Levy’s appointment postpones days of reckoning

After months of warning about how disastrous a Dilma Rousseff’s re-election would be, Brazil’s financiers and economists quickly regrouped and began suggesting that Brazil’s economy would be OK after all, just as long as the president picked a Finance Minister the market liked. Now enter Joaquim Levy: a more orthodox choice than anyone was seriously expecting and, to be sure, a source of optimism for those hoping for fiscal restraint, inflation-targeting and the maintenance of Brazil’s investment grade rating.

Prior to his announcement, I was speaking to a senior Brazilian economist on the sidelines of the Felaban conference (held in Medellin in mid November) who suggested that growth would return to the Brazilian economy – and pretty aggressively – if there was simply a signal of a policy shift in Brasilia. That would lead to investment, which would lead to growth. The switch from a consumption-led economy to an investment-led economy will be that easy, apparently. The Chinese, struggling to re-orientate their economy might be amused to know how easy it is to transform a country’s fundamental model of economic growth.

Brazil’s problems won’t be solved by appointments or statements, however investor-friendly. The country faces a fight with inflation that will be long and painful and will test the patience and discipline of policy making as the economy – and the public mood – sours. Investments won’t just materialize – they will need structural reforms to transform the basis of the economy. Fiscal cuts won’t just be achieved through realization of the problem: 85% of rampant spending is non-discretionary. Real cuts will need real reform. Good luck with that, Mr Levy. Devaluation will likely bring some potential growth from the export sector but Brazil’s productivity weakness goes far beyond the value of its currency.

Levy’s appointment is, of course, to be welcomed. Rousseff’s election campaign castigated bankers as thieves of food from the mouths of children – so to opt for such an orthodox member of their ranks shows how pragmatic Rousseff is prepared to be, recognition of the scale of the problem, or Lula’s continuing influence. But if, as was widely reported, Levy’s colleague at Bradesco, Luiz Trabuco, declined the post because of lack of assurances as to his autonomy, are we supposed to think Levy was given such guarantees? It would seem unlikely. In which case, what happens, when push surely comes to shove, and unpopular decisions are called for, and the ranks of the PT call for Rousseff to take the populist choice? It would be naive to think the relationship between the President and Finance Minister isn’t going to be severely tested in the coming 12 months. And it would be complacent to think that decisions will continue be taken in Brasilia to appease the markets, especially as unemployment is likely to rise in 2015.

Not everyone is complacent of course. A leading Brazilian investment fund, Credit Suisse’s CSHG Verde, recently wrote to investors saying that Brazil is “way more fragile than the market prices suggest”. The fund, which was founded by Luis Stuhlberger in 1997 (who according to Reuters has generated total returns of 8,800%), has lost money in recent months hedging against expectations of negative expected asset performance. The client letter said that: “The reasons why our hedges have not been triggered are the following: the global outlook and the extreme complacency of investors, especially foreigners, with Brazil.” Recent experience suggests locals are just as likely to be guilty of this as the foreigners.

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