Is Brazil’s Shrinking Economy A Warning Sign For Emerging Markets?

The beginning of 2015 has not necessarily been the best start for Brazil. With the year barely under way, Brazilian economists and analysts have revised down their projections for the country’s economic growth this year. At the end of 2014, the central bank predicted that by January 2015, Brazil’s gross domestic product will be expanding by 0.7% per month. The reality was that by the second week of January, the expansion of Brazil’s gross domestic product stood at just 0.4% per month. It is an extremely uninspiring start to the year by Brazil; however this slow start is not only hugely significant for the Latin American country but it is also extremely relevant for the rest of the world’s emerging markets.

Brazil’s Economic Backtracking

With President Dilma Rousseff beginning her second four-year term in the Brazilian government, the future of Brazil hangs very much in the balance. During the election that took place in October 2014, Rousseff continually demonised the ‘neo-liberal’, market-friendly policies of her opponent, Aécio Neves of the centrist PSDB. This factor played a significant role in winning her a second term as Brazil’s president although it seems that Rousseff is beginning to backtrack. Faced with an urgent, almost desperate need to encourage economic growth, President Rousseff has appointed a market-friendly economics team that had Neves won the election he might have chosen this team himself. This should come as no surprise as Rousseff’s leftwing Workers’ Party, the Partido dos Trabalhadores, has pulled such a trick before. In 2003, Rousseff’s predecessor and mentor, Luiz Inácio Lula da Silva welcomed the orthodox economic policies of the previous Partido da Social Democracia Brasileira (PSDB) government. Having campaigned against it for years, da Silva changed his tune and as a result enjoyed two terms in office and several healthy years of growth.

Brazil Faced With Four Important Risks

The global economic climate under which da Silva was operating was of course different due to the driving commodities market and floods of cheap money. With this environment, da Silva was able to keep the PDSB’s reforms in place but had no need to advance its reform agenda which he and to a greater extent Rousseff always found disconcerting. New investors in Brazil are putting their hopes in the idea that Rousseff will put into action PSDB type policies in what is now a much more challenging global context. Rousseff’s supporters may indeed feel that such a notion is far-fetched although the reality may be that she is left with no other alternative course of action. Brazil needs to be cautious that if or when the domestic adjustment takes place it is not at the same time as a serious flare-up of other external risks. From rising interest rates in the United States and a strengthening US dollar to slower growth in China and falling commodity prices; some of the possible dangers appear to be certainties. Brazil is certainly unique due to its exposure to all four of these risks at the same time when compared with the other emerging markets in the world.

Investors Not Learning From Europe’s Austerity

Even so, when looking to the recent downfall in Europe it appears that some investors have forgotten the fact that when Europe’s fiscal austerity was deployed it hurt both growth and markets. Brazil along with China is perhaps the only emerging economy in which a policy-induced adjustment could become disruptive to other emerging markets. The fact that investors have heavily poured their money into Brazil only increases the risk that a domino effect will then spread to the other emerging markets. Economies that receive large capital inflows face a higher risk of a sudden stop. A banking crisis or sudden stop is multiplied greatly after a period of intense investment. If the investments are debt-driven, as can be seen with the recent increase in foreign ownership of emerging market domestic debt, the Achilles heel of emerging markets, the probability is even higher.

The Uncertain Future Of The World’s Emerging Markets

Whether or not the world’s emerging market assets survive factors such as rising interest rates in the United States and a slowing Chinese economy remains to be seen. However what is certain is that the outcome very much depends on Brazil’s ability to get through its economic adjustment unscathed. Some economists argue that the other emerging markets are already preparing to face this unhappy truth as history has shown Brazil’s inability to successfully execute its macro adjustment.

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