Things fall apart?

2015 could be the year that breaks Brazil, but it could also be the year the country rebounds argues João Schlüter No Se Mancha’s Brazil insider

Things are getting serious for Brazil’s President Dilma Rousseff

“Things fall apart” is the title of a famous 1958 novel by Nigerian author Chinua Achebe. Yet it could also describe the mood in Brazil over recent weeks as the country slides ever deeper into a political and economic crisis.

The economy is expected to shrink by about 1 percent this year – worse than in 2009 and the worst since 1990. Since December, the Brazilian economy has been shedding jobs at a rate of 200,000 a months, driving up unemployment whose historical low had helped President Rousseff win reelection back in October.

The currency has lost about a third of its value in less then a year, 17 percent in 2015 only. Inflation is reaching eight percent as the government has raised electricity tariffs and fuel prices dramatically. Mass-demonstrations against the government on March 15, brought over 2 million to the streets, and about 1 million in São Paulo alone.

Lurking behind the crisis is the ever-expanding corruption scandal surrounding Petrobras.

The so-called “petrolão” scandal first broke a year ago but seems to be getting bigger by the week. In a nutshell, corrupt Petrobras officials, appointed by politicians, would demand contractors, such as oil services firms and construction conglomerates, to overcharge Petrobras on their projects and then recycle this money to party financiers through a network of agents, Swiss bank accounts and money launderer, including car-wash business which gave the investigation its name “lava-jato”.

Petrobras’ CEO and Dilma Rousseff intimate Maria das Gracas Foster resigned earlier this year and Petrobras’ bonds have been downgraded to junk. A long list of politicians, almost all for the governing coalition and including the chairmen of both chambers of congress, has been indicted for receiving illicit funds through the scheme.

Both these gentlemen are member of President Rousseff’s most important coalition partner, the PMDB. This largest Brazilian party, and it is really not much of a party at all. Rather it is an agglomeration of state-level strongmen and political networks. If things escalate, it may well break into a pro-and anti-government block.

Tensions are already running high with congressional PMDB leaders threatening to derail the government’s fiscal consolidation program, apparently to increase their bargaining power over the investigation into their involvement in the Petrolão. The education minister, Cid Gomez, a Rousseff ally, had to resign after calling congress members, especially the powerful PMDB leader Eduardo Cunha, a bunch of racketeers.

Even though she has not been directly implicated, most Brazilians believe that the president was “in” on what happened at Petrobras, whose board she chaired for years as energy minister under President Lula. The president’s approval rating is down from 42 percent after her election to 13 percent, the lowest of any President since Fernando Collor who was promptly impeached.

And then there is the talk of impeachment

Joao Augusto de Castro Neves of Eurasia Group, has put the odds of impeachment at 20 percent for now. Yours truly is not ready to put a number on it so far, but what was an off chance in the beginning of the year, the resignation or removal of the newly reelected president, has become somewhat more likely in recent weeks.

Oh and did we mention that large parts of the country could run out of water and electricity this year?

So it really looks as if things are falling apart, – but will they?

Economic adjustment is underway and is likely to be successful

This was the main rational for S&P maintaining their investment grade rating and stable outlook for Brazil on March 23. Sure the adjustment is late and painful, but better late than never and better to face the pain now and get it over with than continuing to delay it.

So yes, growth will be terrible this year, but there is a good chance it will recover next (S&P expects 2 percent growth in 2016). Inflation is high now but that’s because regulated prices are finally being adjusted and it is therefore almost certain to fall next year. The fiscal adjustment will be difficult, but Finance Minister Levy and by extension his boss President Dilma remain committed and are likely to succeed in turning things around already this year.

Joaquim Levy’s job: teach a tough lesson on economic adjustment

The weaker Real is good for Brazil.

While it’s bad news for Brazilians who’ve become used to shopping trips to Miami, the depreciation of the Real is good news for the Brazilian economy. For many years Brazilian industries complained about an overvalued Real, which made them uncompetitive abroad, and relative to imported goods. Now this should be alleviated.

The equilibrium or “fair value” exchange rate has long been estimated to be somewhere between 3.20 and 3.75, so pretty much in the range the real has recently entered. It’s not hard to see the deprecation as an overdue and thoroughly positive development. Sure it will bring some short-term pain through inflation and expanding external debt, but those are manageable and in the long term it should help Brazil regain external equilibrium.

Rain and high prices might resolve the water and electricity crisis.

Rains have been relatively good in February and March, so this plus the shrinking demand due to large price increases may be enough to get by without rationing this year. Sure, the problem may come back next year – or it may not; it all depends on the rain and what happens to investment and regulation in the sector.

Petrobras’ most serious problem is essentially a technicality.

The biggest risk for Brazil right now is that Petrobras continues to be unable to produce a balance sheet, which accounts to write-down losses on corrupt over-invoicing in a way that satisfies the auditor. Understanding the difficulties involved here probably requires an advanced degree in accounting, but at the end of the day, it’s just that: an accounting problem.

In terms of fundamentals, the company is actually in a pretty good shape. It has massive reserves and some of the most advanced offshore technology to tap them. Production of crude and refined products is finally increasing as platforms and refineries built in recent years come online and cash flow has improved due to the hike in domestic fuel prices.

If Petrobras makes the filing deadlines of the next few months, there is no reason to believe that it will not come back stronger.

There is even a silver lining to corruption

Corruption is a big part of what’s wrong with Brazil. However it’s obviously not a new problem or one very specific to Brazil. What’s new and not too common however, is corruption being investigated thoroughly by the appropriate independent institutions and those responsible being punished even if they are some of the most powerful people in the country.

If anything, if we tend to believe that the rule of law and accountability is paramount, than moving to uncover, investigate and punish corruption should leave the country better off in the future.

The politics are a mess but when isn’t it?

Let’s face it: Brazil is a difficult place to govern in the best of times. 28 parties in Congress, about a dozen in the governing coalition, it’s a wonder anything ever gets done. So of course there will be back-and-forth on the fiscal adjustment, of course the fact that a long list of politicians are under investigation will complicate things, but at the end of the day Brazilians will find a jeithino to do what is necessary to stabilize the economy.

The PMDB, at least the part that’s not under investigation, may well be bought off by giving them a few more (or more meaningful) ministries. That could stabilize the government coalition to the degree necessary to approve economic adjustment measures.

It may not be much and it may not be pretty, but certainly enough to keep things from falling apart.