Can the country of tomorrow make it through a dark night?

Two Brazilians had a particularly bad year 2012. One is Eike Batista, Brazil’s richest man and the World’s 7th according to Forbes, the other is Brazil’s Minister of Finance Guido Mantega.

When we visited Mr. Batista’s headquarters in Rio as part of the Johns Hopkins SAIS LASP study trip in March last year, the fortune he holds in his enterprises, the most valuable of which is OGX, Brazil’s largest private oil exploration company, was still worth an estimated $30 billion. Batista saw his wealth collapse by more than half shortly thereafter as investors lost confidence in his ability to deliver returns on his massive investments in natural resources and infrastructure leading OGX’s share price to plummet (more on Batista from our friends at Avenida América).

Mr. Mantega on the other hand, was repeatedly embarrassed, as he had to adjust his optimistic projections for Brazil’s annual GDP growth, downward several times, starting at more than 4 percent in the beginning of the year, ending at a meager 1 percent.

What is maybe most disturbing about this downward trend is that it continued despite the authorities unveiling significant measures to revive growth. An overvalued exchange rate, often presented by the government as the culprit for sluggish activity in the manufacturing sector, has come down significantly. Interest rates, once among the highest in the world have been cut by 5.25 percentage points since the second half of 2011 and are now only about 2 percentage points above inflation. The government even tried stimulating the economy by cutting payroll taxes for manufacturers as well as electricity tariffs – apparently to no avail as growth came in significantly lower in 2012 than the already disappointing 2.7 percent recorded in a less favorable environment the previous year.

Forecasts for 2013 are also being corrected downward. The IMF just moved its estimate from 4 percent to 3.5, which would be a lot better than last year, but still only average as the entire world economy (which includes a depressed Eurozone) is expected to grow at the same pace.

Given her poor record on the economy, The Economist has called on President Dilma Rousseff to overhaul her economic team beginning with sacking Mr. Mantega. 

Deus não mais é brasileiro?

So what is the matter with Brazil? The best explanation seems to be that the previous drivers of growth have simply run out of steam and new drivers are failing to take their place. Brazil’s boom throughout most of the 2000s was driven primarily by two factors: high commodity prices combined with expanding production of these commodities and increased consumer spending of a growing middle class.

While prices of commodity exports remain high, they are no longer rising. And while the middle class might still be expanding, the country appears to be going through the backside of a credit cycle as consumers are using more of their income to pay off the loans with which many had bought their first cars and refrigerators.

E agora José? – What to do now

The good news for Brazil is that, while we might not be able to help Mr. Batista’s business fortunes, we probably know how to tackle the bottlenecks that are constraining the country’s potential growth. Structural reforms, in particular tax reform (simplifying the tax code, broadening the base, lowering some rates) and labor market reform as well as crucial infrastructure upgrades have been on the agenda for many years. However, the only area the government is addressing so far is infrastructure, which is being ramped up in preparation for the 2014 World Cup. While to government is clearly making an effort here, even breaking leftist taboos by privatizing some airports, things are progressing at a painfully slow pace.

Overall, the country needs to begin a transition from a model of economic growth driven by commodity exports and consumption to one fueled by investment. To achieve this, the government will need to finally address the infamous Custo Brasil, the high cost of doing business in Brazil. Otherwise the lackluster growth of the present might well continue and Brazil will remain once again the country of the future.

Cornelius Fleischhaker is currently an Analyst at the International Monetary Fund.