MBA ~ Managerial Economics Case Study on \k Describe Economic Condition of Brazil in 2011, Q2, What is meant by ‘Brazilian Costs’ how significant are they, and what should government do to eliminate them? One bus manufacture: complained, sport rom Brazil has become very expensive... The coatsin Brazil are too high For that season we RCM 22P f moved part of our production to China,” In 2008, in order to prevent an excessive inflow of foreign USDE chX De capital the government introduced esptal contol in the form ofa tax on fixed income fom forcgn Per *atQint investments. Finance Minister Guido Mantega insisted that Brazil was fighting an international Ug eatita. euiveney we, in which government atourd the word were competing to lower tetr exchange rates, ectvely raising thei own compeltivencss, Despite a bref depreciation during the global nancial = ’ erisis, the Real continued to appreciate an additional 39% from 2008 to 20104 In the fll of 2010, the Partido dos Trabalhadores won the national election in the second round, and ‘Rousseff beeame the first female president of Brazil. When Rousseff took office on January 1, 2011, the inflation rate stood stabbornly around: 7%, well above the Central Bank's target of 45%. Having, ‘Profsor a Afr nd een Ase Hy We repre hic cae. Tu cc we Oeeiped foc bled ey HS ee are evo sli ate aw forces arson Coes re et ened a sre as edaranneiy ous of pnt da or Bsc at civ or thc warageme. Copyright 2 2919 President and Feliews of Bard Cellege. To ceder ope or met permission oreprodace mates Al) 105- [ib wed Hana buen Shoal Pubstog Benony MA CELE, po to Mol harvacdeda/ eases ae pubeton aye ‘gon, phorapt oredr reduced posed or Ustata wton i pemnon of Barend Sacer Sco, ans forucecly N71 Contomporry Econ Ars ar Pe Fly Ln by Or San Chatansomnan tang Tesh Urry tam et er tbe OH whosnis0w Beasts Enigma: Sustaining Lang-Term Growth, cost” Following the t of Brazil's new e intemational spotlight (Would Renscor™ be able to roan atting the exchange rate flexible, and exercising Brazil during the 2000s: The Lula Years ‘Throughout the 2000s, Brazil appeared increasingly likely to emerge as one of the world’s leading economic powers? From 2000 to 2008, Brazil's hi igh inflation had been tamed, fecal deficits had bees State papa cxtemal debt had declined (Gee Exhibit 6, in 2008, brat upgraded to BBB+ analyst os Gang ences, earning the nation “iwestmen grade” state eee Poor's credit Polke Sehineller, commented, “The upgrades reflect he materste oe Brazil's institutions and atthemore, programs aimed at reducing the nation’s poverty, inated during the Fernando inate Cardoso government (1995-2002) and Lae Inicio "tala da Sees government (2003-2010), z re eros cryin Nes Arabs se Or Sesh Chthamsthan ath Utero ‘ht documents hase rue ely NET? TY Contenpatny Esonnts res ee ny tanvang Terk ertyBrazil's Enigma: Sustaining Long-Term Growth Brazil in the International Community: Trade and Globalization Since colonization under the Portuguese in the sixteenth century, the Brazilian economy had been substantially dependent on commodity exports to Europe, the United States, and Latin America From the late 1930s to the early 1980s, an import-substituting industrialization (ISI) development strategy, fist instituted under President Getilio Vargas and continued under the nation’s military Gictatorship (1964-1985), encouraged the substitution of foreign imports with domestically produced goods. Under ISI strategy, tariffs were raised, and the exchange rate was fixed. However, by the early 1980s, the Brazilian economy slid into recession. In an effort to revitalize the economy, Brazil imderwent a substantial trade-lberalization scheme from 1988 to 1994. As a resalt, tariff averages dropped from 60% in 1987 to 15% in 199838 President Cardoso further nrged Brazil to better integrate into global markets, and in 1995, Brazil joined the World Trade Organization (WTO). Through its memberzhip in the WO, Brazil took a leading role during the Dcha rounds, contending that developed nations needed to reduce their agricultural subsidies and that emerging markets should have flexibility over patents in order to ‘access essential medicines under the Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement. in 2007, Brazil became the frst major nation to issue a compulsory icense under TRIPS, ‘breaking the intellectual property (P) tights of the pharmaceutical firm, Merck, for the HIV drug, Bfavirenz, thus lowering the price of HIV medication for Brazilians. In 2008, in response 40 allegations that the US, government was putting Brazil exporters at a disadvantage with cotton ssabsidice, the WTO ruled that Brazil cold impose US§820 milion in xetaliatory tariff. The raling ‘was the second time the WTO approved crose-sector retaliation, and Brazil responded by raising, tariffs against he U.S, on 102 products inchuding cotton, electronics, and automobiles.” Brazil had also made efforts to improve its international standing by joining the Mercosur tade bloc and the G20, In 1994, Brazil entered a free trade agreement swith Argentina, Paraguay, and Umagnay, which together mate up Mercosur. Since 200s, tazil had also boon a member of the G20, the main economic council for the world’s advanced and emerging economies, Brazil's Commodity Boom ‘Throughout the 2000s, Brazil's economy made consistent progress, culminating fs GDP growth of 7.5% in 2010, Driving this steady growth was a commodity boom, primarily fueled by exports of iron ‘ore, ofl, and soybeans, a5 well as an increase in domestic consumption, stimulated by an emerging middle cass and a stable macroeconomic environment. By 2009, Brazil was ranked the world’s biggest exporter of iron ore and the second-biggest exporter of soybeans. Such growth was further fueled throughout the late 2000s by the discovery of several large oilfields. In October 2006, the BG Group discovered. the Tupi cil feld in the Santos basin off the coast of Brazil, while the Jupiter field ‘was found nearby in 2008. With each field capable of producing an estimated 8 billion barrels of recoverable cil, Brazil was expected to become one of the world’s top-five ol producers by 2020.3 Brazil's exports were a major contributor to the economy's growth, accounting for 14% of GDP by 2010 (Gee Exhibit 9). Between 2000 and 2010, Brazilian exports increased from RS707 billion to. 132.4 billion, an average anriual growth rate of7.3%. During the same period, imports amounted to $70.4 billion, growing by an average of 10.2% per annum to reach RSI56-4 billion (see Exhibit 10) While Brazilian exports continued to vise throughout the decade, the nation’s export structure Degan to shift Since 2010, export earings from manufactured goods had steadily declined, such that ‘primary goods began to make up the bulk of Brazil's export earnings. China was the main driver of 5 “Tie docuet suerte oso ln NFI7 1 Corereseay Exact ube Ply Cn) by Dr Swan Chk at Naeyang Technolog Ue ft ‘Sopsnber 2018 tary 2016iso ‘Brazil's Enigma: Sustaining Long: Term Growth this shift, as the nation’s demand for iron ore and crude oil drove up export prices. Traditional labor- intensive industries, such as textiles and shoes, also lost ground to producers in Asia, Despite serving as only a marginal trade partner in 2003, China now led the demand for Brazilian exports, increasing its total trade with Brazil twelvefold over the decade.” In 2009, China surpassed the United States a8 Brazif’s leading export market (see Exhibit 11). Yet, there existed concerns that Brazil's economic growth was becoming dependent on China. Such dependency was problematic if China's own ‘growth began to slow, thus reducing demand for Brazilian exports. Custo Brasil Contributing to the nation’s troubles with manufacturing exports was the high cost of condueting business in Brazil, denoted by the term Custo Brasil. Coined by the National Confederation of Industries, the phrase “Brazilian cost” referred to the extemal costs a firm faced when operating in ‘Brazil, resulting from a lack of inGrastructuro, high taxation, and excessive financing costs. in the 2010 Doing Busines report, in witich the World Bank measured the ease of conducting business ina given nation, Brazil placed 129 out of 188 countries (see Exhibit 12) Some speculated that the cost of doing business hindered Brazil from surpassing its competitors, China and India, in economic growth, ‘The “Brazilian cost” was seen as responsible for reducing the competitiveness of Brazilian producers in global markets. The tax burden in Brazil, for example, was an estimated 95% of GDP. In the United States, the tax burden was close to 25%; in Korea, 25%; in Mexico, 18% and in China, around 17% of GDP The World Bank xanked Braai's tax system 150 out of 189 mations due to the high cost of payments and the complicated fli procedure. Firms, on average, spent over 2,600 hours per annum preparing and filing taxes, while paid taxes comprised 69.3% of a firm's profit (eee Eehibits 13a and 13b)> Despite having @ heavy and complex tax system, no systematic tax reform ‘had boon implemented in Brazil Additionally, interest rates in Brazil remained high in comparison with intemational standards, ‘tthe end of 2010, Brazil had one of the highest interest rates in the world, with a base rate of 10.75% (Gee Exhibit 14)” While these high rates were attractive to foroign investors, the interest rates limited credit opportunities for domestic businesses (see Exhibit 15), ‘The Brazilian Development Bank (BNDES) operated as the main supplier of long-term funding for development projects in Brazil, financing 40% of the country's investments in manufacturing and infrastructure. BNDES loans were subsidized, offering lending rates at an attractive 6%, compared. with the 12% yield on goverriment bonds or the 40% commercial bank rate.2 However, critics of BNDES argued that the bank focused too mrich on lending to large corporations, which received roughly four-fifths of the bank's R137 billion annual disbursements. Other critics argued that BNDEShad developed too much politcal clout and could choose which businesses would receive the ‘bank's much sought-after credit opportunities. Tony Volpon, an economist at Nomura, wamed, “It ‘begs the question about what isthe subsequent political relationship between companies that become much larger and more powerful largely based on their access to subsidized lending and the governments doing the subsidized lending. It creates a very dangerous set of incentives.” ‘= eeral tas comprised 60% of he tla en slate and municipalities were responce for 24% and 16%, rexpectively of the remaining amount. 7 “he conumertls eran eve ey NE17 11 Contrporaty torrie Anas ant Puc Pokey (ae by Cx San Crane a Nanyang Teghelgal Ura om ‘Septber 2034 aren 2015Brazil's Exige: Sustaining Long-Term Growth According to Transparency International, Brazil ranked 75 out of 189 natione on how corrupt the ‘public sector is perceived." A respected Brazilian newspaper estimated that between 2002 and 2008, over R$40 billion of the fiscal budget was lost cue to bribery and corruption. Despite recent improvements, the nation’s struggling education system cantributed to the lack of skilled labor, The 2009 OECD Pisa (Programme for Intemational Student Assessment) study showed ‘that Brazil rariked 52 out of 65 nations for both reading and science; for mathematics, the ranked 56 Brazilian companies faced shortages of qualified local professionals, and firms were forced to offer aggressive salaries to attract Workers™ The poor educational system also affected national productivity, which had increased by only 1.5% per annum during the past decade: The ‘problem appeared to lie in the quality, rather than the reach, ofthe education system. In 2005, 95% of children of official primary school age were enrolled. ‘Other analysts mentioned that the costs to employers resulting from Brazil's highily regulated system of labor relations were another component of the Brazilian cost. Employers were zequired to Provide extensive benefits to their full-time employees. Compulsory benefits included a 20% contribution of wages to social security, 2 calendar days of paid vacation, unemployment benefits, and a bonus amounting to one month’s pay (referred to as the 13% salary). Poor infrastructure further hindered national growth, In the World Economic Forum's Global Competitiveness Report, Brazil raniked 110 out of 133 nations for quality of roads: th 2009, Brazil's investment-to-GDP ratio fell far below its BRIC counterparts, causing some analysts to suspect that ‘weak infrastructure investment would be a future “bottleneck to growth."=* Brazil's fixed capital formation stood at 18% of GDP, in comparison to 46% of GDP in Chiina, 32% in India, and 22% in Russia® ‘A Battie against Currency Appreciation We haw, ond we are ready to use a wle arsenal to prevent or neutralize the excessive appreciation of our cureney ~ Finance Minister Guido Mantega In 2001, the chief economist at Goldman Sachs, Jim O/Neill, projected that Brazil and three other nations, collectively known a§ the BRICs, would soon surpass the G7 in GDP growth, attracting ‘enthusiastic backing of these emerging markets (see Exhibit 16)" Yet, in October 2002, leading up to the presidential election, foreign investors’ trust in Brazilian markets faltered after the prediction that the leftleaning candidate, Lula, would win the presidency. Lula, whose former presidential campaigns promoted a socialist agenda, was believed to have litle cancer for corporate profits or the repayment of foreign debt; investors’ fear of his election caused Brazil's risk premium to jump to 23%, while the stock market fell 46%. Despite fears about Lula's leadership, growth, trust, and capital inflows returned to Brazilian markets after several years. Between 2004 and 2007, foreign investments were again accelerating into Brazil. The International Institute of Finance estimated that foreign capital inflows increased from USB11.2 billion in 2006 to 1U5S795 billion the following year:® As Brazil emerged as the biggest recipient of foreign eapital in Latin America, upward pressure was placed on inflation, and the exchange rate luctated greatly. In 2008, the Real reached RS1.6 per US. dolar froma low of F$3.1 per US. dollar in 2004 (oe Exhibit ans 3 ‘Ti coouent is auorand wc ny In NZ Tt Conleporary Econere Aras and Pubic Potcy Cn) by Dr Sean Chae a Nanyang Teens Ue fn “Sepumker 14 one 3085wy, 7is0%0 Braaif's Enigma: Sustaining Long-Term Growth, Speculation emerged that the strong appetite for Brazil's assets was causing currency appreciation and the subsequent weakening in competitiveness of the county's manufacturing fadustrles. One Brazilian official commented, “It seems investors will buy anything, ....They have to become mare discriminating. We're really getting into a bubble.” Companies wortied about the effects of exchange rate appreciation on the future opportunities available within Brazil. One businessman commented, “Were suffering under incredible pressure. If this goos on we're going to see the de, industrialisation of Brazil”s6 Oscar Becker, the finance director at lochpe Maxion, one of Braait’s largest automobile manufacturers, complained, “For manufacturing companies, ifs hard to export from Brazil’? His fiom began using overseas factories to supply foreign markets, using Braziian factories only to meet local demand. He concluded, “I hope we will not reach the point whore we have to supply the Brazilian market from overseas.” In an attempt to stabilize the exchange rate and reduce the upward trend in inflation, the central goverment bogan to consider adopting a system of capital controls on inflows from abroad. By March 2008, the central government established the Imposto Sobre Operupies Financrires (JOF), ‘inancial transaction tax of 1.5% placed on incoming foreign fixed-income investments, as a means of uelling the flow of capital into the national economy. However, by October of that year, the wie: Teaching effects ofthe international financial crisis were becoming clear. Foreign diect investment in Brazil nearly halved frou USH45:1 billion in 2008 to US825.9 billion in 2008. In an effort to quell the outflow of investment, the government eliminated the IOF. Xet Brazil recovered quickly from the economic downturn, and during the first nine months of 2009, approximately US§20 billion of foreign investments entered the Brazilian equities market! On October 20, 2008, the government reintroduced the IOF, expanding the tax to a 2% rate on fixed income, in adilitin to portfolio and equity investments. The IOF did not apply to inflows of direct investment Since its reintroduction in October 2009, the IOF became a way for the Brovil, governient fo control the influx of capital into the nation, and the tax was repeatedly both raised and expanded to include other forms of investments (see Exhibit 18), Brazil's own competitiveness. Mantoga stated, “We're in the midst ofan international currency war, 2 general weakening of currency. This threatens us because it takes away our competitivencse."® Or October 5, 2010, Mantega announced that the IOF on fixed-income instruments was to be raised tc 4% Jess than two weeks later, the tax was raised to 6%. Despite rhetoric about fighting the effects of fhe “international currency wars," Mantega insisted that Brazil would maintain its lating exchange rate, Mantega stated, “We have to zepeat thatthe Brazilian government does not consider that there an ideal exchange rate or an exchange rate range for floatation. Our exchange rate regime isa floating one and itis good that it remains s0."st The Election of Dilma Rousseff é ‘Wis doce is auhotue ruse nNFAT Tt Conlonserar Econ nabs nd Pub 1D Sv Chiltometan aang Teton tom ‘Seolomber antiphaseDrazsEnigzna: Sustaining Long-Tenn Growth Ronssoff, the daughter ofa Bulgarian entrepreneur, grew up in a midile-class household. Yu her Inte teens, Rousseff shed her traditional background, becoming involved inthe left-wing guerre ‘roup the Palmares Armed Revolutionary Vanguard, in opposition to Bris military dtcurcip, Which ruled the country from 1964 to 1985. Starting in 170, Roussetf was jailed for three years wade subversion charges, during which time she was fortred by her interrogators. After completing her sentence, Rousseff earned a master’s degree in economics and soon held seties of mien goremmens Jobs In 2008, Rousse joined the Lala admanistration asthe energy minster, becoming Prior to the election, Rousseff promised that her government would reduce interest rates, boost investment, and intprove productivity through enkanced fiscal sigor. Between 2002 and 2010, goverment primary spending increased by 23% of GDP.# Rousseff snnosmnced, “We will pace ng {tort to improve the quality of public spending, to simplify and lighten the tax burdened te {improve the quallty of public services." Additionally, Roussff insisted that her governnent would {arget growing inflation, namely, by ensuring price sibility. By late 201 inflation had seachea seven-year high of 6.5142 ‘Tha question ofthe goverment’ ideal role in regulating the economy was highlighted in the rane 32.2 fhe general election Rowsseffs opponents accused her of bing “stat” following her open support for Inger govemmental role in economic planning and policy. Commenting on whe accusation, Laila stated, “Not that that’s a bad thing. I¥s good. Obviously you won'Cmertes rationalize tze repair shops, bars and plzzerias, But [about) things that are strategie, at ert working and need to be put to work better, we must not be afraid of taking decisions that ae {mparian for ou county.“ However, ome word that greater tale iva -inentin the edonoey Wotlk choke out the private sector. O/Neill of Goldman Sache warned, “A bigger state will ecomd ace the private sector. Ifyou want lower real intorest rates you have to reduce the rle ofthe sate Yet, {n contrast tothe election of President Lula, investors appeared less concerned with the sotcoms of {his election, assuming that neither Rouseeff mor her opponent, José Serra of the Partido da Sedat Democrecia Brasileira (PSDB), would deviate far from the econoriie polices pursued under the Lat, administration. ‘eceseaty majority. In the following runoff election agninst Serra, Rousseff won, becoming the fink ‘female president of Brazil, However, Lula’s endorsement and his close relationship with’ Rowectt Reviving Productivity During the first year of Rousseff’s presidency, Brazil was experiancing a swift rise in the cost of Tabor, In 2010, the average labor cost per hour rose 204% from the previous year to $ib.e Censoquetl, as productivity growth fated to keep pace, unit labor costs were on the rise ose SHIBE 19), With the relative cost of production tn Brailinereasing sharply, there Was gree, ‘i ecm setter N71 Canyon Ser ts nd ab Py yO Svan Chait Naan eee nytnis00 Bran Enis: Sustaining Long-Term Growth incentive for businesses to import goods rather than buy domestically. Carlos Ghosn, the CEO of Renault-Nissan, explained, "Brazil steel is fsome] of the most expensive in the world... Brazif’s iron ‘ore goes to Korea, is turned into steel there and comes back to Brazil. After that is still cheaper than local steel there's something wrong there." By early 2011, growth in industrial production was weakening, growing only 0.2% in March and contracting in the following month (Gce Exhibit 20). In an effort to jumpstart the economy, the government unleashed a series of stimulus packages aimed at reviving industrial production. Fabio Kanceuk from the University of Sio Paulo described the new presidents initiatives: “Although industry does not generate as many jobs as the service sector, and cheap imported goods are benefiting the common people, Dilma believes itis important to protect the industrial sector. Ik is a question of ideology, that old belief thatindusteialization is necessary for development" Foremost, Brazil's existing infrastructure was a hindrance to improving competitiveness. In March 2011, Rousseff announced the introduction of PAC-2, the second phase of the Actleracio do Crescimento, the Growth Acceleration Program begun under President Lula. Both rounds of PAC focused on improving transport, sanitation, energy, and logistics. PAC-2 consisted of a RS959-billion pledge to be invested between 2011 and 2014, bringing the total cost of the two programs to RBL59 brlion.§6 Commenting about the project's importance to Brazil’s future, former President Lula stated, “T consider PAC2 as a portfolio of projects that the next administration can build from rather than starting from scraich, as there is no time tolose.”° ‘Throughout early 2011, the exchange rate continued to remain at RSL against the US. dollar, and Mantega, who continued as minister of firance under Rousseff, targeted the blame for Brazil's currency appreciation on incoming foreign capital originating in developed markets. The finance minister insisted that the liquidity injected into American and European banks following the Intemational financial crisis was the eause of the currency wars. Mantega focused his criticisms on the United States, citing that the country’s policy of quantitative easing spurred an imgaoderate infiox of foreign capital ino Brazil. Mantega stated, "The advanced counsies axe stil running expansionist monetary policies... . Te developed world is taking longer to ecover than expected and this means their carencies ae sill devaluing, which is causing the overvakvation of the Real.” Yet, many in the intemational community blamed the onset of the “currency wers" on China, Analysts suggested that the Chinese government had been intentionally undervaluing the renminbi ‘through its closed capital account and pegged currency, thus damaging the export prospects of other nations. Several other Asian countries, including Japan, South Korea, and Taiwan, alzo tried to make their domestic currency cheaper. The Western Hemisphere director for the Intemational Mone!ary Bund (IMP), Nicholas Eyzaguirre, commented, "There is a corzeation [between] the fact that China pegs its currency and pressures on the exchange rate of Brazil or Peru.”® Despite US. accusations of cunency manipulation, China continued to ignore calls to revalue the renminbi. As the renuninbi remained undervalued, Chrina’s neighbors rashed to reduce thelr own exchange rates.” Contributing to the problem, Brazilian interest rates were particularly attractive to overseas investors. AS the inthie of foreign capital threatened to overwhelm the Brazilian economy, the ‘government decided to raise the JOF to 6% on foreign loans with a minimum maturity of up to 360 days in March 2011, By early April, the IOF was extended to loans with a maturity of up to two years. “The increase in tax rate represented a shift avay from a dependency on high interest rates to combat the growing levels of inflation in Brazil. Commenting on the effect of such short-term loans on the Brazilian economy, Mantega stated, “Three-month loans are not for investments. The inflow of dollars is too strong, damaging the exchange, appreciating the Real and harming exporters, We want ‘hs docoeti uerz for an ela NF? CentemporayEsonone Abs and Pb Pay (nd yO Sinan Cautamshan at anyag Toke very om "Sepsenor201 to Mara 245ras Enigma: Sustatning Long-Term Growth nse {o avoid that”! While the tax served to deter some short-term bond investors, long-term Braziian bonds still offered a yield of 11%, even with the tox. Kieran Curtis, the emerging markels fas ‘anager at Aviva Investors, commented, “Fha’s higher than you can got anywhere ele, especially {for an investment-grade credit” Jn Angust 2011, Rousseff unveiled a second stimulus package, called Bras! Maior (Bigg Br), iene was a multifaceted spprosch to restoring the Brazilian economy to vitality, partewary {following reports that Brazilian productivity had fallen to a weak 1.6% in June of that yeat. Under Brasil Meir, the government offered $25 billion In ewmptions on payrell taxes for the tent 118% placed om corporate revenues. The plan also changed existing regulations on the Government Pronurement Law, introducing a preference margin for domestic, rather than imported, products ENDES agreed to invest R$2 billion in the Braiian Innovation Agency, i addition to pledging RSTS billion in investments for technical services, information technology ecitipment, and hybrid Leserot Commenting on the plan, Roussef stated, “This ithe fist step to boost Brasi’s compelitivenes relying on imovation, demanding more added value and fighting unfair and fraudulent prectces by competitors."7 Jn pevtotlar, the plan addressed the “fraudulent practice” of avoiding Brazi's antidumping faritis, In an attempt to protect domestic industrialists, Brazil had created a series of dulicn ne Imported goods that were believed to be priced below the market value in thai county of exgia-To ‘The government's next defensive move focused on the nation’s automobile market, the fifth, Jangest in the world. In September 2011, Rousseff announced a 90 percentage point increase in be industrialized products tax (IP) on foreign-built car, rising the tax to 55% 0m eertain models, set factoring in edetional shipping cots and izmport dts” The tx applied to vehicles containing los than 65% Iocal content or automobiles made outside of Mexico or the Mercos sur region. Jn April 2012, automotive sales fell 142% from the previous month?® In a further attempt to improve the competitiveness ofthe local automotive industry, the goverment announced anthes stimulus package, amounting to over RS18 billion, inthe form of temporary outs to the IF on saad vehicles. The package also covered a reduction of the]OF tax for individual borrowers and deste ed reserve requirements for car loans. Mantega stated, “We want Brazil to remain among the largot players. the global auto industry.” Jn the wake of the numerous stimulus packages, some analysts worried that the government's ‘protectionist policies would escalate the currency war into a wider trade war, while others contencied ‘hat the increase in import tarifs reduced efficiency and productivity. Ilan Goldfajy, chief scone at Hau Unibanco Banco Comercial, stated, “What the industry should want is not protection bat ompetitiventss. If [the industry] realizes it has protection, there is a feeling that maybe there wil he Tess productivity growth in the future, which leads to underinvestment”® Other economists complained that the Rousseff government should be reforming the tax systein and doing more lo improve productivity grovrty rather than stimulating consumption of domestic goods, Theoughout ‘he 2000s, Bras growth Had largely been driven by an expanding middle class and coneusption growth rates had outpaced those in production. Yet, as the economty continued to grow, investments feiled to reach Brazi’s industries. Forme Central Bank president and founda of Gane, Jnwestments, Antnino Fraga, further explained, “It is natural and desirable that consumplicn ‘Ti antes saat hoe ny NF? Tt Calgon erp oss nd Re Petey) ah ‘September 2014 to aren 2015, bY Dr Swan Cans st Nanyang Teche Uy fomee nis0%0 Brazil's Enigma: Ststalning Long-Term Growth increases, ... However, growth in demand must be accompanied by growth in supply, which is not ‘happening fast enough to keep GDP growth at 4% 5% a year" Additionally, the decison to place capital controls on incoming investments was not unanimously supported. Edomir Pinto, chief executive of the Brazilian Stock Exchange, called the government tb Fomove some ofthe existing capital controls on the grounds that the IOF was damaging the equity several key reform bills, including tax reform legislation. Between June and September 201, Rousseff's chief of staf, the minister of agriculture, and the minister of defense were dismaced og clurges ranging from influence peddling to bribery. While some encouraged the new presilents fough approach to government corruption, the removal of the minister of transportation, Alfred Nascimento, led to a renewed round of infighting, resulting in the ultimate withdrawal of te Partido 4: Republica from Rousseffs coalition government Such infighting weakened the majority needed to By carly 2012 the goverment had learned thet total factor productivity grovth had contacted by 09% during the preceding year, strengthening the administration's determination to addrec Productivity issues As the next component of the Rousseff government's stimulus wave, the administration created the Science Without Borders program to address the nation’s shartage of skilled labor. The program created a scholarship fund with a budget of RS3.6 billion to enable 100,000 Brazilian university students to study abroad The Brazilian government and Harvard University signed an additional five-year agreement in order to facilitate the undergraduate and graduate studies of Brazilian science students at the university. The agreement stated that the Bresiling government would fund tuition and other related expenses, while students would stil be required to ‘undergo Harvard's normal admissions process Critics of the program contended that this substantial investment offered by the Brazilin government could be better spent on improving the quality of Brazil's primary and secondary schools, while others worried that sending talented students abroad could result in an exodus of the nation’s highly educated individuals, As the economy continued to be unresponsive to the goveminent’s stimulus epending, the Central Bank began aggressively cutting its oversight rate, known as the Sec rate, in an attempt to push, down the Real. Copom, the monetary policy board atthe Central Bank, had voted to cut the Seis rate eight consecutive times aver a 10-month period, reducing the rate from 125% in late August 2011 to 8% in Judy 2012 The reduction in the Seic rte represented a dramatic shift in monetary policy Previously, the govemment had seta kigh rate order to combat inflation consistent with a paliy of ination targeting ® The Copom decided to reduce the Seli rate, despite inflation measuring 85% in 2011, above the target set at 4.5%. ‘The manipulation of the Selic rate also indicated a new offensive position for Brazil in the quency wars. Arturo Porzecanské, professor of economics at American University, commented, “The Brazilian govemment has been so voce} about the fact that Japan, the U.S. and Burope have een pumping money out the window. Now it looks like rather than fighting them, they'se joining. ‘hem."” 2 ‘is eons aud forest NPT} Catenpary Exons rs Pui Poy Cn by Stn Cuthamothan t Nanyang Tete Une ry ‘Sepltr201 toons 2015Brass Enipins Sustaining Long-Term Growth ‘The future of the exchange rate management plan appeared uncertain. Since its R§17 level in mid- February 2012, the Real weakened to R32 per US, dollar in May.* Additionally, the inflation rate in May 2012 dropped to 4.99% from 5:10% in April Even though Brazil had replaced the U.K. as the world’s sixlvlargest economy, with a GDP of USS25 trillion by the end of 2011, GDP growth measured only 2.7%, the lowest since 2005. A New Growth Pian On August 15, 2012, Rousseff announced Brazil's newest stimulus plan, which aimed at improving ‘the nation’s infrastructure through an investment of R$193 billion. The stimulus represented an increased willingness of the PT to engage in public-private partnerships, as the government offered private companies the opportunity to buy the rights to operate roughly 7.500 Kilometers of roads and 10,000 kilometers of railvrays2* Rousseff argued thatthe stimulus would help reduce the cost of domestic manufacturing: "We want better infrastructure to cut costs for businessce and taxpayers, and most of all to ensure more and better paying jobs.” For these transportation improvements, RS79.5 billion was slated to be spentover the next 5 years, while the remainder was to be spent over the next 25 years, This announcement followed the earliog privatization of the nation’s three largest airports in February. Overall, the stimulus was projected to double the capacity of the existing highway system, while zestoring investor confidence in Brazilian productivity. Rousseff explained that this was just the first wave of a new series of investments: “We've staring an initial stage from which Brazil will emerge richer and stronger. . .. Brazil will ‘Ainally have an infrastructure that’s compatible with is size."™ In an effort to tackde the Brazilian cost, Rousseff also armounced that the government would ext ‘lectrcity rates in early 2018 by an average of 20%. Brazilian companies insisted that the high cost of cenergy hindered the government’ efforts to increase manufacturing competitiveness, In a teport by the Rio de Janeiro Industrial Federation, it was estimated that Brazilian manufacturers paid mort than double on energy bills than their counterparts in the U.S. and China® However, critics contended that the burden of the cuts fell on the utility firms, causing investors to be wary of the growing involvement of the state. As Electrobas’s share price dropped after agreeing to the governmentimposed revenue cut, Volpon of Nomura Securities asserted, "I fail to see how destroying shareholder value helps to attract investment” One foreign investor in Flectzobas warned, “We see this as a form of nationalisation of property.% ‘The Rousseff administration's stimulus plan also marked a pronounced change from eatlier ‘economic policies. Throughout the 2000s, the government focused primarily on fueling domestic ‘consumption, facilitated by the expansion of credit access and the rising Incomes of many Brazilians, However, as GDP growth stagnated by 2011, it appeared the goverrunent could no longer rely on ‘increases in consumption to drive the economy. While the economy appeared increasingly dependent con the government for growth, Mantega adamanily dented accusations that ad hoe state intervention hhad been the reason for Brazil's inconsistent growth trajectory: As the PT had previously opposed privatization, many analysis supported Rousself’s plan, arguing that the president was embarking on ‘a more pragaiatic policy that would contribute to long-term growth. While the stimulus plan was aimed at addressing Brazil's problems with compotitiveness and Infrastructure, it threatened to disrupt the government’ careful management ofthe exchange rate In an attempt to attract investment in the proposed stimulus projects, the goverment offered bonds ‘exempt from the IOF. Octavio de Barros, chief economist at Barco Bradesco, stated, “The bonds will 7 ocaotn aon roe yn NFITT1 Cortera Eee Ahn Pubic yD Stan Cutlnetam t anjang Techs rym a a "estore 24 ona} Daal’ Enigma: Sustaining Long-Term Growth be very attractive to foreign investors and the government will be very unlikely to inhibit those inflows with the JOR. Itwill be a big challenge for the governmenton the exchange rate.” Moving Forward By September 2012, Rousseff's task of revitalizing the Brazilian economy appeared daunting. The new stimulus package suggested a move toward promoting long-term growth, but the success of the plan was far from certain. Moreover, the approaching World Cup and Olympic Games ensured that the international community was carefully monitoring the Brazilian advances in infrastructure. Many ‘were concemed that this large-scale infrastructure project would become riddled with corruption, and that the program would greatly exceed the projected timeline for completion. Furthermore, Brazil's growth for the past four quarters stood at only 1.2%. This was the lowest sggowth rate since 2009 when the economy contracted 0.3% following the financial eisis” Former President Henrique Cardoso commented that Brazil was now “paying the price for not carrying out necessary reforms,” such as attracting fixed capital investments. By the end of the second quarter of 2012, the savings rate had reached its lowest point in 10 years, while the investment rate had reached its lowest point in 5 years (see Exhibits 21 and 22). Brazil's investment rate amounted to only 18.7% ‘of GDP, significantly behind the 30% of GDP in Peru and 27% in Chile" “The fature of Brazil’s exchange rate also appeared elusive. In Brazil's early winter of 2012, the ‘exchange rate had begun to weaken for the frst time since 2008. Finance Minister Mantega was optimistic that « fall in the Real would help the competitiveness of Brazil's industries In the intemational currency wars. Yet as billions of dollars in foreign investment flooded into Brazil, with the privatization of the nation’s two largest airports and the exploitation of vast oil fields, the ‘exchange rate trend remained unclear. Goldman Sachs economist Atborto Ramos commented, “Brazil ‘priced themselves out of the global economy by not containing costs—Brazil does not have an exchange rate problem; it isa cost ompebitiveness problem At the close of 2012, the Rousseff administration hinted at a move away from its strong involvement in both interest rate and exchange rate management. Mantega contended, “In 2013 we ‘will reap what we have sown. ...2013 will be calmer, with fewer measures, because they’ve been done." ‘As a:new year began in Brazil the Rousseff government prepared to face the many challenges preventing the revitalization of the Brazilian economy. With an approval rating of 77%, the highest of any presidentin the second year of his or her mandate, Rousseff held the political capital necessary to pursue changes in Brazil's economic growth. What actions, if any, should Rousceff take to ‘encourage the competitiveness of Brazilian exports intemationally? Should the Central Bank adopt a mere hands-off approach to the Selic rate, as Mantega suggested? And how could the Rowsself {government best pursue reduced inflation, a flexible exchange rate, and low fiscal spending? 2 “Te documents altrnd ros oiyh NF17 Contomperary Ezoroni Aas ad Publ ey tnd) by Swan Chatham at Nanyang Tecasegel Ube Sor "Septanr 2014 Mach 048