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WSJ, August 28 2015
How Brazil’s China-Driven Commodities Boom Went Bust
Developing nation’s big bet on China turns sour as China’s appetite for
By JOHN LYONS and PAUL KIERNAN
SÃO PAULO—Not long ago, Brazil stood as the leading example of how a
developing nation could rise toward global prominence on the force of a
China-driven commodity boom.
As its economy surged, Brazil stormed the world stage—hosting a World
Cup, demanding more say at the United Nations and blocking a U.S.
free-trade plan for the Americas.
Now Brazil is looking like a symbol of something else: resource-rich
nations’ habit of ending their booms with spectacular busts.
Brazil’s stock market is down 22% in the past year. Its currency has
lost a third of its value against the dollar. And on Friday, Brazil is
expected to report that in the second quarter, its economy shrank at a
pace of about 1.7%. Economists are voicing fears of prolonged stagnation.
China has caused turmoil in many places, but none more so than in this
prime supplier of commodities to a country whose once-voracious appetite
for them has dimmed. Brazil’s pain from China’s slowdown isn’t largely
confined to the financial markets, as in some countries, but goes to the
heart of its real economy.
“We went from Brazil mania to Brazil nausea,” said Marcos Troyjo, a
former Brazilian diplomat who leads a Columbia University center
studying emerging markets. “We are looking at a lost decade, where
growth stagnates, inflation is high, and, most sadly, a decade where
you’ve learned nothing.”
For Brazilians who believed, as their leaders were saying, that the
country would climb to first-world status during the resources boom, the
downturn has come as a profound disappointment. Big antigovernment
demonstrations are now regular events: Protesters decry the corruption
that a sweeping investigation is uncovering, and many call for President
Dilma Rousseff’s ouster. As inflation nears double-digits and as
unemployment and interest rates rise, middle-class households are
starting to miss car payments and the poor are eating less meat.
“Beef is the first to go!” said Janeide Ferreira, a 54-year-old cleaner
in Rio de Janeiro who must take a sweaty two-hour bus ride to work each
day from the slum where she lives. “Things were so much better five
years ago.”
Brazil is in danger of losing its investment-grade rating, to judge by
the negative views of credit-rating firms, potentially sparking a
disorderly currency decline.
Some wealthy Brazilians aren’t sticking around to find out. Rich
Brazilians are snapping up homes from South Florida to Scarsdale, N.Y.,
often with the long-term plan of raising families there. A cover story
on the phenomenon in the weekly magazine Istoé this month is titled:
“Bye-Bye Brazil.”
Poised to Benefit
Looking back, it is easy to understand the frenzy of optimism. If the
biggest economic story this century was China’s rise, Brazil was
uniquely poised to benefit from it.
Rich in iron ore, soybeans and beef, not to mention oil, Brazil was
positioned as a supplier of many things China needed. Its annual trade
with China, only around $2 billion in 2000, soared to $83 billion in
2013. China supplanted the U.S. as Brazil’s largest trading partner.
China’s rise helped spur global investors to pour more than $1 trillion
a year into emerging markets by 2011, a fivefold increase in a decade.
Brazil was a leading destination. Because its securities markets were
more transparent than China’s, some investors bought Brazil as way to
play China.
In the midst of this, Brazil’s state-controlled oil company made a huge
deep-water discovery, at a time when oil analysts were focused on tight
supply and prices were rising. Voters in this nation of deep economic
inequality had elected a president who rose from poverty, Luiz Inácio
Lula da Silva. He positioned himself as a voice for millions being
lifted in the commodities boom, clinching Rio de Janeiro’s right to host
the 2016 Olympics in a stirring speech saying the games would be a gift
to the poor.
But Brazil had boomed several times in past decades, only to go bust. A
1966-1973 expansion was dubbed the “Brazilian Miracle.” What followed it
in the 1980s was a tumultuous decade of hyperinflation, debt crises and
falling living standards.
This time was supposed to be different. In digging out from the 1980s
mess, Brazil had cut spending, stabilized its currency and tamed the
four-digit inflation. A combination of fiscal rectitude and increasingly
competent government was meant to allow Latin America’s biggest economy
to converge with advanced nations such as the U.S.
The longtime quip about Brazil had been that “it’s the country of the
future—and always will be.” In 2005, a book by a Brazilian economist was
titled “The Future Arrived.”
Brazil, one of the emerging-market investment darlings known as the
“BRIC” countries (which also included Russia, India and China), turned
in a sterling growth rate of 7.6% in 2010. Global development experts
started talking about exporting the “Brazil model” to other emerging
nations.
Mr. da Silva envisioned the China-based commodity windfall as funding
new roads, ports, dams and industries such as shipbuilding. Brazil was
taking its place among the world’s developed nations. Officials began
traveling to investor meetings with a booklet suggesting their economy
would grow at an average of about 4.5% a year in perpetuity.
It wasn’t to be. Brazil fell under what some economists call the
“resource curse,” a theory describing how countries with abundant
natural resources sometimes do worse than countries without them. The
idea is that the money from commodity sales can lead to overvalued
currencies and shortsighted policy-making, leaving such countries badly
exposed when the resource boom finally ends.
“Unfortunately, the history is that commodity-dependent economies do not
catch up with the U.S.,” said Ruchir Sharma, head of emerging markets at
Morgan Stanley Investment Management. “Not just oil producers. More
countries end up being poorer, compared with the U.S., after they find a
commodity than catch up.” Using data going back to 1800, he said
commodity-dependent economies typically grow for a decade, then spend as
long as two decades wallowing or slipping back.
Some reasons are structural. The influx of hard currency from commodity
exports strengthens a country’s own currency, which can toughen
conditions for non-commodity industries such as manufacturing by
hampering exports and making imports cheaper. At the height of Brazil’s
boom, Goldman Sachs declared Brazil’s currency, the real, the world’s
most overvalued. Movies and taxis in downtown São Paulo were more
expensive in dollar terms than in New York. Brazil’s manufacturers began
contracting.
Many of Brazil’s problems were homegrown, though, said Alexandre
Schwartsman, a former Brazilian central-bank official: “We managed to
produce this recession ourselves.”
Buoyed by China trade, nationalist-minded politicians launched a foreign
policy meant to reduce the role of the U.S. in Latin America. Brazil
blocked a U.S. free-trade initiative for the Americas. They teamed with
Venezuela to create a regional security council to supplant one that
included the U.S. The foreign minister worked from an office with a huge
map of the world upside down, offering the message that the era of
emerging markets was at hand.
But the world wasn’t upside down. While Brazil tied itself more closely
to anti-American governments like Venezuela, Argentina and Iran, some
regional neighbors—Chile, Colombia and Peru—went around Brazil and cut
individual free-trade deals with the U.S.
Brazil also started spending its commodity windfall before its oil and
ore were out of the ground—another feature of the resource curse.
Anticipating commodity sales, the government spent increasingly heavily.
Government banks supplied Brazilians with easy credit. Brazil subsidized
energy bills, issued cheap loans to big companies with government ties
and built stadiums to host global events such as the 2014 World Cup and
the 2016 Olympics.
Brazil’s national development bank, BNDES, lent so much that its loan
portfolio became bigger than the World Bank’s, making many loans at
below-market rates.
Other investments failed to pay long-term returns. The credit-driven
consumer boom ran out of gas, and some World Cup stadiums sit unused.
Meantime, Brazil produced far less oil than predicted. Production
actually shrank in some years, as Petróleo Brasileiro SA, known as
Petrobras, struggled with the enormous task of developing oil fields in
extremely deep water.
Officials sometimes budgeted as if oil and ore prices would stay high,
in what economists call another common mistake of resource-rich nations.
Consider Vale SA, a mining giant with close government ties. As China’s
demand for construction materials lifted iron-ore prices in Brazil to
$126 a ton from $19 between 2000 and 2011, Vale executives began a $16
billion expansion of their main iron-ore complex and ordered a fleet of
super-large “Valemax” ships to carry ore to China.
When China’s growth began to slow, Vale’s ferrous-division director,
José Carlos Martins, kept telling investors iron-ore prices would remain
high. In dismissing analyst concerns on a July 2014 conference call, he
said, “It’s amazing how much you focus on China.”
Mr. Martins left voluntarily that year as iron ore headed south. He said
his forecasts were thrown off by oil’s drop and the dollar’s
appreciation, noting: “In the corporate world, you spend half your life
making forecasts and the other half explaining why that forecast was
wrong.” Vale has cut its dividend and sold some ships, but is pushing
ahead with the mine project.
Corruption scandal
Commodities’ support of the economy allowed Brazilian leaders to put off
addressing certain problems that had long bedeviled the nation, such as
a political system that tended to breed corruption and a bureaucracy
that stymied business innovation. “Brazil became complacent because of
the intoxicating effects of China trade,” said Thomas Trebat, a former
emerging-markets investment banker who directs Columbia University’s
Columbia Global Centers in Rio de Janeiro. “Now they are suffering a
hangover.
The commodity boom may even have turbocharged some unhealthy practices.
Brazilian prosecutors are looking into the activities of dozens of
executives and politicians in a sweeping bribery and kickback
investigation centered on activities at Petrobras as the oil giant spent
heavily to develop its offshore field.
Though corruption has long plagued the country, the figures this time
have shocked even jaded Brazilians. Petrobras says at least $2 billion
was stolen from it in the past decade. One executive indicted in the
probe has agreed to return nearly $100 million. The leader of the lower
house in Congress, Eduardo Cunha, is being investigated on suspicion of
taking $5 million. He denies it.
Brazil’s electoral court has authorized investigations of whether some
of the corruption helped fund Ms. Rousseff’s 2014 re-election campaign.
The treasurer of her Workers Party has been jailed on an accusation,
which he denies, of money laundering. Ms. Rousseff and her party deny
any wrongdoing.
Amid the downturn, the government is fracturing, hindering its ability
to turn things around. Ms. Rousseff’s public approval rating is down to
8%. Her vice president, Michel Temer, recently said he is no longer
pursuing a vice president’s usual role of helping the president get
things done in Congress, prompting speculation he wants her job.
“Someone needs to unify everyone…because otherwise the country could
enter into an ugly crisis,” Mr. Temer said this month.
Ms. Rousseff and her advisers defend her policies, saying the downturn
would have been worse had her government not expanded the social safety
net and provided subsidies to industries to help them avoid laying off
workers.
While Brazil’s economy is forecast to contract by 2% this year,
government officials are hoping the outlook improves next year as Ms.
Rousseff introduces measures to streamline the government and works to
rekindle good relations with the U.S. Brazil’s now-weaker currency might
help revive manufacturing and exports. In addition, the country has $371
billion in central-bank reserves to cushion the slump.
“We’re renovating the foundations of the economy, and we will resume
growing with all of our potential,” Ms. Rousseff said this month.
But China is the X-factor. Brazil’s exports to China tumbled by 19% in
the first seven months of this year.
For more than a decade, China has been there when Brazil needed it most.
Brazil entered the latest commodity upswing, around 2002, verging on
default, but Brazil’s economy began to catch fire from resource prices
buoyed by Chinese demand.
Brazil then again looked as if it could come undone after the global
financial crisis in 2008. China’s $586 billion stimulus package helped
reignite global demand for what Brazil produces.
Even now, Brazil is looking to China for help. In May, Ms. Rousseff met
in Brasília with Chinese Premier Li Keqiang. At a time when some global
investors were starting to shun Brazil, China agreed to lend Petrobras
$10 billion. The Chinese government also said it would consider
investing in Brazilian railroads, ports and roads. Whether these things
come to fruition is now a question, as China’s own economy slows.
—David Luhnow contributed to this article.
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