The Bloom Has Fallen Off The Brazilian Rose

Enjoy the Ride While It Lasts – ‘Cause It Never Does

“Don’t cry because it’s over.  Smile because it happened.”

-Dr. Seuss

by Lucas Jackson,
There have been a number of things that have happened in Brazil over the last year or so that could have sparked some to say that the good times experienced during the Lula years were officially over.

Perhaps it was the way the government handled the Petrobras gas price increase.  Perhaps it was the way the government pressured the banks to lower fees.  Perhaps it was the way the government pressured the telephone companies.  Or perhaps it was the way the government decided to handle the renewal of certain utility contracts.  All of this, and other issues to be sure, had the feeling of the left-leaning populist governments of the past, not the forward looking socialism Lula and Dilma have been championing.

But while these events may have been off-putting for investors, they were ostensibly for the benefit of the lower/emerging classes.  With headline inflation running perniciously high, Dilma obviously felt it was necessary to try and micromanage lower prices where she could, sacred cows be damned.

So with Dilma seemingly working hard to limit inflation on the emerging classes, why have these same people decided to protest over the increase of bus fares in Sao Paulo by R$.20?  Hint, it’s more than just inflation.

Something to Lose

First things first, the media loves to tout the statistic that Lula and to some degree Dilma helped bring over 40mm Brazilians out of poverty and into the ranks of the middle class(they like to give them the full credit, deservedly or not, and conveniently ignore President Cardoso and the Plano Real).  If this number is indeed true, it means over 20% of the country now has something significant to lose for the first time in their history.  More Brazilians than ever have access to credit, better housing, better education and more plentiful jobs.  This is the good news.

The bad news is, much of what has brought these gains has come from foreign money.  What makes me say this?  Let’s look at Brazil today and Brazil in 2002.

Financialization – Hot Money Comes In, Hot Money Goes Out

I remember quite clearly what happened when Lula was elected in October, 2002 – investors panicked!  Don’t believe me, check out the chart on the BRL.

So what were some of the issues facing Lula and Brazil that investors were so worried about in 2002?

Corruption

Inefficient government – lack of basic services

Inefficient/unfair tax system

High inflation

Low education standards

High level of wealth inequality

And what, pray tell, are the issues the protestors are upset about in 2013?

Corruption

Inefficient government – lack of basic services

Inefficient/unfair tax system

High inflation

Low education standards

High level of wealth inequality

So what changed to give Brazil the luster of almost-developed world status?  When the powers that be decided to draw a line in the sand in Brazil to fight the Thai Crisis in 1998/1999, Brazil began to look like a country that mattered on the world stage. By late 2002/early 2003, the conservative fiscal effects of the Plano Real made the Brazilian government look less risky than ever before.

All of this combined to make Brazil a destination for foreign capital.  Like never before.

And boy oh boy did the money roll in!

Equity IPOs boomed from 2003 until 2007 or so.  Yields on government debt fell and foreigners bought more Brazilian debt than ever in the country’s history.  The net effect of this was that a lot of people got rich and the credit tap – turned off for decades – was suddenly turned on.  More than this, it was turned on for the maids as well as the homeowners.

Credit cards suddenly became something almost anyone could have.  Plentiful jobs brought about by growing exports and rising domestic sales meant paychecks could be used to secure more credit.  Government programs designed to encourage low-income home purchases (Minha Casa Minha Vida) were introduced as a way to get folks out of the favella and into the formal economy.

Almost overnight, the fast money was everywhere and people were using it.  The domestic consumer was shopping like never before.  Real estate prices were rising by unsustainable levels (and still are in some areas).  The government was spending more money on the poor than ever before.  In short, the country was booming – not because of the discipline of the Plano Real, more productivity, more efficient government or significant improvements in education (in fairness, progress was made in all these areas, but not enough to account for the spectacular growth seen in the IBOV - from 10,000 when Lula was elected to over 74,000 at the peak in 2008).  Brazil was booming because the country was finally invited into the globalized party of growth via credit creation.

But looking at the market today, one would be forgiven for thinking the hot money is decidedly heading for the exits.

The IBOV recently dipped below 50,000 which represents about a 33% fall from the post-2008 highs.  Bond yields have recently been on a steady march north.  And despite the government’s best efforts to contain the move via the swaps market, the BRL keeps leaking lower – currently trading at 2.17 having been as high as 1.94 this past March.

Enjoy the Ride While It Lasts – ‘Cause It Never Does

Which brings us to the protestors currently taking to the streets all over Brazil.  With better access to credit, housing, jobs and overall standard of living than probably anyone in their family has ever experienced, you would think that the average Brazilian would have little reason to hit the streets.

And yet, they are.

While the credit-fueled boom has been great and looks likely to continue for at least a little while longer, the reality of a government that has made little real progress improving the overall standard of living is becoming all too obvious.

The protestors are frustrated.  Frustrated with persistent inflation – that hits them much harder than the upper classes who in many ways benefit from it.  Frustrated with corruption – while the Brazilian congress tries to pass a law that would limit the number of corruption cases that can be brought.  Frustrated with inefficient government – the infrastructure development for the World Cup and Olympics is already running up against cost overruns with projects of questionable long-term value.  But mostly frustrated that due to all of this incompetence, they could lose all of the gains they made since 2002.

Dilma faces a reelection in 2014.  Adding more access to credit probably won’t help her chances of reelection at this point.  Inflation is already running too high.  If she is to reverse her recent decline in popularity and address the concerns of the protestors, she will have to make real progress in changing the Brazilian political landscape writ-large.

She still has the popularity, time and executive skills to make a big effort in this regard.

However, changing the nature of any nation’s political system is difficult, to say the least.

Changing Brazil’s well-established rich/poor, connected/unconnected, boom/bust political and financial system will be difficult in the extreme.