A tall, relaxed bespectacled man was waiting patiently on a cushy sofa for his next appointment at the St Regis hotel during the latest annual IMF meeting in Washington.
In spite of the political tensions at home amidst a tough presidential election and global financial uncertainties, the then chief executive of Bradesco Asset Management (BRAM), Joaquim Levy, did not seem to have any problem to “sell Brazil” with a broad smile on his face.
Asked if he would consider becoming Dilma Rousseff’s finance minister should she win the run-off at the end of that month, Levy kept a smile on his face. “I have not received any phone call,” he told this correspondent.
Yet a few weeks later, the phone rang. When he finally took the job, he put an end to several weeks of speculation and uncertainty among investors, who had also picked the previous central bank governor, Henrique Meirelles, and the CEO of Bradesco, Luiz Carlos Trabuco, as other potential candidates.
To most investors, Levy looks like the right man at the right place at the right time — unlike his predecessor, who was not widely liked by the financial community.
“I am pretty sure that Joaquim is indeed [the right man]. We will have to see if he delivers the results now,” says Fernando Honorato Barbosa, who used to work with Levy as BRAM’s chief economist.
In private, a senior banker admits there is a real concern that credit ratings agencies may be on the verge of downgrading Brazil’s sovereign debt and that the budget tightening promoted by Levy is Brazil’s best chance to avoid losing its investment grade.
Indeed, Brazil has a huge mountain to climb. “It is difficult to say whether the country will manage to go through a stage of ‘blood, sweat and tears’ after so many years of ‘sex, drugs and rock and roll’. This is not going to be easy to implement,” says Luis Stuhlberger, managing director of Verde Asset Management.
The hangover hits
Fixing Brazil will not be an easy task. Levy’s orthodox adjustment potion, a bitter mix of tax rises and spending cuts, will be a sobering experience — especially after 2014, a year of living dangerously.
Deficits have worsened to the point where some are threatening to get out of control. Rising public spending in an election year and falling tax collection together with a stagnant economy, as well as tax breaks for various sectors, have led to a whopping 6.7% of GDP fiscal deficit last year, more than twice as much as that of 2013. The emerging market average is below 2%, according to the IMF.
Fiscal accounts have deteriorated to a point where instead of obtaining a primary fiscal surplus (before interest payments), as required by law, Brazil registered a primary fiscal deficit of 32.5 billion reais ($11.3 billion), equivalent to 0.6% of GDP in 2014. It was the worst performance since the 1990s.
As a result, Brazil’s gross public debt has reached 63.4% of GDP in 2014 (according to the Brazilian methodology), up 6.6 percentage points from the previous year. Shortly after his appointment, Levy’s first move was to set new primary fiscal targets at a surplus of 1.2% of GDP for this year, and 2% of GDP for the following two years.
“He is no savior of the nation, but it was about time [that someone like him was appointed],” says Jean Louis Martin, head of macroeconomic research at Crédit Agricole in Paris. “The public finances drift was unsustainable. There is nothing irreversible here, but the fact is that Brazilians are already paying dear to service their debt and they cannot afford to let it grow.”
The trend will not be reversed immediately. The central bank admits that gross public debt may reach 65.2% of GDP this year, while it expects that net debt will increase to 38.2% of GDP (from 36.7% in 2014).
Levy, who acknowledges that gross debt may only stabilize from 2016 before it declines, says it should then trend towards 50% of GDP. “This is a positive, long-term objective,” he said over breakfast with journalists in Brasilia. “The length of time that is needed will depend on fiscal policy and GDP growth,” he said.
Even when he was part of the banking community, Levy never joined the chorus of investors who blasted Brazil for its unorthodox economic policies and its tropical version of state interventionism. Nor did he buy the concept of the “Fragile Five” or Brazil’s supposed vulnerability, thanks to the country’s reasonably healthy solvency indicators and the comfortable level of its international reserves.
Yet, he has always made clear that the battle would have to be led on the fiscal front. In 2015, this means a fiscal adjustment of 66 billion reais, equal to 1.2% of GDP. “We have been mature enough to correct things before an economic crisis settles in,” he says. It is a tall order, but credibility is the name of Levy’s game.
Meanwhile, there are other challenges. The current account has deteriorated beyond expectation. At the beginning of last year, Levy told this correspondent that he expected the deficit would fall back below 3% of GDP.
Instead, the current account gap kept getting wider and ended 2014 at 4.2% of GDP, the worst performance since 2001. Despite a significant currency depreciation, the sharp decline of export commodities prices led Brazil to register its first trade deficit in 15 years ($3.9 billion) in 2014.
Levy is also facing slippery terrain on inflation, as he has started to raise tax on gasoline and hike electricity rates. Moreover, currency depreciation will weigh on prices. When he told investors in late January that Brazil had “no intention of letting the exchange rate appreciate artificially”, the dollar gained 3% against the real in a single day. This may only be an appetizer as looming US interest rate hikes point to weaker currencies in emerging markets. The Brazilian real may be in for a rough ride, especially given the size of its current account deficit.
Just click “Like”
To the general public, Levy was still largely unknown until recently. So, shortly after taking office, a smiley Levy appeared on Facebook — no tie, no jacket — to introduce himself to the general public. “Hello, I’m Joaquim! I’ve just taken on the job of finance minister…” He explained that his job is all about “taking responsibility for raising money and spending funds”, before taking (just a few) online questions.
But to the business and financial world, Levy has been well-known for quite some time. At 54, his résumé speaks volumes. Not only does he enjoy experience in Brasilia as a former Treasury secretary under Lula’s first presidential term and as an economist under the previous Cardoso administration, but he was also appointed finance secretary in the government of Rio de Janeiro before moving back to the private financial sector in São Paulo.
The Chicago-trained economist and engineer’s international experience has ranged from the IMF to the Inter-American Development Bank, where he held a vice presidency, as well as a short stint as a visiting economist at the European Central Bank in 2000.
While President Dilma Rousseff decided to attend the inauguration ceremony of Bolivia’s President Evo Morales in the Andes last January, it was Levy who was sent to Davos with the central bank governor, Alexandre Tombini. There, he led the Brazilian delegation at the World Economic Forum to convince the global investing village that his task was no mission impossible.
“Credibility will be restored if [fiscal] targets are met,” says Ilan Goldfajn, chief economist at Itaú Unibanco. “There was indeed a risk of losing investment grade, but thanks to the appointment of Joaquim Levy [at the finance ministry], and the new fiscal targets, that risk has declined a lot,” he said.
Levy, no doubt, is aiming high despite all the challenges at home and abroad. “We need to have a minimum of ambition to achieve an A- rating,” he told local reporters in January. “It is true that some countries in Europe are going down, but in our stage of development, we have to aim at climbing up the ladder,” he said.
His market-friendly arsenal includes criticism of “credit dualism”. A two-speed credit system is still in place in Brazil, but the long-term subsidized interest rate, known as TJLP, has just been raised for the first time in a decade from 5.0% to 5.5%, while the benchmark Selic rate was still at 12.25% in February. Levy has also lashed out at patrimonialismo — the use of public goods for private purposes — and told local reporters he would like to allow the private sector to take on a greater role.
“It is the market economy that must lead” he said. “The role of some public banks needs to change a little bit,” as transfers from the Treasury to BNDES, the government-owned development bank, will be curbed. “The market will gain precedence (over the state),” he said.
Nevertheless, some measures are already facing stiff opposition. For example, Levy’s announcement of a cut in unemployment benefits has been bombarded by trade unions, and now faces an uncertain fate in Congress.
No surrender
For the political newcomer, the road ahead will not be easy.
“The economic team in 2015 has focused on the objective of avoiding the loss of investment grade,” says José Serra, a leading opposition senator and a former presidential contender, defeated by Rousseff in 2010. “I think they have benefited from a positive response with the strong support of the press and the business and financial community. It is a sign [they are heading] in the right direction.”
But on the other hand, “it is a kind of straight jacket,” he says.
“Last year’s figures were bad, and this year’s will not be brilliant either,” Serra says. “If the fiscal area is to play any role [in the economy] this year, it will be towards some contraction. We are going to watch the forced march towards recession or stagflation. The trend is going be negative.”
Yet not everybody is convinced that the fiscal adjustment will be successful. The mainstream of the ruling Workers’ Party, as well as pro-development economists who enjoyed a great influence on economic policy in the previous government, have warned that Levy may be plunging Brazil into a long period of recession and rising unemployment (which stood at an historic low of 4.8% in the country’s main large cities at the end of last year).
“They got scared due to the risks of losing the investment grade status. They submitted themselves to this change of policy,” says Luiz Gonzaga Belluzzo, an economics professor who used to lecture Rousseff at the University of Campinas and who still describes himself as a friend of the president. “It is a form of capitulation. It is an unconditional surrender to what the financial markets were defending during the electoral campaign. At the time, Dilma criticized what the markets were saying, but she ended up accepting the message,” he says.
The optimistic view among economists is that the Brazilian economy will return to growth after a transition of one or two years of macro-economic policy adjustment.
But Belluzzo would rather adopt a stern view. “There will not be a recovery — even next year. It is like in Europe, starting a fiscal adjustment in an economy that is already in a recession does not sound quite right. But the government does not have the political ability to defend alternative policies — it has given up. There is no social pressure to oppose such policies and to present any alternative,” Belluzzo says.
Indeed, in the short term, the outlook is grim. BNP Paribas’ research department said in late January that “2015 will be a lost year in terms of growth” and Itaú Unibanco cut its growth forecast for 2015 to -0.5% at the beginning of February. If the threat of water and electricity rationing materialize, the bank estimates the year’s economic growth would fall further, to -1.1%.
“Brazil is putting its house in order. It is a year to fix everything, and the adjustment will extend to 2016 as well,” says Goldfajn.
Levy will need strong political support from the president and the rest of the government to survive this period of austerity. “The point is not that investors are skeptical, because they tend to believe in the economic team. But an adjustment like this is always controversial. And [investors] still wonder whether the government will enjoy political support,” he says.
“The initial impact on the welfare of the population is going to be negative. There will be more inflation due to the increase in government-controlled prices and tax increases,” says Armando Castelar, coordinator of applied economic research at the Getulio Vargas Foundation, a business school, in Rio de Janeiro. “So it is going to hurt people’s revenue and at a difficult time. The pressure on the economic team will increase. And then, the big issue is whether the president will stick with those policies or not,” he says.
But according to top bankers, there is not much choice. “It is a tough year. But I do not see any alternative,” says Roberto Setubal, president of Itaú Unibanco. “It is time to do the homework.” LF