Forget Brazil's Strengths, Let's Look At Its Weaknesses

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Looks like that old law of physics, "What goes up must come down," applies to the world of punditry. The May/June issue of Foreign Affairs has an article with a down-ish view of a country that's been up in pundits' estimation for years.

The headline: "Bearish on Brazil."

The theme: Brazil's focus on controlling inflation and building a social safety net has placed a "hidden cap" on economic growth, leaving the country vulnerable to a drop in Chinese demand for Brazilian commodities.

The article's conclusion: "For now, Brazil appears to be clinging to its hard-won stability. But if it fails to reform, its commodity-driven surge will soon begin to wash away."

Producers of soybeans, cattle and other American products that compete with Brazil's for international markets, take note. Though the article is focused on the country's macro-economy, its agricultural implications are intriguing. If, as it suggests, Brazil's economy goes into a tailspin or policies change to prevent that, its agricultural competitiveness could be affected.

The article's author is Ruchir Sharma, emerging-markets guru at Morgan Stanley, a major Wall Street firm. Investors in equities have for years hailed Brazil as one of the stars of the emerging-markets world, the B in the celebrated BRICS--Brazil, Russia, India, China, South Africa.

Sharma worries that Brazil's star status relies on exports of oil, iron ore, copper and other commodities (he mentions sugar but not soybeans or beef or cotton). As a result, the country "will become increasingly vulnerable to violent swings in commodity prices and to the coming slowdown of China."

It's especially troubling, Sharma says, that unlike China, Brazil has favored economic stability over economic growth. For understandable reasons, to be sure: In 1994 Brazil had a near-death experience with inflation. Prices rose 2,100%; checks were losing 30% of their value before they were deposited. In response, Brazil has become "a paragon of financial responsibility," using high interest rates to tame hyperinflation and keep it tamed.

Those interest rates have attracted foreign capital and strengthened the Brazilian real, whose value against the dollar has doubled in 10 years. That, Sharma says, has given Brazil a hyped stock market but also boosted domestic prices to the point where it's "prohibitively expensive to do just about anything."

Manufacturing's share of the economy is low, by developing-country standards, and falling. And while Sharma doesn't mention it, our correspondents in Brazil, Kieran Gartlan and now Alastair Stewart, have frequently reported on Brazilian farmers' difficulties with the country's high interest rates and strong real.

The gusher of foreign capital, Sharma says, has funded a welfare state rather than roads and bridges. Government spending is 40% of the economy, up from 20% in 1980, but Brazil invests only 2% of its gross domestic product on infrastructure. China invests 10%; the developing-country average is 5%. American farmers who've been to Brazil have seen how poor roads and ports hobble their Brazilian counterparts.

Because Brazil under-invests, inflationary pressures start to build when the economy grows by as little as 4% a year adjusted for inflation, about half the rate at which China's economy overheats. "And because Brazil historically raises interest rates at the first signs of inflation, thereby restraining growth, the country tends to stall at that 4% threshold."

On top of everything, Sharma says Brazil is "one of the most protectionist economies in the world." Trade represents only 20% of gross domestic product, the lowest level among emerging-market economies.

Sharma urges Brazil to "take risks and open up the economy." Lower trade barriers. Spend less on welfare, more on infrastructure, education and research and development.

Good advice, perhaps. But there's no sign Brazil will take it, and that might be just as well for American farmers. A humbled Brazil that's forced to alter its economic course would likely end up with a weaker real. That would make Brazilian soybeans and beef even more attractive to Asian buyers while boosting farmers' costs for foreign-sourced imports.

And if, over time, Brazil could bring interest rates down the way China has, Brazilian farmers would make higher profits. That would encourage them to acquire and plant uncultivated land, which the country has in abundance.

Sharma's is a contrarian voice, to be sure. Many pundits are still up on Brazil, and up in particular on what Sharma is most down on, the economic management. Fiscal responsibility is popular with the pundit class. Unlike most of its fellow BRICS, Brazil also has other strengths pundits like: a relatively stable, democratic political system and something approaching rule of law.

Still, Sharma is right to point out the weaknesses. It's interesting to contemplate the possibility that a major U.S. ag competitor is headed for a fall -- or some profound changes in policy.

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Urban Lehner can be reached at urban.lehner@telventdtn.com

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