South America Calling

Brazil's Crisis and the Threat to Ag

Brazil has been enveloped in crisis and scandal for the past year.

The newspapers are filled with a daily diet of bleak economic news, political machinations and stories of corruption, often involving public officials and multi-million dollar Swiss bank accounts.

The Brazilian economy is in a rut, with industry hit particularly hard. GDP is set to contract 3% this year and 1.2% next year, according to a central bank market survey.

Agriculture is one of the few sectors to have been spared. That's because as a major exporter it has benefitted massively from the 33% decline of the real against the dollar in 2015.

As a result, Brazilian grain farmers see positive margins for the upcoming 2015-16 soybean harvest when previously they had feared losses due to the sharp decline in international prices over the last year. Meanwhile, Brazil's massive animal protein industry can be hugely aggressive on international markets with the devaluation on their side.

The difference between town and country is clearly apparent. While in Sao Paulo, the ubiquitous malls and restaurants are half full and even the city's notorious traffic has thinned out, city centers in farm towns in the Center-West and south continue to bustle.

Of course, there is a negative side to the crisis for agriculture. Credit has become tighter. The lack of operating credit is a key reason why farmers have sold so much of the 2015-16 soybean harvest ahead of planting and reduced fertilizer applications. It has also influenced a slowdown in expansion of area in the agricultural frontiers.

If Brazil starts to climb its way out of this crisis from next year, no harm will be done to the ag sector. That isn't impossible as if you look at the economic problems they are serious but not terminal.

The real problem appears to be a crisis of governability, where the president and Congress are unable to work together to address the economic problems.

The prolongation of this political gridlock represents perhaps the biggest threat to Brazil's economy and its ag sector. For without decisive simple things like getting the budget balanced, Brazil doesn't recover.

I thought it might be instructive to explain here how Brazil reached this state of affairs and look at some scenarios for the future.

A SAGA UNFOLDS

Brazil has suffered an undignified fall from grace.

Five years ago, it was the darling among the emerging economies. It had come through the global economic crisis with little more than a few scratches and Brazil was ready to "take off" in the memorable words of The Economist.

But cracks soon started appearing in the veneer.

By 2012, two key economic cycles were coming to an end. The first was the boom in non-agricultural commodities, driven almost exclusively by Chinese demand for raw materials. The second was the domestic credit boom that had fired consumer spending over the previous seven years but was fizzling out as the population faced the reality of paying off those loans.

President Dilma Rousseff opted to try to paint over the cracks. Instead of contemplating the much-needed reforms to boost productivity, she sought to keep the party going, offering stimulus to industry and choosing to ignore peaking inflation.

That was enough to keep the wheels on for long enough to get her re-elected in October but since then the severity of Brazil's economic malaise has hit.

As I said, Brazil's economy is expected to contract 3% this year and 1.2% next year

Meanwhile, the government has become mired in what could be the world's largest corruption scandal.

For just about the first time, Brazilian investigators have been allowed free reign to delve into corruption in a major state-owned company and, with the help of Swiss authorities, have uncovered a scheme to skim billions off contracts with oil giant Petrobras.

Brazilians have marveled at the sight of the heads of major construction conglomerates being arrested, people who for years had been suspected of corruption but were seemingly untouchable, and Petrobras officials being condemned to long prison sentences, prompting them to turn state's evidence.

But the investigation has caused panic among the political parties, to whom most of the siphoned money was allegedly destined.

One of the focuses of their ire has been President Dilma Rousseff, who allowed the federal police free reign to investigate and also, they suspect, chose not to protect government allies in an attempt to save those in her closer political circle. Members of Rousseff's coalition were already unhappy with the president for her autocratic style.

Mass job losses, surging inflation and constant headlines of corruption meant Rousseff's popular support collapsed.

The result was open rebellion in her coalition and the opposition calling for the president's impeachment.

Whether Rousseff can fight off the opposition's motion to kick her out of the presidential palace remains unclear. It seems a tall order to obtain a two-thirds majority in both houses of Congress to throw her out, but such is the discontent among Rousseff's allies that they could get there and, should the crisis deepen, it may seem more attractive to some.

The problem is that while this political theater unravels, paralysis in government is causing Brazil's economic crisis to deepen.

On starting her second term in January, Rousseff conceded that Brazil had to put its economic house in order, stop the profligate government spending and get inflation under control.

She appointed Joaquim Levy, a market friendly economist, as finance minister to balance the budget. But Levy's initiatives have floundered amid Congress' unwillingness to help Rousseff out and the president's unwillingness to make cuts to key social programs.

The government can't let its debt balloon at a time when revenues are falling and the base interest rate is a vertiginous 14.25% per year to combat inflation but it is struggling to find a solution and this inability to balance the budget has spooked markets

What Brazil needs is a president with a workable majority in Congress.

That could potentially be achieved if the divisive figure of Rousseff stepped aside and a new "unifying" coalition were formed. But the president isn't inclined to do that nor is the opposition inclined to give up its shot at impeachment.

The whole episode has highlighted how dysfunctional the Brazilian political system really is, with too many Congress members only interested in obtaining lucrative government posts and pork-barrel politics. But there is no easy fix to that, especially while senior Congress members wait to see if they too will be charged in ongoing corruption investigations.

Instead they leave the economy in limbo. That's very dangerous for as long as the government can't balance the budget, the economy drifts and credit will remain tight and investment won't return.

In turn, the ag sector will continue to only have limited access to credit, which impedes plans to improve infrastructure that over the long term are necessary if Brazilian agriculture is to grow.

(CZ)

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