Brazil braced for recession with no respite in sight

Brazilian markets have come back from the brink in the past few weeks, as what looked set to be a rout across all asset classes has moderated. The currency, for example, which hit R$3.30 to the dollar in March, was - briefly - back below R$2.90 in the last week of April. Stocks have been trending up, at least in local currency terms, since February.

But this is unlikely to be the dawn of a brighter future. "It has to do with the cycle of the political crisis," says Luis Costa, currency and credit analyst at Citi Research. "Every crisis starts like this - you have a peak then another cycle. But there are still a lot of difficult battles to be fought. It is going to be tough."

The numbers are still depressed. The real opened the year at R$2.65 to the dollar and even went below R$2.60 before starting its latest slide. Four years ago, it was trading around the R$1.60 mark. The Bovespa stock index, at about 57,000 today, is up from 47,000 in late January, but down from nearly 73,000 in late 2010.

That was when many investors still believed the boom years of the 2000s were set to last. Brazil, after all, had come through the 2008-09 crisis remarkably unscathed and was riding a wave of credit-fuelled consumption helped along with government stimulus.

But since Dilma Rousseff, the current president, came to power in January 2011, the boom has steadily gone into reverse. Critics say this is partly because the conditions for sustained growth had not been put in place.

Growth over the previous decade or so had been powered in large part by a commodities boom led by China and by the floods of cheap capital provided by monetary stimulus in the US and elsewhere. As first one, then the other, ended, investors became increasingly alarmed by the interventionist policies of the Rousseff administration.

Petrobras, the government-controlled oil group that has an overbearing presence on equity and bond markets, lost as much as $20bn by some estimates as it was forced to sell petrol and other products below market prices to keep inflation in check.

Investors were also unhappy at the government's habit of picking winners among individual companies or sectors, handing out subsidised loans and tax breaks that skewed the competitive environment and did little to encourage overall improvements in productivity.

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But the policy changes brought about by Joaquim Levy, the new finance minister, are designed primarily to balance the books and are likely in the short term only to deepen what looks certain to be a recession in 2015.

As David Hensley, economist at JPMorgan, notes: "One unusual (and worrisome) feature of the Brazilian landscape is that there is no relief in the pipeline from policy."

Even as asset prices have ticked up, the economy has gone on ticking down. Unemployment, which remained re­markably low as GDP growth fell during the first Rousseff administration, has started to climb. Real wages are falling as inflation moves further beyond the 6.5 per cent upper limit of the government's tolerance band.

It is not only that current policy is likely to worsen the short-term outlook, there is also little prospect of reforms to tackle Brazil's structural weaknesses of inflexible labour markets, a bloated public sector, bureaucracy and other brakes on productivity.

Still, the country has weathered crises before and while barriers to growth remain, there has been progress at the margins.

"The Brazilian market is cheap," says Richard Titherington, chief investment officer for emerging markets at JPMorgan Asset Management.

He adds: "Things will reverse at some point. It's too early to be optimistic, but it's also too early to write Brazil off."

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