Brazil Enigma Sustaining Long Term Growth
The Brazilian economy has faced lots of ups and downs after the country’s currency crisis in 1999, the economy of the country was boosted up in between the year 2000 and 2008 under the ruling of president Luiz Inacio “Lula” Da Silva of the Patrido dos Trabalhadores (PT). During that era the global demand for the Brazilian commodities was significantly increased which in turn 
increases the domestic production and exports of the country and thus Brazil became the darling of international markets. From the year 2003 and onward the country’s GDP growth were continuously increasing except for a brief recession faced by the country due to the global economic crisis in the last quarters of 2008.However the country doesn’t suffer a lot and had recovered soon from the impact of those crises in the early 2009, the quick rebound to the Global financial crisis attracted the foreign investors to Brazil. The increased wave of foreign investment has granted Brazil the title of the host nation for the 2014 World cup and for 2016 Olympic Games.
The continuing boom in exports causes’ excessive inflow of foreign capital into the economy placed upward pressure over the Brazilian currency. During 2001 to 2008 the role of the state was appreciated by 32% which in turn increases domestic competitiveness among the manufacturers of different sectors and they complained that the production cost in Brazil is very high rendering the exports unprofitable, for that reason we are planning to move our production units to china. In order to prevent domestic manufacturers from the impact of foreign competitiveness the government needs to control the foreign capital inflow, for that purpose the Brazilian government introduced capital controls by imposing a tax on a fixed income of foreign investment. Finance minister Guido Mantega stated that Brazil was fighting an international currency war in which different governments of the world was lowering their currency exchange rates in order to raise their own competitiveness effectively. The real GDP of the country continuously appreciated an additional 39% from 2008 to 2010 overriding the impact of Global financial crisis.
During the Fall of 2010, Dilma Rousseff was elected as the first female president of Brazil as a result of the general election of 2010. Dilma Rousseff took the charge of her office in January 2011 and at that time the inflation rate of the country stood stubbornly at 7%, well above then the central bank target of 4.5%. The new president promised the nation that she would maintain the triple goal approach for the achievement of economic stability and these goals were reduced inflation, flexible exchange rate and fiscal rigor, She also assures that her government will increase exports, particularly of manufactured goods on the priority basis in order to stabilize the fiscal measures of the state. Beside the above mentioned promises the industrial production had fallen to a weak 1.6% by June 2011, many economists blamed that the reason behind that fall is the lack of domestic competitiveness.
Beside the above mentioned challenges the new government has to face many other challenges like Nations poor infrastructure condition, a high tax burden which prevents the foreign investors as well as the domestic investors from investing their money, and the most problematic challenge is the lack of proper and developed educational system which produced a shortage of highly skilled professional workers, all those factors are collectively known as “Brazilian Cost”.
How is Brazil doing? What Challenges is the country faces? Would you buy a Brazilian bond in July 2011? How would you make your Decision? What other information would you like to have?
Brazil was doing very well throughout 2000’s, that time it was likely to emerge as world’s leading economic power. During the period from 2000 to 2008 Brazil has made significant economic achievement like the high inflation rate and fiscal deficit had been controlled and debt from foreign countries had declined. As a result Brazil was upgraded to the BBB+ status by the rating agencies, earning the nation “investment grade” status. The up gradation reflects maturation of the Brazilian institutions and their policy framework. After the election of Rousseff the economic conditions of Brazil are getting better day to day because after taking possession of the Office Ms. Dilma Rousseff had unveiled a new stimulus plan, aimed to inject up to US$ 66bn into the economy to fund infrastructure roads and railroads over a twenty five year period. According to the transparency international, Brazil ranked 75 out of 183 nations which show that how corrupt the public sector of the country perceived. A well reputed newspaper of Brazil stated that during the period from 2000 to 2008 over R$40 billion fiscal budget was lost due to bribery and corruption. Beside the continuous struggle with the government for the betterment of educational system the production of skilled labor force is still negligible. The 2009 OECD Pisa (Program of international student assessment) study showed that Brazil ranked 52 out of 65 nations for both reading and science and for the study of mathematics the country ranked at 56 numbers. The Brazilian government is also working to manage both the exchange rate and interest rate in order to put the economy on the right course.
The country is facing a number of challenges which include the lack of basic infrastructure in most areas of Brazil and also lack of professional education which causes a vacuum in the supply of skill full labor to the industrial sector, which is the basic cause of increasing production cost which is termed as “Custo Brasil” Which is also known as “Brazilian Cost” which means that the external cost a firm faces in the process of production when operating in Brazil. This cost is usually sustained by a firm due to lack of infrastructure, high taxation and financing cost. The Brazilian cost was seen as the responsible factor behind the reduction in the competitiveness of Brazilian producers in the global market. The Tax burden in Brazil is also very high which is 35% of GDP, whereas in the United States it was close to 25%, in Korea 25%, in Mexico 18%, and in China around 17% of GDP. World bank ranked the Tax system of Brazil 150 out of 183 nations due to the high cost of payments and complicated filing system. The interest rate of Brazil is also very high as compared to other countries and in 2010 Brazil was the highest interest rate charging country. Another problem is the continuous increase in the exchange rate appreciation which causes the subsequent weakening in the competitiveness of the country’s manufacturing industries. Companies are worried about the effects of exchange rate appreciation of the future investment opportunities available within Brazil.
No, I would buy the Brazilian bond in July 2011 because of the increasing tax rate IOF which has been enhanced to 6% the Brazilian bond is not a better choice for short term investment. However for long term purpose it would be a bit better choice as it is offering the highest interest rate of 11% even with the IOF tax. The emerging market fund manager at Aviva investors commented “That’s higher than you can get anywhere else, especially in an investment grade credit: The investment toward these bonds shall depend upon the economic stability of Brazil and its contribution toward the Global economic structure.
Would you buy a Brazilian bond in July 2012? What has Changed?
Yes, I would prefer to invest in the Brazilian bonds in July 2012 because the Rousseff administration’s Stimulus plan was aimed to address Brazil’s problems with competitiveness and infrastructure. According to this plan the government attracts the foreign investment by introducing such bonds that are exempt from the IOF and provides a very good chance for the foreign investors to invest even in the long run or short run. The impact of these bonds will be the gaining of exchange rate stability and to increase the competitiveness among the domestic investors. According to Octavio de Barros, Chief economist at Banco Bradesco, Stated, “The bond will be very attractive to foreign investors and the government will be very unlikely to inhibit those inflows with the IOF. It will be a very big challenge for the government on the exchange rate.
What are capital controls? Why did Brazil institute the Imposto Operacoes Financerias (IOF) in 2008? Did the controls meet their objectives?
Capital controls are defined as those policies, which are designed to reduce or redirect transactions into the capital account of a given nation. Capital Controls are divided into direct or administrative controls, such as required approval for transactions, and market based on indirect controls i.e. taxes. Such controls can be implemented on the inflows and outflows of capital into the economy. Capital controls can control the flow of capital into the economy and determines whether the economy needs any capital or not.
The Brazilian government was very depressed with the instability of exchange rates in the year 2008 therefore in an attempt to stabilize the exchange rate and to reduce the upper trend on inflation, the Central government decided to adopt a system of capital controls to control the inflow of capital from abroad. By March 2008 the central government established the Imposto Sober 
Operacoes Financerias (IOF), a financial transaction tax that is imposed on the foreign fixed-income investment at the rate of 1.5%, in order to slow down the flow of foreign investment into the country’s economy. The IOF was increased to 2% in 2009 and later on it was increased to 4% in 2010 and then in 2011 enhances to 6%. Yes the objectives of such imposition were achieved because in 2009 the foreign direct investment in Brazil nearly becomes half i.e from US$ 45.1 billion in 2008 to US$ 25.9 billion in 2009. After such an excessive quelling the government eliminated the IOF for some time in order to get back some investment into the economy. Yet Brazil recovered very quickly from the economic downturn and has gained an investment of US$ 20 billion into the Brazilian equities market just within a nine month period.
Are capital controls a good strategy for emerging markets such as Brazil? Will they help solve the challenges the country is facing? What other policies should Brazil implement?
In my opinion Capital gain is a good strategy for emerging markets such as Brazil because if the foreign investment and Capital inflow increases in the country the domestic industry will suffer badly as it fetches the opportunities from that segment of the economy and on the other hand the countries like Brazil having a floating exchange rate system affected badly by an increase inflow of capital. The domestic investors don’t have much capital to buy quality and modern technology for their production whereas the foreign investors have a surplus of capital and they gain economies of scale easily leaving behind the local industry and even don’t let them grow above their bud. Capital control can solve lots of economical problems of the country but it has to be managed very smartly because the excessive use of such controls can also cause the economy into a downturn and will result into the lack of investment and capital deficit in the economy. Capital controls can help the country to solve almost all the challenges it faces regarding the economic growth because it provides a suitable place for the domestic industry to grow, it increases the competition among different segments of the economy which turned out in the development of the overall economy. Brazil should make their fiscal policy better and should encourage an independent commission for the assessment of fiscal measures in order to reduce the chances of corruption and bribery. The Brazilian government should reduce also reduce the tax burden from the small cottage industry in order to encourage the industrialization into the far fledge areas of the country and should provide better professional educational institutions on the ground level so that the industries can get skilled labor locally. The central bank should adopt a more hands-off approach to the Selic rate which will push up the real and will make the government spending more responsive.