at running a business—the national oil “protecting” industry with more government company Pemex is a case in point—Mexico control and more red tape, is likely to do little has instead sought to expand its markets and more than drive away foreign investment and now has 14 commercial treaties, though it is jeopardize the gains in economic equality Brazil still heavily dependent on the performance has made in recent years. Are those really the of the U.S. economy. When it lost labor- government’s goals? intensive maquiladora industries to China, Or, like Mexico, Brazil could move forward, Mexico promoted sectors with high added honestly identifying (and doing) what needs value and extended supply chains. As Manuel to be done to become more competitive in Molano, director general, Mexican Institute for global markets and build on the gains its Competitiveness, said, “We gained market share people have made economically. For years the with world-class products, not protectionism same problems have been diagnosed—lack or local content rules.” Meanwhile, Brazil has of infrastructure, unbalanced taxation, the been putting pressure on Mexico to limit its car high price of electricity, an education system exports to protect the Brazilian car industry. that doesn’t properly prepare students for This issue’s discussion of what is happening employment—and an occasional bandage has in neighboring economies is a natural follow-up been applied, but there has been no real effort to the last issue’s cover story and interview with to cure, much less prevent, such problems. Ozires Silva, once a minister and president of Doing something about them will help Brazil the successful aircraft maker Embraer. The to move forward. Doing nothing means going April cover story analyzed the government bet nowhere but backwards.

May 2012 Ÿ The Brazilian Economy 8 FOREIGN POLICY

Brazil and the U.S.: A lot to talk about

João Augusto de Castro Neves, Washington D.C. memoranda of understanding—ranging from aviation to food security—but also t first glance, Brazil-U.S. relations with U.S. recognition of cachaça as a seem to be booming. April began distinctly Brazilian product (it was classified with President Dilma Rousseff’s A as rum before), a decision that will probably first visit to the United States to meet with lower its tariffs. President Barack Obama. Then U.S. Secretary In Brasília, Secretary Clinton and Minister of State Hillary Clinton traveled to Brasilia Patriota conducted the Brazil-U.S. Global to talk to Rousseff and the Foreign Minister, Partnership Dialogue (GPD), a mechanism Antonio Patriota. A few days later U.S. for advancing cooperation and promoting Secretary of Defense Leon Panetta swung shared interests around the world. This year’s by Brasilia to chat with Celso Amorim, the GPD addressed such areas as education, Defense Minister. science and technology, social inclusion, In Washington, President Rousseff’s human rights, and sustainable development. agenda was more concerned with business Later Secretary Panetta and Minister than politics. Her trip was intended to Amorim launched the U.S.-Brazil Defense underscore the importance of economic Cooperation Dialogue, which deals with partnership at a time when Brazil is trying science, innovation, technology transfer, to respond to the effects on its currency of humanitarian assistance and disaster the global financial crisis by implementing response, cooperation in support of African policies to make its own industry more nations, cybersecurity, and defense support competitive. She and President Obama to civilian authorities at major international gave particular attention to agreements events. on educational exchanges, innovation, and energy cooperation. Rousseff left Washington not only with a stack of [email protected]

May 2012 Ÿ The Brazilian Economy FOREIGN POLICY 9 Photo: Roberto Stuckert Filho / Presidência da República

President Dilma Rousseff greets President Barack Obama during their meeting at the White House.

The succession of high-level meetings misunderstandings related to Colombia, highlights the growing economic importance Honduras, Cuba, and Iran in the final years of of the relationship between the two largest President Lula’s administration, Washington economies in the Western Hemisphere. With and Brasília seem to have established a more a US$60 billion trade flow in 2011, the U.S. is consistent framework for consultation. This Brazil’s second leading trade partner; it is an does not necessarily imply a common view important market for manufactured goods as well as commodities. For the U.S., trade with Brazil produced one of its highest trade The succession of high- surpluses in 2011, US$11 billion. Investment level meetings highlights and tourism numbers are also impressive. Therefore, despite the lack of a major the growing economic trade deal, the economic engagement is importance of the promising. More broadly, these meetings underscore relationship between the the fact that the two countries share a two largest economies in mutuality of interests not only bilaterally but in the global arena as well. After the Western Hemisphere.

May 2012 Ÿ The Brazilian Economy 10 FOREIGN POLICY

Brazil could do a better Even if some of these considerations may hold elements of truth, ultimately they keep job explaining to the U.S. relations between the Western Hemisphere’s (and the world!) how it two most important democracies from reaching their productive potential. Brazil would behave as a global could do a better job explaining to the U.S. power with a permanent (and the world!) how it would behave as a global power with a permanent seat on the seat on the U.N. Security Security Council. The U.S. could also rethink Council. some of its arguments against that. For example, the fact that Brazil is not a on all issues, but it does convey the idea that nuclear power and that South America is not disagreements need not result in diplomatic a strategic region should count in favor of, squabbles. As a leading U.S. diplomat said not against, Brazil’s aspirations. If the region not long ago, Brazil and the U.S. need to is relatively calm, it is because Brazil and learn to agree to disagree on some issues. Argentina made a collective effort to end Nevertheless, despite these positive their economic and military rivalry in the developments, there is one issue where 1980s. That rapprochement also defused the Brazil and the U.S. have not yet reached an nuclear component of the rivalry, something understanding. Brazil’s diplomatic “holy that India and Pakistan have not been able grail” is a seat at the Security Council table, to do. and the U.S. is not likely to endorse its bid The U.S. decision to endorse India’s any time soon. According to foreign policy bid and ignore Brazil’s sends a perverse specialists in Washington, Brazil does not message: It rewards a country that has deserve a place in the top echelons of snubbed every major nonproliferation the U.N. because it is not a nuclear power regime, while punishing a country that has and is unwilling to share the burden of willingly adhered to all those regimes. leadership. Another argument is that the The question of whether Brazil deserves a U.S. does not endorse Brazil’s bid—as it did place on the Security Council and whether India’s—because South America is not very it is capable of bearing the burden of global relevant to U.S. strategy. Finally, there is the leadership is another story. It will certainly argument that such an endorsement could give Brazil and the U.S. a lot to talk about at hurt U.S. interests with regional allies Mexico any of the many strategic dialogue forums and Colombia. that have been created.

May 2012 Ÿ The Brazilian Economy COVER STORY 11 Cloudy waters After 15 years there’s not much to show for Brazil’s national water policy.

Photo: Biwa/Getty Images

Solange Monteiro, Rio de Janeiro and data collection for a national water information system. razil owns about 10% of the However, 15 years later, the results fall world’s fresh water—an essential short. The institutional framework that Bresource for food production. the law envisaged was not disseminated However, water is unevenly distributed throughout the country but was across the country: the northern region, concentrated in the Southeast. Charging where there are the fewest people, has for water use, which would encourage most of the water, while the Southeast, sensible consumption and raise funds which has two of the largest cities, Rio to improve the watershed, is still the de Janeiro and São Paulo, is threatened exception. Of watersheds under federal with water scarcity. jurisdiction, only four charge for water With passage of the National Policy use: Paraíba do Sul, Piracicaba-Capivari- of Water Resources (the Water Law) in Jundiaí (PCJ), São Francisco, and Rio 1997, Brazil acknowledged that water Doce. By 2011 the four had taken in is a limited valuable natural resource. R$209 million. Charges are negligible Since then, water management has by international standards. begun, with division of watersheds, a Marilene Ramos, director, State plan for water resources, allocation of Environmental Institute (INEA), has water rights among consumers in each tracked the efforts to carry out water region and sometimes charges for its use, policy since its beginning, such as

May 2012 Ÿ The Brazilian Economy 12 COVER STORY

“Today we have the signs of change in consumer attitudes. awakening of a global “In the Rio Doce Basin, which established water charges at the end of last year,” he consciousness that the says, “collections ​​are higher than those water issue is really charged in other basins.” He adds that, “While in the Paraíba do Sul Basin each critical.” cubic meter captured costs 1 cent of Marilene Ramos Brazilian real, in Rio Doce Basin it costs 18 cents, and charges for organic matter released into rivers are 7 Brazilian cents creation of the Paraíba do Sul River per kg/BDO compared to 10 Brazilian committee, which began charging for cents in the Rio Doce.” water in 2003. “In France, revenues from charging for water use represent 30% A collision of interests to 40% of the investment budget of the In a participatory and decentralized watershed agencies,” she says. “Here, system, each sector will seek to look the average is 6% to 7%. There, annual after its own interests. According to water revenue is equivalent to US$30 per experts, irrigated agriculture, which capita; in Brazil, it is not even US$1.” uses the most fresh water, is the sector that most opposes water charges. “Can A fee, not a tax you imagine an industry with an interest For Vicente Andreu Guillo, director, group so strong that it can bring down National Water Agency (ANA), revenue a forest code?” INEA’s Ramos asks. “It collection is inversely proportional to is very difficult to collect water charges resistance to pay for water use. Laura from farmers. France and Germany could Stela Perez, technical advisor of the not do it either. In France, collection of Department of the Environment of water charges from the agricultural the State of São Paulo adds, “There is sector accounts for less than 2% of total widespread misunderstanding. Many revenues.” believe it is a water tax. But how could Representatives of agribusiness, such it be a tax if users are defining what they as former minister Roberto Rodrigues, pay?” For years, Perez has been involved argue that irrigated agriculture uses in the rather sluggish debate on water use water but does not necessarily consume charges in the Alto Tietê Basin. it: 90% of irrigation water returns to the ANA’s own study of users in the hydrological cycle, they say. ANA data, Paraíba do Sul Basin found that after however, shows that agriculture takes water charges were established only 25% 54% of total water consumption, of of respondents took measures to use water which it consumes 72%; industry takes more rationally. But Giordano Bruno 17% and consumes 7%; and cities take Bomtempo, an ANA expert, is seeing 22% and consume 9%.

May 2012 Ÿ The Brazilian Economy COVER STORY 13

“Rice cultivation — one of Laura A ntoniazi, Rede Agro researcher, says that agribusiness generally works the most water-intensive with tight costs and volatile margins, crops — in Rio Grande do which makes it sensitive to any new charges. “We cannot deny that in Brazil, Sul has reduced water use water is indeed wasted by some crops. But there are also advances. In Rio from 15,000 cubic meters Grande do Sul rice cultivation—one per kilogram in the 1970s of the most water-intensive crops—has reduced water use from 15,000 cubic to 8,000 today.” meters per kilogram in the 1970s to Laura Antoniazi 8,000 today,” she explains. Guillo also sees room to improve If companies do not become efficiency, since the loss of treated water efficient, the cost of water can shoot can reach 50%. “Today, industry is up. An example is the new Petrobras working to improve efficiency quickly chemical plant being built in Itaboraí. because it can be directly reflected in Because water supply in the region is productivity gains,” he says. Examples insufficient, Petrobras had to make an abound, even among heavy users expensive decision: the company will of water. CSN, the national steel bring in water from the Alegria water company,, used to use 10 cubic meters treatment station through a pipeline of water per second. Today that has under Guanabara Bay, an investment been cut to 5 and CSN is planning to costing about R$600 million. Ramos reduce that to 2. comments that “Petrobras will also need to invest another R $ 2 5 0 m i l l i o n to build a dam on the Guapiaçu river to provide safe water to the expected increase in population at its Photo: Ricardo Zig Koch Cavalcanti. new plant site.” The risks of water shortages are stimulating industry to undertake water- saving projects, says Demetrius David da Silva, vice chancellor, Water shortages are already affecting São Paulo city.

May 2012 Ÿ The Brazilian Economy 14 COVER STORY

University of Viçosa, Minas Gerais state. He spent the last two years coordinating a study to establish a coefficient matrix of consumption so that Photo: Ricardo Zig Koch Cavalcanti. industry can estimate the water resources necessary to expand a given economic sector. “It was only Irrigation of crops consumes a huge amount of water. quantitative; we didn’t study the quality of water returned,” he plus R$14 million in other income; yet of says. “Nevertheless, it was an important the R$83 million total, so far only R$25 initiative given that the latest data for million has been invested. “Why should Brazil was from the 1970s.” we collect more in water charges, when The study was delivered in April to we have almost R$60 million in cash?” the Ministry of Environment. There has he asks. been progress in some areas of water To ensure more efficient use of water use. The pulp and paper industry, for resources, the ANA and the National example, reduced its water use from 200 Confederation of Industries in February cubic meters per metric ton of product signed an agreement for technical to between 10 and 46 cubic meters. For cooperation. The partnership, effective iron ore production water use has been through December 31, 2014, will look reduced from 6 cubic meters to 1 cubic into ways to allow water customers to meter. “We are beginning to establish access part of the water charges collected an important relationship with industry, to buy equipment and production and see that there has been significant processes to make water use more progress,” da Silva says. efficient. Currently, collected water charges cannot be transferred to private Adjustments needed companies because they are a public Jorge Peron, environmental expert, resource. Federation of Industries of Rio de Janeiro Another key issue in Brazil is how to (Firjan), argues that Brazil needs to not revise the institutional framework for only collect more in water charges, but water management, which is complex also improve the way the funds raised are and slows the pace of work. For instance, used. He says that from 2004 through there is an excessive number of watershed 2011, the Paraíba do Sul River watershed committees. France has five; Rio de collected R$69.8 million in water charges Janeiro state alone has 9 and São Paulo

May 2012 Ÿ The Brazilian Economy COVER STORY 15 Photo: Ricardo Zig Koch Cavalcanti.

The Doce River basin supplies cities in Minas Gerais and Espirito Santo states.

state 20. Then there is the problem of water regardless of whether their region overlapping jurisdictions when a river has a watershed committee or agency. crosses more than one watershed or state The priority should be streamlining, and federal administrations—something says ANA’s Guillo. “We are seeking to that happens in 50% of cases—and is harmonize management of watersheds thus subject to multiple decisions. Ramos with the administrative boundaries of argues that the ideal would be to replicate each region,” he says. the model of Rio de Janeiro state, where “Today we have the awakening of all consumers are charged for use of a global consciousness that the water issue is really critical,” says Ramos. She “Today, industry is points out that the federal government is willing to prioritize sanitation, with working to improve several projects included in the Growth water efficiency Acceleration Program. “Today we have enforcement and fines for industrial quickly because it can pollution, but untreated urban sewage is be directly reflected in still a big problem,” she says, noting that, in Rio de Janeiro state, sewage treatment productivity gains.” covers only 33% of the population. Vicente Andreu Guillo

May 2012 Ÿ The Brazilian Economy Clean water, far-from-clean sewage treatment

Thais Thimoteo, Rio de Janeiro Losses Lack of sanitation has major economic impact— Although believed to be the sixth largest world especially absence from work and school and falling economy, Brazil has many shortcomings in areas productivity due to gastrointestinal problems. The considered central to economic and social develop- 2010 study conducted by the Institute Trata Brazil ment. These start with the minimum requirement for and the Getulio Vargas Foundation (FGV), published an acceptable quality of life: water and sanitation in- as Economic Benefits of Brazilian Expansion of Sanita- frastructure that gives the whole population access tion, demonstrates the extent of damage to both the to safe water, sanitation, solid waste management, public and the private sector. The federal National and storm drainage. Health System would save an annual average of R$42 In recent years, Brazil has achieved almost univer- million from a reduced number of intestinal infec- sal safe water supply in 5,564 towns, but collection tions if all municipalities had sanitation services. The and treatment of sewage is still very worrying. Data private sector in turn spends R$547 million a year from the 2011 Atlas of Sanitation from the Brazilian on wages paid for hours not worked to employees Institute of Geography and Statistics (IBGE), based on absent due to gastrointestinal infections. the 2008 National Survey of Sanitation (PNSB), show The study also shows that lack of sanitation has that less than half (46%) of Brazilian households have other economic costs. “An area with tourist potential access to sewage systems, but the percentages vary but without the necessary sanitation infrastructure widely by region. In the Southeast, 70% of house- will have no financial return. The same applies holds have access, in the Midwest 34%, in the South to residential developments,” says Edney Dias, 30%, in the Northeast 29%, and in the North just 4%. Sanitation infrastructure is most lacking in rural areas and the outskirts of large urban centers. With more education “There is a serious imbalance in the supply of and purchasing power, sanitation services. We have seen an evolution since the 1970s in supplying safe water, which today Brazilians are beginning to covers 90% of the country. But when it comes to sewerage, especially collection, we are more than 20 realize how important it is years behind. About 70% of waste returns to nature to have clean tap water and without being treated, and this affects health,” says Édison Carlos, CEO, Institute Trata Brazil. good sanitation.

May 2012 Ÿ The Brazilian Economy COVER STORY 17

The private sector spends are among the largest managers of resources for sanitation. He points out that “In selecting projects, R$547 million a year on problems began to appear in relation to quality, often outdated or poorly designed plans without wages paid for hours not environmental permits, and the inadequate execu- tion capacity of bidders,” This experience led to more worked to employees absent rigorous project selection in PAC 2: “Now, we verify due to gastrointestinal the suitability of all projects. If selected, their viability is then evaluated by the government savings bank, infections. Caixa Econômica, as agent of the ministry.”

Election consultant to the Brazilian Institute of Economics However, all efforts to improve the quality of life (IBRE) and contributor to the study. are of no avail if society does not understand the Since 2007, the Ministry of Cities (MIC), through importance of sanitary conditions. “Brazilians live the Growth Acceleration Program (PAC), has made reasonably well with open sewers,” Carlos says. “The efforts to relieve the problem by lending resources citizen demands asphalt, security, transportation, to states and municipalities to invest in sanitation. before sanitation.” Yet, it is possible to see signs PAC 1 (2007–2010) allocated R$40 billion and PAC 2 that with more education and purchasing power, (2011–2014) another R$45 billion. But the results so Brazilians are beginning to realize how important far have been meager. According to the MIC, only it is to have clean tap water and sanitation. “The 9% of the projects funded by PAC 1 were carried out, population is already concerned [about sanitation], so that only R$3 billion was spent. “Today we offer so local governments are acting. But what happens about R$15 billion a year for sanitation projects but is that a city often outsources sanitation services to cannot even spend R$8 billion. Considering that the companies and shifts the blame to them for eventual aim of MIC is to universalize services by 2030 and failures. However, the government is responsible that the federal government intends to allocate for administering the service,” Giustina says. Car- R$420 billion for the sector over the same period, we los adds that “Gone are the days when sanitation are not even at half the spending needed to achieve yielded no votes. We have to take the opportunity the sanitation goal,” Carlos says. we have in an election year and discuss the sanita- Yuri Giustina, MIC infrastructure specialist, at- tion agenda outside the offices. Only when people tributes the slow progress to a lack of planning and ask for improvements will the authorities mobilize management, especially by the municipalities, which more arduously.”

“An area with tourist potential but without the necessary sanitation infrastructure will see no financial return.” Edney Dias

May 2012 Ÿ The Brazilian Economy 18 INTERVIEW

Brazil: Environmental power

The Brazilian Economy—How do you assess the current government’s industrial policies in terms of the envi- ronment? Rubens Ricupero—Development of Brazil in the last 30 years has gone through several phases, in each of which there was a predominant problem. In 1994, when I was finance minister, the problem was hyperinflation. The second phase was the expansion of global Rubens Ricupero demand as the middle classes grew. These Former Minister of Finance and Environment two problems did not disappear but we Kalinka Iaquinto, São Paulo are moving into a third phase, where the

Investing in the green economy is key for Brazil emphasis should be on long-neglected to achieve competitiveness, productivity and issues: competitiveness, productivity, efficiency, says former ambassador Rubens Ricupero, and efficiency. It is in this phase that the now director of the Faculty of Economics at the environmental implications of policies Armando Alvares Penteado Foundation (FAAP). become an issue. Previously minister of finance and the environment in the Itamar Franco administration and secretary- What should be prioritized? general of the United Nations Conference on Trade In 15, 20, 30 years, the world economy and Development (UNCTAD), Ricupero affirms that will increasingly rely on products and Brazil has five environmental strengths: the world’s services based on low-carbon-emission largest rainforest, the largest reserve of fresh water, remarkable biodiversity, clean and renewable technology. A good case is China, which energy (40% of the total), and a globally unique for a long time practiced predatory devel- program of biomass fuel (ethanol) that can power opment of natural resources but today is millions of vehicles. investing heavily in clean and renewable

May 2012 Ÿ The Brazilian Economy INTERVIEW 19

wind and solar energy, where gradually renewable energy—but the tax burden it is becoming a major equipment manu- on electricity is huge. facturer . . . . Another curious fact is that in the Would more economic use of natural past companies with high stock market resources offer a way out? capitalization were those that had giant Brazil is a kind of environmental power industrial facilities. Today, Microsoft because it has five advantages: the world’s and Apple have intangible assets that largest rainforest, the largest reserve of require minimal power. These days Brazil fresh water, remarkable biodiversity, cannot be anchored in an industry like clean and renewable energy (40% of the vehicles, which are almost the symbol of total), and a globally unique program of the industrial revolution. biomass fuel (ethanol) that can power millions of vehicles. No other country What is the best route to competitive- has this combination of advantages. ness? Why is Brazil so efficient in producing Brazil cannot indefinitely postpone and exporting food? We have water and addressing bottlenecks that continuously sun. This huge advantage explains how we raise the cost of producing everything. If went from a country that was only signifi- that were true, some might advise that cant in two or three agricultural products we take refuge in agribusiness, or in to take a leading position in 15. iron ore. Production costs increase for all sectors, [but] in the case of manufac- How do we make the transition to a turing, which is inefficient, there is no green economy? margin, so any increase in production Last year, the United Nations Program costs undercuts competitiveness . . . . for Environment (UNEP) published a If nothing is done to curb rising costs, report assessing the cost of this transition [eventually] no Brazilian product will as 2% of global GDP (US$1,300 billion)1 be able to compete, except perhaps for . . . . Brazil has both natural forests that oil. In the case of commodities, Brazil could be managed and also the potential does have a competitive advantage, and to plant more forests. [But] China in one the erosion of competitiveness caused year is planting more than Brazil has by higher cost there is slower, but still planted in 20. As yet Brazil has not had steady. Also, for years, tax revenue has been greater than the In 15, 20, or 30 years, the world growth of the economy . . . . economy will increasingly rely on Brazil is proud to produce a products and services based on low- high proportion of clean and carbon-emission technology.

May 2012 Ÿ The Brazilian Economy 20 INTERVIEW

a rational long-term Brazil cannot but she is isolated. forest policy. We made indefinitely postpone Unfortunately, envi- mistakes in the 1970s, addressing bottlenecks ronmental awareness for instance, when is not among the great areas of Minas Gerais that raise the cost of merits of our president. state were destroyed producing everything. I think she recognizes because forests were this fact, but she has planted in unsuitable places . . . And given more emphasis to social and though Brazil has formulated advanced economic policies. genetics for eucalyptus reforestation, unlike South Africa, we use relatively Should we take more account of what little eucalyptus for furniture manufac- environmentalists and scientists are turing. saying? The attitude of most governments is Can the Rio+20 conference help us to denial. Anyone can download the latest further the transition? 2007 report of the Intergovernmental We are working in this direction. The Panel on Climate Change. If you do, group of which I am part argues that you will find that the situation is bad. Brazil should take this opportunity and Even though there is unanimity among produce a report like the UNEP did [on scientists, the silence [of governments] transitioning to the green economy] . . . is absolute. It is disturbing to learn that It is sad to see measures, to increase the most likely scenario for the Amazon taxes for imported cars and financing for was an average temperature increase of selling more cars, that have no environ- 8°C in 2008. mental counterpart. They are emergency measures that may even exacerbate the With economies failing, will economic problem. Whenever the economy slows, concerns override environmental the government has only one solution: concerns? increase car sales. This is done without This is the trend, although Euro- requiring, as is done in other countries, peans have been resisting it bravely, that cars be less polluting and more fuel- despite their being most affected by the efficient. economic crisis . . . . So far they have a much more progressive policy than ours. What is the government’s position on In the case of developing countries, some the environment? islands will be flooded, many coastal The person in government who is areas will have serious problems, and environmentally sensitive is Izabella African food production will be affected Teixeira, (the Environment Minister), tremendously.

May 2012 Ÿ The Brazilian Economy INTERVIEW 21

How are other coun- Whenever the What environment tries addressing energy economy slows, the policy is needed? production? One of the goals of In most countries efforts government has only Rio+20 should be to mitigate the genera- one solution: increase to set goals, much tion of greenhouse gases car sales. like the Millennium are related to measures Development Goals for low-carbon emissions. . . . In Brazil [for poverty reduction]. Probably we will there is a curious case of dissociation. not be able to put numbers on them, but The Brazilian effort [to reduce green- we can establish targets, for example, to house gases] is appreciable—the country increase the share of clean and renew- committed to ambitious goals in Copen- able energy. . . . The conference should hagen—but most efforts go to reducing set these goals and assess the viability of deforestation in the Amazon. That does financial resources (through the World not build a green economy, it just avoids Bank, funds, technical cooperation) to burning the forest. help countries reach them. The most effective path to a green economy is simply to reduce energy What would be the best way to measure waste. During the electrical blackout progress? crisis, Brazil showed that it can greatly One of the major problems of [Rio reduce energy consumption. … If we can + 20] is that there is much disagree- reduce waste, many of the power plants ment on the choice of indicators to being built in the Amazon would not be assess progress in environmental necessary. matters . . . Usually national accounts Brazil had a very important role in never compute what is being perma- developing ethanol for fuel—a large nently destroyed. Today countries are green economy project . . . . But Brazil designing an accounting framework has rested on its ethanol laurels. Ethanol to compute environmental liabilities. was the flagship of Lula’s diplomacy, but That would be the best way. today, because of deep-sea oil, we do not 1 UNEP, 2011, “Towards a Green Economy: Pathways to Sustai- talk about it. In the long run, if we do not nable Development and Poverty Eradication—A Synthesis for invest and others discover technologies Policy Makers,” www.unep.org/greeneconomy. to use cellulose and other sources, Brazil may lose China in one year is planting this advantage. more forests than Brazil has planted in 20.

May 2012 Ÿ The Brazilian Economy 22 DOMESTIC POLICY How should the State Participation Fund be shared?

Congress has until until the end of the year to set new criteria for how the states will share in the Participation Fund. Because the options suggested so far antagonize interests, Congress is far from consensus.

Claudio Accioli , Rio de Janeiro

t is not difficult to understand why committee to review not only new FPE Congress has not yet formalized the share criteria but also the federative Ireview of the State Participation Fund pact and the tax system more generally. (FPE) the Supreme Court mandated last Notably absent from the discussions is February. The states of Goias, Mato Grosso, the Rousseff administration. Without Mato Grosso do Sul, and Rio Grande do Sul effective coordination, and with elections had filed a suit charging that the current scheduled for October, it is unlikely that allocation is unconstitutional, and the court the dispute over FPE shares can be ruled that the shares of the 27 states in FPE resolved by January 2013, the deadline resources do not meet the constitutional the Supreme Court set. principle of promoting social and economic balance between states and therefore EQUALIZATION compromised the federative pact. When the constitutional reform of 1965 What should be a theoretical debate established the FPE, its resources were to about redistributive principles has been be shared on dynamic distribution criteria, contaminated by state financial agendas. geared to reflect socioeconomic changes The R$50 billion in the FPE consists of 21.5% between states over time. The original of what the federal government collects formula to share the resources, which then in income tax (IR) and excise tax (IPI). In consisted of just 10% of federal IR and IPI the fight for shares, however, the states’ tax collection, allocated resources based demands do not add up realistically. on state area, population, and an inverse of Several draft supplementary laws on state per capita income. Some limits were the matter are pending in Congress, and imposed to protect less populated and on March 16 the Senate created a special developed states, but the important point

May 2012 Ÿ The Brazilian Economy DOMESTIC POLICY 23

was that the allocation would always vary and Midwest, and 15% to the South and to accomplish the desired equalization. Southeast—São Paulo received a meager For the states, the 1965 constitution made 1% and Rio de Janeiro just 1.5%. two major changes: it introduced both the Unicamp economist Sergio Prado points ICM (a state value-added tax) and the FPE. out that the states and Congress never They were intended to complement each revisited the sharing criteria, so there other—the FPE sought to compensate for was an agreement that in effect replaced inequality in ICM collections, which at the what should be a mechanism to promote time were much more concentrated in the equality among states for a system of southeastern states, explains economist fixed ratios for sharing taxes. “It was to be Fernando Rezende of the Brazilian School of reviewed in two years,” he says, “but it has Public and Business Administration, Getulio remained in place.” Vargas Foundation. No discussion of tax reform in Brazil José Roberto Afonso, a Unicamp since 1988 has addressed the federal economist specializing in public finance equity issue, yet in the last 20 years, the and a consultant to the Senate, adds that profile of the population has changed the system obeyed the logic of transferring radically in economic, demographic, and income from richer to poorer states and social terms. Rezende points out that municipalities in order to reduce disparities “Regions that were poorly developed, like between regions. the Midwest, have gained tremendously from the growth of agriculture. However, A PERMANENT TEMPORARY FIX because the sharing coefficients remained With few changes, the 1965 FPE criteria static, there has been a huge disparity in remained valid until 1988, when a new fund transfers among states.” constitution was approved. The 1988 Afonso notes that in 1985, according to constitution expanded the amount of funds the Brazilian Institute of Geography and in the FPE to 21.5% of IR and IPI collections. It Statistics, only the South and Southeast also mandated that a law defining new criteria for sharing resources be voted on within one No discussion of tax reform year. However, since there was no consensus in Brazil since 1988 has on new sharing parameters, Congress, based on a study of the National Board of Finance addressed the federal equity Policy(Confaz), in December 1989 created a issue, yet in the last 20 years, table with fixed coefficients for the 27 states; it was established that 85% of FPE resources the profile of the population would be allocated to the North, Northeast has changed radically.

May 2012 Ÿ The Brazilian Economy 24 DOMESTIC POLICY

When the constitutional reform tax code, or create a new mechanism that of 1965 established the FPE, could incorporate into the system of income equalization parametric criteria such as those the sharing of resources was used by federations like Germany, Australia, based on dynamic distribution and Canada. “The parametric model has been the tradition in Brazil, but it does not criteria, geared to reflect take into account how much revenue each socioeconomic changes state itself takes in. It simply applies the parameters and distributes resources. If the among states over time. state is poor, for example, it receives more. Equalization of revenue, which is unknown in regions; the states of São Paulo, Rio de Brazil, takes into account a state’s direct tax Janeiro, Rio Grande do Sul, Santa Catarina, collection and shares resources according and Amazonas; and the Federal District had to state per capita expenditure. This is a GDP per capita above the national level. By more modern system, which deserves our 2007, income per capita in the Midwest was attention because it reflects the states’ also above the national average, while in the funding capacity,” Prado says. Northeast it was far below. Whatever the sharing formula, experts warn that there will be difficulties in moving SHARING OPTIONS toward a concrete solution for the problem. Most bills that the House and Senate are Changes in the distribution of the FPE could considering propose that FPE resources be reduce state resources by up to 15% or 20%, shared according to such parameters as which could be catastrophic. income per capita, gross domestic product (GDP), Human Development Index (HDI) WHOLISTIC CHANGE? status, population numbers, land area, FPE reform offers a good opportunity for and more specific indicators, such as share discussion of other federation issues, in of houses with access to safe water and particular the tax exemption war between sewerage. the states, the sharing of oil royalties, and The resources at stake are significant. the restructuring of state debts. However, According to Afonso, the net amount of the in the opinion of Afonso, although there FPE is equivalent to 1.4% of GDP, 13% of state is a consensus among planners and policy tax revenues, and 22% of ICM. makers on the desirability of analyzing the There are two obvious alternatives for issues together, the federal government has addressing income equalization: go back to no sympathy for the idea. “The Executive the original model, which prevailed in the argues for a case-by-case assessment,” he

May 2012 Ÿ The Brazilian Economy DOMESTIC POLICY 25

says. “There is a lack of rationality, of strategic FPE reform offers a good vision.” Reform of the FPE could be a tool for opportunity for discussion adjusting other disputes between states. Realizing that its decision has consequences of other federation issues, in for state budgets, and because it is a case of particular the tax exemption partial omission—there is a law, but it does not meet constitutional standards—the war between states, the Supreme Court in declaring unconstitutional sharing of oil royalties, and the the criteria for distribution of the FPE also held that the current law should still apply restructuring of state debts. for the next two financial years until a new sharing formula is issued. Given the lack January 2013; otherwise the Supreme Court of consensus on the issue, however, this will have a substantial ‘hot potato’ on its may not be enough time. Small states like hands. The hope, according to Afonso, is that Rondônia, Roraima, Acre, and Alagoas the federal government will come forward cannot survive without FPE resources. to arbitrate the issue, even if only in its own This problem needs to be resolved before self-interest.

IBRE ECONOMIC OUTLOOK The Brazilian economy and macroeconomic scenarios

The Brazilian Institute of Economics (IBRE) Economic Outlook provides statistics, projections and analysis of the Brazilian economy:

• Economic activity • IBRE business and consumer surveys • Employment and income • Inflation and monetary policy • Fiscal policy • External sector and trade • International outlook • IBRE focus

To know more, go to: www.fgv.br/ibre or call (55-21) 3799-6799 and (55-11) 3799-3500 26 LATIN AMERICA

Mexico reinvents itself

Even though its economic outlook is improving, Mexico still needs to make changes if it is to achieve sustainable growth.

Solange Monteiro, Rio de Janeiro

ot long ago Mexico was the Chinese purchasing strength and its Nlargest economy in Latin America, domestic economy is faltering. Meanwhile celebrating a return to full democracy after Mexico’s economic outlook is improving. 71 years of Institutional Revolutionary Last year, Mexico’s GDP grew 3.9% Party (PRI) governance, and opening up compared to Brazil’s 2.7%. This year the economy through the North American the Mexican economy is again expected Free Trade Agreement (NAFTA), which to grow more (3.43%) than the Brazilian increased trade with the United States (3.22%). “The recovery of the U.S. and Canada from US$50 billion in 1994 economy and higher international oil to US$700 billion in 2011. prices are favorable factors for Mexico,’ However, when China joined the World says Lia Valls, coordinator, Center for the Trade Organization in 2001, Mexico lost Study of the External Sector, Brazilian U.S. markets and investment. Meanwhile, Institute of Economics (IBRE). Brazil has benefited from high demand Manuel Molano, director general, and prices for its commodities and the Mexican Institute for Competitiveness growth of its middle class has stimulated (Imco), adds, “There’s always a growth domestic demand. As a result, in 2011, rebound after a major recession.” He Brazil reached twice the Mexican GDP, notes that Mexico’s GDP fell by 6.2% becoming the sixth largest economy in of GDP in 2009 after the financial crisis the world. It has also gained international in the United States, the destination for influence by forming partnerships with 80% of Mexico’s exports. Contributing to other large emerging markets, the BRICS today’s rebound, says economist Renato (Brazil, Russia, India, China, and South Baumann, University of Brasilia, is that Africa). “Mexico has sought to expand its markets But fortunes may be changing again. and now has 14 commercial treaties, Today Brazil faces uncertainties about a commendable effort.” But, he notes,

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 27 Photo: Elza Fiúza/ABr.

Brasil’s Foreign Minister Antonio Patriota, and Mexico’s Foreign Minister Patricia Espinosa, during a meeting at the Itamaraty Palace, Brasilia. further growth will still depend on the content rules,” Molano says, underlining performance of the U.S. economy. the difference between Mexican and Brazilian industrial strategies. (Recently Changes the Brazilian government put pressure on To confront Chinese competition, Mexico Mexico to limit its car exports to protect had to make changes in its production the ailing Brazilian car industry.) base; the results have been positive. “The loss of labor-intensive maquiladora Today Brazil faces industries to China made us look for uncertainties about Chinese sectors with higher added value,” Imco’s Molano observes. The result was the purchasing strength and creation of extended supply chains, as in the car parts chain that today its domestic economy is supplies the auto industry, which in faltering while Mexico’s 2011 exported 2.1 million vehicles. “We gained market share with world-class economic outlook is products, not protectionism or local improving.

May 2012 Ÿ The Brazilian Economy 28 LATIN AMERICA

To confront Chinese main concern. Molano diagnoses the problem as “an incomplete transition competition, Mexico had to a market economy.” He believes the to make changes in its lack of political power of the National Action Party (PAN) administrations has production base; the results prevented major reforms. “Today,” he have been positive. says, “most modern industries have to pay toll to the old establishment, such Mexico is moving fast to expand other as maintaining large public and private sectors of the economy, Molano goes monopolies and property rights practices, on: “While Mexico’s oil sector recorded among others, that stifle the economy and a 6% increase between 1993 and 2011, increase production costs.” its manufacturing sector grew 58%.” Even after speeding up the volume of However, this was not enough to get its trade with the rest of the world for Mexico’s trade balance back in the black. more than 30 years, Mexico still has the Even though the winds are changing, same share of global GDP. Hector Aguilar Mexicans are aware that their economic Camin, Mexican journalist, writer, and growth rate is still far from ideal. Any historian, asserts that the main challenge open economy is vulnerable to external for the next president, to be elected in shocks—Mexico’s international trade is July, will be to escape what he calls the about 60% of GDP—but that is not the middle-income trap. In the prologue of his book, Future for All, which he presented to the CHANGING FORTUNES presidential candidates in Mexico's and Brazil's GDP (US$ Trillions) 2.5 April, he wrote: Brazil “Countries that have Mexico fallen into that trap have wages too high to 2.0 be competitive in basic manufacturing associated with cheap labor, but at 1.5 the same time they do not have the technological c a p a b i l i t i e s , h u m a n 1.0 capital, and institutions necessary to produce more sophisticated products 0.5 and compete with more 2002 3002 4002 5002 6002 7002 8002 9002 0102 1102 advanced countries. That Source: World Data Bank. is, [they are] unable to

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 29 move from growth driven by commodities Poor infrastructure, lack of to one stimulated by competitiveness and productivity.” skilled labor, a shortage of engineers, and the high price Problems José Gerardo Traslosheros Hernandez, of electricity are among the Mexico’s consul general in São Paulo, believes that some of the weaknesses that issues that both countries affect Mexican competitiveness are also have to address. common in Brazil. Poor infrastructure, lack of skilled labor, a shortage of safe and was a pole of attraction for engineers, and the high price of electricity business; today it is recording an exodus are among the issues that both countries of entrepreneurs. “The security issue have to address. But there are also is still really sensitive,” says Marcelo contrasts. One is tax revenues, which Ciasca, CEO for Latin America of in Mexico are among the lowest in the Stefannini, a Brazilian information region. Not only do tax revenues there technology company. Ciasca, who has not even reach 20% of GDP, they are also been working in Mexico City for eight heavily dependent on the tax payments years, nevertheless recognizes Mexico’s of the state oil company, Pemex. Tax enormous business potential, noting that reform would improve fiscal management “Over the past three years, our company and would be an effective tool against has grown at annual rates of 50%.” corruption: Today, with low tax revenue Imco’s Molano believes it will be and guaranteed federal transfers, local crucial that the next president put in place governments are not accountable and are a consistent reform agenda. “Before 1970 not motivated to spend efficiently. we had already experienced a period [of Businesses would also like to see more high growth like] the BRICS, with growth flexible labor laws and more access to rates that reached 9%, but we did not credit. Both could help to reduce the know how to spend the accumulated informal economy, which exceeds 30% wealth: we invested poorly, and did not of GDP, and help mitigate such long- liberalize [the economy] as we should term problems as drug trafficking and have.” He would like to see Mexico the accompanying violence: In 2010 the take the route Korea took: increase total 25,000 homicides in Mexico were double factor productivity, savings rates, and the number in 2003. “Studies estimate investment—and, of course, open the that drug trafficking carries an economic economy. “Today Korea is richer and loss for the country of 3% to 10% of has a trade balance of 98% of GDP,” he GDP,” says Alejandro Fonseca, professor, points out. “In other words, openness Egade Business School in Monterrey. Eight helps the economy, and protectionism years ago Monterrey city was considered condemns it.”]

May 2012 Ÿ The Brazilian Economy 30 LATIN AMERICA

The hazy future of Mexican oil

he state-owned oil company, Petroleos “We cannot imagine any meaningful reform TMexicanos (Pemex), must deal with a without a massive crisis or a popular enough true dilemma: having to ensure a large part president to form a coalition and raise public of federal government revenue yet not hav- awareness,” says Carlos Elizondo, professor ing the autonomy to make the investments of political science, University of Oxford, it needs to stay competitive with the world’s England, and Mexico’s former ambassador to leading oil producers. For years, Pemex num- the Organization for Economic Cooperation bers have been heading downhill: proven and Development (OECD). He explains that reserves fell 50% in the last decade, and daily a constitutional change needs the approval production declined from 3.4 million barrels of two-thirds in both houses, plus one half of oil in 2004 to 2.5 million in 2012. Although plus one of the states’ chambers. past administrations have made efforts to To further complicate matters, there is little stabilize production, reversing this situation popular support for reforms. depends on deeper reforms, such as allowing “The majority of Mexicans are misin- private capital to invest in oil exploration. formed. Although they defend competition That would require changes in the Con- if it will give them better services, such as stitution, and therefore building political gas stations, they still see Pemex as a symbol consensus beforehand. Today, with a large against foreign imperialism that must be part of Pemex revenues going to pay taxes preserved,” says Gilles Serra, professor of and royalties, which constitute 35% of fed- political economy, Center for Research and eral revenues, and restrictions on private Economic Policy. “It may be that this change involvement in the oil sector, there is little would only gain support if there were a room for investment. For instance, Pemex shock, such as a sharp drop in production, lacks sufficient money and technology to an accident that would put in doubt Pemex’s explore prospects for deep-water oil in the ability to control it, or a major corruption Gulf of Mexico. scandal.”

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 31

With 35% of Pemex revenues exploration and production of oil itself.” There is some precedent for that opinion. In going to pay taxes and his 2008 reform bill, President Felipe Calderon royalties and with restrictions of the PAN (National Action Party) proposed to on private involvement in the open the refining sector and pipelines to private competition but was defeated in Congress; the oil sector, there is little room PRI was then in opposition. “Now,” Gilles says, for investment. “Peña Nieto will need more than desire: he will need to negotiate majorities and, above all, Promise have a firm grip on the nationalist wing of his The first signals from Enrique Peña Nieto, PRI own party, which is influential among service (Institutional Revolutionary Party) candidate providers and the Pemex workers’ union .” for president, who has been heading the The Pemex union is strenuous in its defense of polls, suggest a willingness to liberalize. In worker rights. Pemex ended 2011 with a labor April at the World Economic Forum, Peña liability of U$56 billion, mostly related to pen- Nieto said that Mexico should depoliticize sions for workers. the decision to attract private capital for the Reforming Pemex “would be a radical change,” oil sector, citing the Brazilian oil company, Elizondo says, noting that it would require two Petrobras, as a model. Analysts, however, say other factors: an administration that collects that such a statement is far from reflecting more revenue and has more discipline in a search for a true model of privatization; spending, to reduce the tax burden on Pemex, Elizondo comments that, “Peña Nieto may be and a regulatory framework that will prevent defending competition in sectors such as gas, monopolies and ensure a balance of power for petrochemicals, and distribution, but never new participants in the market.

“We cannot imagine any meaningful reform without a massive crisis or a popular enough president to form a coalition and raise public Photo: Pemex gas station/Wikepedia Commons. awareness.” Carlos Elizondo

Is there space for private sector in Mexico’s oil industry?

May 2012 Ÿ The Brazilian Economy 32 LATIN AMERICA

Brazil and Mexico: Similar challenges

J o s é G e r a r d o an agreement with the United States that also Traslosheros Hernán- changed the geopolitics. dez, Mexico’s consul general in São Paulo, In the beginning, NAFTA was related to the believes that because expansion of the maquiladoras in Mexico. the two largest Latin These are no longer an issue. American economies Traditional maquilas are ceasing to exist. have similar prob- These plants were established on the Mexi- lems, they should can side of the border, imported component seek greater integra- parts, used only Mexican labor, and exported tion. For him, Brazilian competitiveness, like Mexi- finished products to the United States. From can, depends on opening up the economy. my point of view, that had benefits because Despite a good recovery from the crisis of it generated jobs. Over time, the difference 2008, why is growth in Mexico still rela- between industries that only sell abroad and tively low? those that sell to the domestic market tended Brazil and Mexico share similar challenges: to disappear. We integrated production chains Mexico needs to make the labor market more in a context of openness, and today Mexico flexible and make it easier to start a business. produces more parts and components—such We must improve the infrastructure of ports, as for autos and electronics—which generate roads, and public transport systems and much more value and are important Mexican train more skilled workers—in Mexico, as in exports. Brazil, education spending needs to be more effective. Has the review of the automotive agreement between the two countries affected Mexican In the last decade, the emerging BRICS coun- willingness to have closer ties with Brazil? tries have gained geopolitical and economic Mexico practices an open regionalism. We influence. Has Mexico been harmed by not are interested that Brazil thinks Mexican cars being part of this group? enrich its market, because they are good, and Mexico is a country with 112 million inhabit- their consumers can benefit. The presence ants, with per capita income similar to that of of Mexican cars may encourage the Brazilian Brazil. It has a growing middle class, increasing industry to develop more competitive cars. purchasing power. . . . Whether it is among And it does not stop there. We have huge the BRICS or not is just a matter of definition. complementarity, for example, in aerospace. For there are also large differences within We would like to have an Embraer plant, be- the BRICS. Brazil’s growth is well below that cause we have parts, engineering service, and of China and India, for instance. The fact is quality design. There are also opportunities in that, like Mexico, they are large markets and other areas, such as capital goods, agricultural that will encourage growth in demand. Just machinery, sugar production, and in particular as important is the fact that Mexico started a biofuels and biotechnology, in which Brazil trend after the Cold War ended by negotiating has made remarkable strides.

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 33 Photo: Presidencia de la Nación Argentina/Wikipedia.

Argentina: On the slippery slope to full nationalization?

Michelle Bachelet, a former president of Chile and Cristina Kirchner, Argentina’s president, next to the statue of Evita Peron

Marcia Carmo, Buenos Aires 51% of its shares, leaving Repsol with only a 6% share in YPF. Repsol risks Has late Argentine first lady Eva Duarte getting nothing for the expropriation: de Peron been resurrected for President Deputy Minister of the Economy Axel Cristina Kirchner’s administration? Evita, Kicillof said it will be charged with who died 60 years ago, embodied the environmental liabilities populist polices of Peronism that previous “We are the only country in Latin President Nestor Kirchner and his wife, America and one of the few in the world the current president, have been reviving that does not manage its own natural since 2003. These policies favor a larger resources,” Kirchner said, claiming that government presence in the economy. the expropriation will help reverse this A picture of the late Evita was the situation. She blamed Repsol for falls in oil backdrop for the president’s announcement production and for Argentina becoming that her government was intervening an importer of fuel. “For the first time in in Repsol-YPF, in which the majority 17 years, since the privatization of YPF shareholder was Spanish company Repsol, in 1998, in 2011 we became importers and was advancing a bill to expropriate of oil and gas,” she said. Last year the

May 2012 Ÿ The Brazilian Economy 34 LATIN AMERICA

Although foreigners Mariel Fornoni of Management & Fit warned that “Argentines support the heavily criticized expropriation, but not blindly. There is Argentina for the Repsol much speculation about how the company will be managed. It is clearly understood expropriation, it was that Minister De Vido is responsible for hugely popular among the energy crisis and therefore cannot head the oil company.” Argentines. Political analysts Rosendo Fraga, New Majority Studies Center, and Graciela Romer, Romer and Associates country had to import US$9.3 billion in consultancy, said that YPF is a symbol fuel. “If we continued like that, Argentina of Argentina’s nationalism. The Repsol would become a unviable country,” she nationalization reversed the president’s said. She considered Repsol-YPF to be recent fall in popularity, Romer said. the major cause of these hardships—even Fornoni noted that “With the measure, though it represents only 30% of gas and she recovered 17 points of support oil production. lost between last December and early Kirchner suggested that the Brazilian April.” state oil company, Petrobras, was now her model: “In Brazil, the government owns A popularity roller coaster 51% of Petrobras shares. We choose to do Several factors had contributed to the the same [with Repsol-YPF].” president’s fall in popularity: the February Even as Kirchner was announcing train wreck that killed 51, rising inflation, the intervention, Minister of Planning the perception that the economy may be Julio de Vido and Deputy Minister of slowing after nearly nine years of growth, the Economy Axel Kicillof occupied the and allegations of corruption against the Repsol-YPF building and gave 16 executive vice president, former Economy Minister directors 15 minutes to leave, which Amado Boudou, who has been accused outraged Spanish diplomats. Kicillof, 41, of influence peddling in choosing the has emerged as the government strong company that prints paper money. “In man. Now the “new YPF” is looking for Argentina, when earnings start to get new foreign partners. short, when the party is no longer for all, accusations of corruption then attract Popular support the attention of voters and naturally Although foreigners heavily criticized affect the popularity of the authorities,” Argentina for the Repsol expropriation Fornoni said. it was hugely popular among Argentines. When a measure has popular support, Opinion polls showed that over 50% of Congress will pass it easily. The the population supported it. However, expropriation bill was approved by a large

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 35 majority in the Senate and the Chamber The Repsol nationalization of Deputies (207 for, 32 against). It also raised a cry for more nationalizations. reversed the president’s Opposition representative Fernando recent fall in popularity. Solanas urged, “We cannot be limited to 30% of the oil sector, the Repsol-YPF market share. The government must suggesting that the company might have control of 100% of this market that review its investments in the province is strategic for any country.” Though of Mendoza due to political uncertainty the governing coalition applauded his and inflation. Days later, a government statement, it raised concerns among spokesperson said that Vale had reassured foreign investors. authorities in Mendoza that it would Nor did the nationalization bandwagon continue to explore for potassium there: stop there: “After the oil, we have to “It’s okay. If plans are not changed, nationalize electricity companies,” claimed Vale plans to invest over US$5 billion unions that support the government. in the mining project, and this could Among embassies and foreign companies, turn Argentina into one of the largest the most common questions are thus: potassium producers in the world.” “Will the government move to other sectors? What could be next?” Declining investment Last year, according to the Economic Distrust Commission for Latin America and the In a survey by Sel Consultant, Buenos Caribbean (ECLAC), the region received Aires, 70% of the corporate executives a record US$153 billion in foreign direct questioned believe that the Repsol-YPF investment (FDI). In 2011, Brazil led expropriation will “worsen the business with US$66.7 billion in FDI (43.8% of environment”—previously 58% had the total), nearly 10 times more than considered the investment climate to Argentina’s US$7.2 billion. “It is hard to be stable. Results of a study by Abeceb construct the model of social inclusion consultancy in early May, however, dreamed by the government, with this found that in the first quarter the low investment,” said former Energy business climate was already marked by Secretary Alieto Guadagni. “uncertainty” due to import restrictions, What is heard from economists exchange controls, inflation, and a and businesspeople critical of the change in the central bank charter (see government is that Argentina is being page 37). “excluded” from the investment map. A few days after the Repsol Many, however, avoid public criticism nationalization, the Argentine press of the government. “We invited 15 published statements by Murilo Ferreira, economists and experts to talk about president of Brazilian company Vale, the economy and the energy situation

May 2012 Ÿ The Brazilian Economy 36 LATIN AMERICA

Among embassies and Ferreres, Ferreres and Associates consultants. “Argentina has been foreign companies, the characterized as a country that breaks most common questions rules. It invaded the Falklands island in 1982 (during the military regime), are: “Will the government defaulted on public and private debt in move to other sectors? 2001, restructured its debt at a discount of 75%, and is now expropriating oil What could be next?” companies,” wrote Eduardo van der Kooy, political analyst for the Clarin in the country, but only 3 came,” newspaper. Senator Norma Morandini noted. In Argentina under Kirchner, there are President’s ambivalence no ministerial meetings or presidential In 1992, Christina Kirchner and her press interviews. Few ministers husband, then governor of the province speak to journalists; the planning of Santa Cruz, called for privatization minister is among those who do not. of YPF. In 2011, as president she praised Repsol investment and productivity in Gas reserves the country. In 2012, she expropriated Repsol has speculated that the Repsol. In practice, there is now a expropriation may have occurred because disconnect between what the government the government “kept an eye” on gas is doing, falling investment, and business reserves and unconventional oil in Vaca fears. Soon after the expropriation law Muerta region, in the rocky ground in was passed, on May 3, television station Neuquén province in Patagonia. Experts TN (Todo Noticias) promoted a debate say there are no reliable figures that can on whether it would be possible to confirm that Argentina could have the amend the constitution to pave the way third largest reserves of unconventional for the president to have a third term. gas in the world, as the U.S. Department of TN asked: “Cristina Kirchner eternally Energy has claimed. According to advisors in power?” to the Neuquén government, fear of an ecological disaster will require billions of From economists and dollars in extra care. The question now is whether the expropriation of Repsol- businesspeople critical of YPF and the Argentine nationalization roller coaster could discourage further the government what is exploration of this gas field. heard is that Argentina is After the expropriation of Repsol, “It will not be easy to instill confidence in being “excluded” from the new investors,” said economist Orlando investment map.

May 2012 Ÿ The Brazilian Economy LATIN AMERICA 37

Controversial moves by President Kirchner

•• Nationalization of pension and retirement the measure caused the dollar to rise funds: The government justified the move in the parallel exchange market. In by arguing that private enterprises were exchange houses and banks, the price mismanaging pension funds. Today, follows the government’s decisions; the nationalization has broad popular in early May, they quoted the dollar at support. about 4.40 pesos. However, in shopping •• Control of imports: New requirements malls, some shops accept U.S. dollars at for imports entered into force in February: the rate of 5 pesos per dollar. Importers must submit to the Federal •• Media concerns: The opposition accuses Administration of Public Revenues (AFIP) the Argentine government of not a complex sworn statement on purchases being transparent in managing public from abroad. The system has increased resources, particularly what it spends red tape and slowed the pace of imports; on advertising. Concern has increased Brazil exported 23% less to Argentina in about the concentration of media in the April than it did in April 2011. Economists hands of companies sympathetic to the estimate that this control will increasingly government, according to the UCR party, affect Argentine industry, which depends after the April announcement of the heavily on imports of components and sale of the group that owns radio Diez, machinery. the most popular station in the country, •• Amending the central bank charter: to C5N TV, which is second in cable The government in March approved a television audience share and owned by change that increased the amount of a businessman that reportedly supports international reserves that can be used the government. The government and to pay government financial obligations. the press have been contending about Those reserves have now been transferred this since at least 2009 when a new law to the Treasury. It also mandated that for the sector was approved. central bank international reserves not •• Inflation: Fearing government fines, fall below US$47 billion. In 2011 they were private consulting firms no longer publish US$52 billion. their own estimates of inflation. However, •• Control of dollars: The government the parliamentary opposition is doing so. has set new limits for purchasing It estimates inflation to be almost double dollars and sending money abroad the official rate, which Indec (National that AFIP is enforcing. Traditionally, Institute of Statistics and Prices) claims Argentines save in dollars. Both the is about 10%. With the lack of reliable middle class and businesses consider price statistics, prices have been increased the measure to be unfriendly. At first, more often, especially for food.

May 2012 Ÿ The Brazilian Economy COMÉRCIO EXTERIOR

The bankruptcy of Mercosur

On April 16, 2012, the Argentine government announced the expropriation of 51% of the shares in oil company YPF held by the Spanish company Repsol, which was YPF’s main shareholder. The justification claimed was that a lack of investment had brought about a trade energy deficit that started in 2010. (Critics of nationalization instead blame the government’s policy since 2003 of controlling oil prices, which inhibited Lia Valls Pereira YPF’s plans to expand production.) Another view sees the expropriation as a nationalist he rise of protectionism and Argentina’s strategy to ensure the development of T nationalization of the YPF oil company Argentina’s strategic reserves, one that illustrates how bankrupt the Mercosur parallels increasing protectionist measures project has become. Brazil can only lose by since 2008. being identified as belonging to the same The nationalist bias of Argentine politics group as Argentina. It is being harmed seems to stem from both political and from an economic point of view, and recent economic assessments. Some nationalist events are being used to strengthen the

position of sectors that do not consider Coordinator of the Center for the Study of the External Sec- regional integration to be relevant. tor, IBRE / FGV

May 2012 Ÿ The Brazilian Economy FOREIGN TRADE 39

symbols (the Falkland/Malvinas Islands The president of Spain, Mariano and the YPF nationalization) are politically popular with some sectors of society. The Rayo, has said that the Argentine economic issue relates to constraints on the decision to nationalize the YPF is country’s stable development. damaging to all Latin America. Growth After defaulting on its external debt and about Argentina’s protectionist trade seeing GDP fall by 10%, Argentina in practices. According to the WTO, among 2003 entered a period of high economic countries that did not sign the declaration growth that coincided with the election of but did express support were Mexico, President Nestor Kirchner. The winds stayed China, Colombia, Peru, Singapore, and favorable due to high commodity prices, Malaysia. Thus the countries unhappy with despite the shock of the global crisis of Argentine practices account for almost 50% 2008–09. However, underlying restrictions of Argentine exports. Argentina’s principal on sustained growth in Argentina came to trade partner, Brazil (market for 20% of the forefront after the crisis as President Argentine exports), remained silent. Cristina Kirchner reaped the legacy of the 2002 default and Argentina found it Exports difficult to obtain financing in international In 2011 Argentina was the third largest capital markets. market for Brazilian exports (8.9%), after In 2011, uncertainties again dominated China (16.5%) and the United States the international scene. World trade had (12%). In early 2012, new Argentine grown by 14% in 2010 but fell to 5% in rules for imports steeply suppressed 2011, and the World Trade Organization Brazil’s exports to Argentina. Though (WTO) expects growth of only 3% in total Brazilian exports increased by 7.5% 2012. At the same time, Argentina started in the first quarter of 2012 year-on-year, recording deficits in the oil and current exports to Argentina fell by 4.4%; exports account balance of payments. A tax of Brazilian manufactured goods fell imposed on soybean exports later had 2.4%. Argentina buys 20% to 25% of to be lifted; private pension funds were Brazilian manufacturing exports. Reports nationalized; and central bank international of Brazilian trucks stuck at the Argentine reserves were used to finance government. border waiting for release of their loads Meanwhile, the Kirchner administration have become frequent. (Though about 50% sought to address the current account of trade between Argentina and Brazil deficits with protectionist measures that is automotive-related, that trade is still have been widely criticized. protected from these measures.) At the March 30 meeting of the Council In addition to the possible losses for Trade in Goods of the World Trade to exporters, the irritation caused by Organization (WTO), the United States Argentinean protectionism further worsens submitted a statement, with which at least the fragile discipline of Mercosur. Speaking 11 countries and the European Union to the World Economic Forum on Latin concurred officially, that expressed concern America in April in Puerto Villarta, Mexico,

May 2012 Ÿ The Brazilian Economy 40 FOREIGN TRADE

We do not believe that Brazil’s recent events as arguments in defense of their positions. Argentina’s protectionist image has been contaminated measures also stimulate demands that by the Argentine government’s Brazil retaliate. policy choices. However, they have We do not believe that Brazil’s image has been contaminated by the policy choices damaged small and medium-sized of the Argentine government. However, Brazilian companies. they have damaged small and medium- sized Brazilian companies that in general the president of Spain, Mariano Rayo, said have more difficulties in overcoming the Argentine decision to nationalize YPF is bureaucratic hurdles and diverting their damaging to all Latin America. The decision production to other markets. creates a precedent that investors fear could Recent events in the region, not only be repeated elsewhere the region, at a time Argentina’s protectionism but also when recovery of the world economy is still nationalization of foreign companies in uncertain. As a result, we should expect Bolivia as well as Argentina, retard the less European investment. Countries in the consolidation of Mercosur, which was region should understand that Europeans intended to raise the region’s competitiveness need regional leaders to work to curb and improve its people’s welfare. This has protectionist actions of their neighbors. If happened before. Mercosur negotiations the European Union supports Spain, Brazil stopped in the late 1990s and did not could promote debate in Mercosur on how resume until 2003. Since then, as the to minimize conflict. After all, strengthening largest economy in Mercosur, Brazil has Mercosur requires that the whole region be been active in promoting investments in the economically stable. The problem here is region and pays most of the joint project that for some time national interests have costs. This new Brazilian attitude, however, outweighed the Mercosur union. has been accompanied by a relaxation and virtual abandonment of any discipline Caution Mercosur created over the years. Countries’ What is the impact for Brazil? The Brazilian claims have been accommodated by making oil company, Petrobras, has announced that exceptions to the common external tariff its investments in Argentina’s energy sector (customs union, if any, is not likely before will continue to be guided by criteria that 2018) and free intra-regional trade. Recent ensure continuing profitability. Brazilian events only reinforce this trend. companies established in or intending to invest in Argentina are on hold, but Argentina is an important step toward internationalization In addition to the possible losses of Brazilian companies. to exporters, the irritation caused So far as trade relations go, agreement by Argentina’s bureaucratic between Mercosur and the European Union seems ever more distant. Those protectionism further worsens the who advocate a Brazilian trade agenda of fragile discipline of Mercosur. agreements independent of Argentina see

May 2012 Ÿ The Brazilian Economy INTERVIEW 41

“Savings with

Photo: Leo Pinheiro/Valor fixed interest rate was an anomaly”

José Júlio Senna Managing Partner at MCM Associated Consultants and former director of the Central Bank

Claudio Accioli, Rio de Janeiro

One distortion to correct another distortion economy, the Brazilian banking system has was very common in times of high inflation learned to be cautious. Also, the Central Bank in Brazil. So says economist José Júlio Senna, of Brazil has a long tradition of regulating and managing partner of MCM Consultancy and supervising financial institutions properly, for instance, applying leverage rules more severe former central bank director of the public than those of other countries. When the crisis debt, describing the system of fixed-interest came, since about 20% of financial institution savings accounts that the government funds were from external financing, we caught dismantled earlier this month. In his opinion, some of the effects of the credit crunch that the alternative of flexible returns tied to occurred elsewhere. However, since we did not changes in the central bank’s policy interest have the same problems as other economies, rate makes sense. the fiscal stimulus has not excessively increased public debt. Above all, the space for monetary easing was enormous due to the high interest To what can we attribute the relatively rates. The results were clear in 2010, when the tranquility of the Brazilian economy economy experienced fantastic growth, 7.5%, through the global crisis? well above its potential. As always, such a Compared to Europe, especially the euro jump raised concerns about inflation, leading zone, which was most affected, Brazil has to reversal of the stimulus measures and the not experienced the excessive and euphoric consequent slowdown in economic activity private sector borrowing that happened in we can see today. We are now in a new phase some European countries. . . . After decades of monetary easing, but the effects of the of inflation that were extremely harmful to the previous phase still predominate.

May 2012 Ÿ The Brazilian Economy 42 INTERVIEW

Brazil’s GDP grew 2.7% in 2011, and IBRE recently adopted by the government. The studies suggest that growth potential is measures promote the idea that only those in the range of 3.5%. How can we improve who enjoy a good relationship with the central these numbers? authorities have a chance to benefit by getting The main problem is that today the Brazilian tax cuts or subsidized credit from government- economy has very modest growth potential owned banks. It is a policy of picking winners due in large measure to low that transmits skewed signals savings and investment. To The main problem to the economy. correct the savings problem, is that today Moreover, it is clear to public sector spending needs everyone that lower interest to be cut; indeed the public the Brazilian rates stimulate economic sector does not save anything economy has very activity, so why restrict the . . . . As a result, investment as modest growth benefits to only 10 or 15 a whole oscillates at less than sectors? The program also 20% of GDP because there potential due in suggests that subsidized loans is not enough savings. Our large measure to may increase the investment infrastructure bottlenecks capacity of Brazil, but again result from lack of public sector low savings and investment requires savings. investment. High taxation investment. A recent study by the Inter- and stifling bureaucracy also national Monetary Fund suppress economic growth. Finally, low concluded that if Brazil had domestic savings productivity is mainly due to the poor quality similar to that of Chile and Mexico, about of human capital. The last census of the 22% of GDP, its real interest rate would be 2 Institute of Geography and Statistics shows percentage points lower. that the share of population with access to primary education had gone up considerably, What do you think of the government’s but the quality of education leaves much to effort to bring interest rates down? be desired. Let’s look at what happened with interest rates: From 2005 to 2008, the average real central Industry has been one of the sectors most bank policy rate was 9.40% and average infla- affected by low economic growth. Is there tion was 4.80%, close to the government target a risk of deindustrialization? of 4.5%. The target was met even when interest As an economy develops, it is natural that the rates were high. Between 2009 and 2011, the share of industry in total GDP declines. But I real interest rate fell to 4.60% and average believe an important part of the recent fall is inflation rose to 5.80% . . . . Inflation rose, but related to two factors: loss of competitiveness, it did not explode. It is easy to understand the due to factors such as those already mentioned, government rationale: If we can reduce the real and an inadequate system of incentives. I am interest rate by more than half and inflation very concerned about the industrial policy rises only moderately, it is worth paying the

May 2012 Ÿ The Brazilian Economy INTERVIEW 43

price. It’s an acceptable trade-off to have a little are helping to keep inflation relatively low . more inflation in exchange for more robust . . . The prices of imported goods have been economic activity, higher employment, and favorably stable, which has generally helped lower interest payments on public debt—not to contain inflation. Thus it appears from all to mention the political gains. Government indicators that we will have a long period of is attempting to take the opportunity of the low interest rates. global crisis to bring about a significant reduc- tion in interest rates, paying a relatively modest What do you think of the changes in the price, according to the official understanding. remuneration rules for savings accounts? But the inflationary risk of this strategy seems The fixed real interest rate for savings was obvious. an anomaly. It was one of those distor- tions created to fight another distortion in What real interest rate level would result a very particular moment in Brazil’s history in a monetary policy that is neither expan- when inflation was very high. The present sionary nor contractionary (a neutral real government has understood this for some interest rate) for the Brazilian economy? time. The recent back and forth on the issue It is a slippery concept, because it is not an reflects the authorities’ uncertainty about observable variable, but there the political cost of tackling are reasons to believe that Our infrastructure the problem. President Rous- the neutral real interest rate seff is very popular in part in Brazil has actually fallen bottlenecks result because the public identifies because inflation volatility is from lack of public her as the mastermind behind lower, the central bank has sector investment. the low interest rate policy. more credibility, and espe- So the government must cially in 2007 the country High taxation have thought that if there is was transformed into a net and stifling a political cost to changing international creditor. It is not the remuneration of savings known, however, how much bureaucracy accounts, there may also be a space the real interest rate has also suppress political gain if people under- to continue falling. Many econ- economic growth. stand that the change can omists worry about future enable even lower interest inflation, given the aggressive- rates [on loans]. I think the ness with which this policy of lowering the adoption of flexible remuneration linked to real interest rate has been conducted. It must variations in the central bank policy rate was be recognized, however, that several factors a correct solution to the problem.

May 2012 Ÿ The Brazilian Economy 44 44 IBRE’sIBRE LetterEconomic Outlook Recovery of the Brazilian economy continues to be slower than expected. The industry decline in March was a cold shower, dampening prospects for a stronger second-quarter recovery. Hopes for improved economic activity must now turn to the second half of the year.

Low fixed capital investment and weak business through April fell to 1.9% from 2.1% in March. confidence are slowing prospects for continuing For the second quarter, IBRE’s preliminary growth economic recovery in the second quarter of 2012. forecast is 1.2%. However, it is expected that the strength of consumer Investment in fixed capital (machinery and demand and recent measures to stimulate industry will equipment) did badly in March. In that month IBRE’s gradually improve economic activity later in the year. Monthly Indicator of Investment (MII) posted another IBRE has lowered its estimate for first-quarter fall compared with the previous month. In fact, all GDP growth from 0.6% to 0.4%, measured by the components of investment fell in the first quarter, moving average Economic Activity Indicator (EAI). leading to a significant decline of 2.5% compared with Despite some acceleration of the 3-month moving the previous quarter. The only reason first quarter average in April, the 12-month change in the EAI growth was not even worse was growth in household and government consumption. IBRE Economic Activity Indicator, April 2010-April 2012. In April, IBRE surveys found business (Percent change over the previous quarter and 12-month moving average over the previous 12 months, seasonally adjusted) confidence generally, and industry confidence in particular, to be weak. 3.0 9.0 12 months (right hand scale) However, business expectations are more 2.5 3 months (Left hand scale) 7.5 favorable over six months, which suggests a good response to the measures to stimulate 2.0 6.0 the industrial sector that the government

1.5 1.2 4.5 recently announced. In contrast to the 1.1 1.0 ebbing confidence of businesses, in April 0.8 1.0 3.0 0.6 the Consumer Confidence Index rose for the 0.5 0.3 0.4 0.5 1.5 third consecutive month. Thus, consumers’ perception of the economy in general 0.0 0.0 remains favorable, especially in terms of

-0.5 -1.5 the labor market and lower inflation. This could favorably affect household financial Apr-10 Oct-10 Apr-11 Apr-12 Oct-11 Jun-10 Jun-11 Feb-11 Feb-12 Aug-10 Dec-10 Aug-11 Dec-11 expectations and increase consumer Sources: IBGE and IMF; IBRE staff estimates. spending on durable goods.

External demand slows Brazil'sreal e ffectiveexchange rate has a ppreciatedsince Ju ly201 1. (January 2010 = 100, deflator IPA) That the global economy is less dynamic is clearly 105 reflected in the slowing of Brazil’s exports: January-April exports increased only 4.5% 100 compared with the same period of last year even though devaluation of the real exchange 95 rate was greater. In the next few months, while 90 the external environment should not have much

effect on export performance, a higher trade 85 balance is expected because growth of the Brazilian economy has been sluggish and recent 80 protectionist measures will slow imports, which

grew 7.4% in the first quarter. Source: IBRE staff estimates.

May 2012 Ÿ The Brazilian Economy