September 22, 2010

Economics Group

Special Commentary

Eugenio J. Aleman, Senior Economist

eugenio.j.aleman@wellsfargo.com ● 612-667-0168

Brazil: Pre-Election Update

Unwanted Presidential Elections: If It Ain’t Broke, Don’t Fix It This coming
This coming presidential election is, perhaps, one of the most unwanted events in Brazil’s history. presidential
Brazilians seem to be repeating the famous phrase by American businessman Bert Lance, “if it election is,
ain’t broke, don’t fix it.” This is likely how most Brazilians feel as they approach the October perhaps, one of the
presidential elections, which has translated into overwhelming support for President Luiz Inacio most unwanted
“Lula” da Silva’s chosen successor, Dilma Rousseff. She seems to be running away from her events in the
challenger, the candidate of the Party of Brazilian Social Democracy (PSDB), Jose Serra, a time- history of Brazil.
tested politician who has held many important elected and nonelected positions within his party
and in the country.
Meanwhile, Rousseff is a political unknown, chosen by the Workers’ Party (PT) to be its nominee
for president but strongly endorsed by da Silva in something reminiscent of the Mexican PRI
party “el dedazo” or “pointing the finger to choose the successor” during the 70-year reign of that
party in Mexican politics.1 For this seven-decade time period, the process worked very well as
every “chosen” candidate was actually elected president of the country through clean, or even
fraudulent, elections until late in the 20th century, when the strategy failed to work and the PRI
had to leave the presidency. However, the differences between the PRI’s “dedazo” and the
Brazilian Workers’ Party “dedazo with caipirinha” are overwhelming, and we do not want anyone
to think there is any other similarity between these two political systems. But, as was the case in
Mexico, at some point in time the way a candidate is chosen has its consequences, and this time
around will probably not be the exception.2
There are several risks that will linger if Rousseff wins the presidency as it is widely expected in
either a first round vote on October 3 or during a second round vote in November if the PT
candidate does not win an absolute majority. Rousseff is taking advantage of the high levels of
popularity that “Lula” has even though he has been in power for almost eight years, something
very strange for any country, let alone a less-developed country.
To the dismay of the Brazilian “right” and even to the “extreme dismay” of the extreme left where da Silva has
da Silva was “fed and bred” and was its first and ultimate leader, da Silva has transcended party become larger
and even class warfare while becoming larger than life for the Brazilian poor and the up-and- than life for the
coming middle class. Furthermore, in our view he is acting as a true statesman, at least compared Brazilian poor and
to other Latin American leaders. Instead of trying to meddle with the country’s constitution, as the up-and-coming
many of his South American peers have done to stay in power, including ex-Presidents Menem in middle class.
Argentina, Uribe in Colombia or President Chávez in Venezuela, da Silva has chosen not to
mention the possibility of trying to change the rules of the constitutional game even as pressure
has increased from his closest allies and friends during his almost eight-year mandate. However,
while this is good news for the Brazilian political system and the country’s institutions, the fact

1 The Mexican Institutional Revolutionary Party (PRI) dominated Mexican politics for almost 70

consecutive years.
2 Caipirinha is a famous Brazilian national alcoholic beverage made out of sugar cane.

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 Brazil: Pre-Election Update WELLS FARGO SECURITIES, LLC
September 22, 2010 ECONOMICS GROUP

that he may remain the force behind the throne if Rousseff wins could bring trouble down the
road, in our opinion.
From Mr. Charisma to Ms. Dilma
One of the biggest One of the biggest risks if Rousseff wins the presidential election is that is da Silva is a charismatic
risks if Rousseff figure while Rousseff has not demonstrated this characteristic. She is described as a technocrat
wins the and da Silva’s ex-chief of staff, who has never stood for elections with leadership skills that are
presidential still untested. While she may be able to ride toward the Brazilian presidency on da Silva’s and the
election is that da booming economy’s back, once there, the presidency and political system are a very tough job and
Silva is charismatic her leadership, or lack thereof, will be tested very quickly.
while Rousseff has
If da Silva has chosen Rousseff so he can come back to the presidency after one period out of
not demonstrated
office, the next four years will be difficult, at least for the country’s political institutions.
this characteristic.
Historically, this type of arrangement has never worked because the “chosen” candidate normally
starts asking for independence from the delegate. While we can assume that da Silva may be able
to keep a lid on Rousseff’s aspirations of independence, nobody knows what will happen to the
rest of the Workers’ Party and its members.
Looking back to the early years of da Silva’s first term in office, we find that the extreme left of the
Workers’ Party, i.e., da Silva’s own party, was very critical of the way he conducted business, as he
continued the main policies of ex-President Cardoso’s economic model but improved it to add
several programs that redistributed income to the poor.3 That wing of the party has been silenced
by the success of the da Silva administration and will probably remain on the sidelines if growth
continues at current levels. However, no one knows what could happen with the economy in the
future. As long as the economy grows fast, then it may be a smooth sailing; however, if it slows
down considerably, we may see some cracks within the political coalition.
So far, the Brazilian economy has been on a roll during da Silva’s presidency, growing at an
average of 4.8 percent from 2004-2008 before posting a 0.15 percent drop in 2009 during the
worldwide financial crisis, but recovering handsomely this year where we expect the economy to
post the best performance since da Silva came to office, with a growth rate of about 8 percent
(Figure 1 and Figure 2).
Figure 1 Figure 2
Brazilian Real GDP Brazilian Private Consumption
Bars = Compound Annual Rate Line = Yr/Yr % Change Year-over-Year Percent Change
12% 12% 10% 10%
Private Consumption: Q1 @ 9.3%
9% 9% 4-Q Moving Average: Q1 @ 6.0%
8% 8%

6% 6%
6% 6%
3% 3%

0% 0% 4% 4%

-3% -3% 2% 2%

-6% -6%
0% 0%
-9% -9%

-2% -2%
-12% Compound Annual Growth: Q2 @ 5.1% -12%
Year-over-Year Percent Change: Q2 @ 8.7%
-15% -15% -4% -4%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1996 1998 2000 2002 2004 2006 2008 2010

Source: IHS Global Insight and Wells Fargo Securities, LLC

Will da Silva Be Back for the Olympics?

This is, perhaps, the biggest question today. If da Silva’s plan is to have Rousseff as a sort of
“interim” president, from 2011-2014, so he can return in 2015 to preside over the Rio de Janeiro
Olympic games, as some are speculating, then the next four years may be very difficult for the
Brazilian political system.

3 The main features of the Cardoso administration were government rationalization, privatization of

government owned enterprises, low inflation, fiscal prudence and overall macroeconomic stability.

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Brazil: Pre-Election Update WELLS FARGO SECURITIES, LLC
September 22, 2010 ECONOMICS GROUP

The most positive argument da Silva has going for him is that we expect the Brazilian economy to
continue to do well during the next four years even if he is not in power. However, strong
economic growth, at the same time, will advance Rousseff’s clout within the Workers’ Party and in
the country, which will make them strong competitors. We believe that the degree of
institutionalization the country has achieved during the past several decades will allow it to
continue its path to modernization irrespective of who presides over it. However, the actual
degree of effectiveness will depend on how strong the economy grows and how consistently the
political system delivers the right combination of policies. To the country’s advantage, the
political system and the country as a whole have learned the lessons from the past, and both
monetary and fiscal policy have been used to help the economy develop as a Latin American
powerhouse.
By not changing direction and adjusting some loose ends, da Silva has managed to keep and By not changing
advance the Brazilian dream of becoming a Latin American and world power broker. Steadiness direction and
and predictability are some of the most important conditions for sustained economic growth, and adjusting some
Brazil has been doing just that consistently since the mid-1990s. While this is something the loose ends, da Silva
country has been practicing since the 1950s and 1960s, the country is now reaping the benefits of has managed to
such policies. Some examples of this consistency are the strong energy development policies, keep and advance
which has included the development of alternative energy sources such as sugar-cane ethanol, the Brazilian
petroleum, hydroelectric, forestry, biomass and other energy alternatives that have made the dream of becoming
country self-sufficient in many energy sources and highly ahead of the curve compared to other a Latin American
countries in the world. and world power
broker.
We believe da Silva’s intention is to return to preside over the 2016 Olympics that will be held in
Rio de Janeiro, because he feels he deserves to be the president for such an important event
because he was instrumental in bringing the Olympics to Rio de Janeiro.
Of course, it is very difficult to know what will happen in four years in such a changing and
challenging political and economic environment. People tend to easily forget, especially if
Rousseff, or whoever wins the presidency, does a good job and international growth conditions
remain positive for the country. Thus, while we believe da Silva wants to return to office in 2015
(2014 presidential elections), we will have to wait and see how this experiment plays out,
especially because no one knows how the strategy of transferring power to another member of the
Workers’ Party would work, as it has never before happened. What is clear is that da Silva will
remain close to power, but his role is yet to be determined. Ultimately, the end result will depend
on how effective and successful the next president is and if that success can make Brazilians
forget Mr. Charisma.
Growth of a Different Type
The Brazilian economy is booming with GDP growth during the second quarter, slowing down While annualized
from the break-neck pace recorded during the first quarter but guaranteeing an almost 7.0 growth during the
percent growth rate during 2010, the best performance by the Brazilian economy since the 1980s. second quarter was
While annualized growth during the second quarter was “only” 5.1 percent, year-over-year growth “only” 5.1 percent,
was 9.0 percent. However, the most important distinction regarding Brazilian economic growth is year-over-year
that it was not achieved by government “fiat,” that is, not by the government throwing money to growth was 9.0
the ceiling, but by the business sector. percent.
Government consumption grew by only 1.4 percent during the second quarter after falling 1.6
percent during the previous quarter. Personal consumption grew by only 2.5 percent, a slowdown
from the previous quarter, when it grew by 5.0 percent. Strong second-quarter growth was due
fundamentally to gross fixed investment. Brazil’s gross fixed investment surged by 40.5 percent in
real terms during the quarter after posting year-over-year growth of 38.8 percent during the first
quarter. Thus, gross fixed investment was up by almost 40 percent during the first half of 2010
compared to the year-earlier period, after falling 20.1 percent during all of 2009.
The growth in investment in the country paints a clear distinction between the Brazilian economy
and other economies in the world that have relied more on government largesse and fiscal
expenditures to support private consumption and the overall economy during the recovery from

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 Brazil: Pre-Election Update WELLS FARGO SECURITIES, LLC
September 22, 2010 ECONOMICS GROUP

last year’s recession. In Brazil, this recovery has not been due to government intervention in the
economy but through a surge in business investment, something that likely will remain in place
for the foreseeable future as the country prepares to become a South American and world
production powerhouse in the coming decades.
A Strong Economy Will Greet the New President
The Brazilian As noted above, the Brazilian economy has continued to boom, and expectations for the next
economy will several years are that it will continue its strong growth as the country prepares for the 2014 Soccer
continue to boom World Cup and the 2016 Olympics. However, the reasons for the boom are not directly related to
as the country gets these two up-and-coming sporting events, even though they will help support an increase in
ready for the 2014 investment in infrastructure, which has been one of, if not “the,” Achilles-heel of the Brazilian
Soccer World Cup economy throughout its history.
and the 2016
The problem of lack of infrastructure is not a minor one. Although Brazil has dealt with this
Olympics.
problem for almost its entire history, it has become more crucial since the country started to
industrialize at a very fast pace in the mid-20th century. The lack of infrastructure, namely paved
roads, ports, airports, etc., has prevented the country’s economy from expanding at a faster pace
over the years. This will continue to put pressure on Brazil’s ability to continue its fast-paced
growth. The weakness has a very important drawback for economic growth. That is, inflation
increases quickly once economic growth accelerates as the country’s production capacity clashes
with the inability to bring goods to markets. Thus, this is why the results for gross fixed
investment during the second quarter were good news for a country that desperately needs more
resources dedicated to investment rather than consumption.
Furthermore, whenever government policies are geared toward domestic consumption, the
productive bottlenecks limiting the ability of the export sector to sell abroad develop and
domestic consumption starts competing with foreign consumption, which puts further pressure
on prices, thus generating an increase in inflation. The consequence of this dynamic is that
interest rates have to rise to prevent higher inflation and the economy slows down considerably or
goes into recession.
Figure 3 Figure 4
Brazilian Gross Fixed Capital Formation Brazilian Consumer Price Index
Year-over-Year Percent Change Year-over-Year Percent Change
30% 30% 18% 18%
CPI: Jul @ 4.6%

15% 15%
20% 20%

12% 12%
10% 10%

9% 9%

0% 0%
6% 6%

-10% -10%
3% 3%
Gross Fixed Capital Formation: Q1 @ 26.0%
4-Q Moving Average: Q1 @ 0.3%
-20% -20% 0% 0%
1996 1998 2000 2002 2004 2006 2008 2010 1998 2000 2002 2004 2006 2008 2010

Source: HIS Global Insight and Wells Fargo Securities, LLC

In a policy report prepared by the World Bank in 2007, the institution discussed the limits to the
current infrastructure program in Brazil, giving policy advice on how to increase infrastructure
development that will allow the country’s economy to grow by at least 4 percentage points faster
than current growth rates.4 According to the report, Brazilian public investment in infrastructure
amounted to approximately 1.5 percent of GDP during 1998-2002 and has only increased
marginally, closer to 2 percent of GDP after that period. Before that, Brazil was spending almost

4“How to Revitalize Infrastructure Investments in Brazil, Public Policies for Better Private
Participation,” The World Bank, Finance, Private Sector and Infrastructure Management Unit, Latin
American and Caribbean Region, Report No. 36624-BR, January 10, 2007

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Brazil: Pre-Election Update WELLS FARGO SECURITIES, LLC
September 22, 2010 ECONOMICS GROUP

twice that much in infrastructure investment. However, after the fiscal and debt crisis faced by
the country in 1998 and 1999, a change in priorities took hold and monies were diverted to keep a
very large primary budget surplus in order to bring down the country’s debt.5
This change in policy has meant that the country again has fallen behind in terms of The country has
infrastructure development, which will continue to limit its ability to grow faster without fallen behind once
triggering higher levels of inflation. Thus, the report by the World Bank proposes a fundamental again in terms of
change in direction for the country’s infrastructure development with a more important role for infrastructure
the participation of the private sector. However, to do that the country has to radically change its development.
regulatory environment regarding private or mixed (public-private) infrastructure projects while
at the same time increasing the rate of return of these projects across the board.
It is clear that economic growth, especially within the context of a developing country, is highly
dependent on investment and, most importantly, dependent on infrastructure investment, which
helps to untangle production and distribution bottlenecks that have historically limited the
growth of a developing country. The World Bank report recommends that infrastructure
investment should reach at least 3.2 percent of GDP, but also recommends the country “reach for
the skies” and invest 4.7 percent to 9.0 percent of GDP in infrastructure investment, which will
add, according to the report, more than 4 percentage points to Brazil’s growth potential.
However, the World Bank’s report also recognizes that, in the current fiscal and debt
environment, spending so much on infrastructure investment will probably not be feasible and
therefore recommends that Brazil take steps to bring more private investment into the mix.
Because the Brazilian economy is currently growing at approximately 5 percent, such an
infrastructure development target will put Brazilian economic growth close to Chinese economic
growth. Thus, it is not difficult to envision an environment that will be reminiscent of China’s
growth rates during the years leading to the 2008 Beijing Olympics. It is true that the Brazilian
economy is a more mature economy than the Chinese economy and that growth may not be
sustainable at rates of 10 percent per year or higher. However, rates of 7 percent to 9 percent on a
sustainable basis may not be that difficult to achieve if the country can put together a reasonable
infrastructure development program, which will probably have to be larger than the ones already
announced by the da Silva administration (PAC and PAC-2).
From PAC to PAC-2
As noted previously, infrastructure investment was not triggered by the country’s future hosting The Brazilian
of the soccer FIFA World Cup and the Olympics. However, these two events may be what the government
doctor recommended to sell the need to invest billions and billions of dollars in infrastructure. To announced the
that end, in January 2007 the Brazilian government announced the implementation of a very implementation of
ambitious, four-year infrastructure investment plan (2007-2010) called PAC for its acronym in very ambitious
Portuguese that translates into Accelerated Growth Program. The PAC is concentrated in three investment plans.
different general areas: 1) logistics, which includes the building of roads, trains, ports, airports,
and navigation infrastructure; 2) energy, which includes the generation and transmission of
electricity, petroleum, natural gas and renewable resources; and 3) the social and urban
infrastructure, including sewage, urban transportation and access to electricity and water
resources. The plan allocated almost $290 billion for these three sectors, with 11.6 percent of the
expenditures going to logistics, 54.5 percent to energy and 33.9 percent to social and urban
infrastructure.
In March 2010, the da Silva administration expanded and extended the PAC with what has been
called the PAC-2, a much more ambitious investment program that will take what the first PAC
achieved and complement it with more resources that will extend into 2014 and beyond.
According to the government, this investment plan is going to allow the Brazilian economy to
grow at a 5.5 percent rate during the next four years while at the same time lowering the deficit
and the country’s debt.

5 Primary surplus is the government’s surplus before paying interest on the country’s debt.

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 Brazil: Pre-Election Update WELLS FARGO SECURITIES, LLC
September 22, 2010 ECONOMICS GROUP

The new PAC-2 program is expected to invest $546 billion during 2011–2014 in several programs
that include what the government calls “better city” with an allocation of 6 percent; “citizens
community” with an allocation of 2.4 percent; “my home, my life” with 29.1 percent of the
allocation; “water and electricity for all” with 3.2 percent; “transportation” with 10.9 percent; and
the bulk of the investment in energy infrastructure with 48.3 percent of the allocation of
resources. Furthermore, PAC-2 expects to invest $361 billion after 2014, with 99.3 percent of that
amount spent on energy infrastructure projects and the rest in transportation.
The government But the most interesting estimate from the PAC-2 is that the Brazilian government expects to
expects to bring the invest this amount while at the same time keeping the primary budget surplus at 3.3 percent of
nominal deficit into GDP and bringing the nominal deficit into a surplus by the end of the planning period, that is, by
a surplus by the 2014, as it expects the budget to turn positive to 0.4 percent of GDP during that year. However,
end of the planning what is more impressive is that the administration is expecting to lower the government’s debt as
period, that is, by a percentage of GDP from the current 40.7 percent to only 28.7 percent of GDP during the same
2014. time period.
Summary and Conclusions
While the Brazilian investment program is very ambitions, especially with regard to the evolution
of the country’s fiscal accounts over those years, we believe Brazil will have no problem growing
by close to an average of 5.5 percent per annum during the next decade. However, if private
capital continues to enter the country at the rates of the past several years, it is not impossible to
foresee the economy growing at a higher rate than 5.5 percent over that period.
Long-term planning is finally paying off for Brazil today at the same time as its political system is
continuing to institutionalize compared to previous decades, and macroeconomic stability has
allowed different administrations to concentrate in redistributing income rather than chasing
short-term macroeconomic volatility. Thus, Brazil is very close to building a strong middle class
that will allow the country to reach the threshold of a developed country in the next several
decades.
Of course, the road is not going to be easy, but we believe Brazil has a lot going for it. The 2014
FIFA World Cup and the 2016 Olympics will showcase the country in the “major leagues” for the
first time while enabling the country to finally take the first steps to crossing that threshold some
time in the near future.

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Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg Global Head of Research (704) 715-8437 diane.schumaker@wellsfargo.com

& Economics (212) 214-5070

John E. Silvia, Ph.D. Chief Economist (704) 374-7034 john.silvia@wellsfargo.com

Mark Vitner Senior Economist (704) 383-5635 mark.vitner@wellsfargo.com
Jay Bryson, Ph.D. Global Economist (704) 383-3518 jay.bryson@wellsfargo.com
Scott Anderson, Ph.D. Senior Economist (612) 667-9281 scott.a.anderson@wellsfargo.com
Eugenio Aleman, Ph.D. Senior Economist (612) 667-0168 eugenio.j.aleman@wellsfargo.com
Sam Bullard Senior Economist (704) 383-7372 sam.bullard@wellsfargo.com
Anika Khan Economist (704) 715-0575 anika.khan@wellsfargo.com
Azhar Iqbal Econometrician (704) 383-6805 azhar.iqbal@wellsfargo.com
Ed Kashmarek Economist (612) 667-0479 ed.kashmarek@wellsfargo.com
Tim Quinlan Economist (704) 374-4407 tim.quinlan@wellsfargo.com

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