By Dom Phillips
The Washington Post
RIO DE JANEIRO — Rodrigo Muchinelli, owner of a computer sales and repair store in Rio, said his business was in the red for the first three months of this year and is still limping. “It is a fight, daily,” said the 38-year-old businessman.
Laercio Soares closed a lucrative deal with a Rio samba school for his embroidery company in December. He used the money to close a family business whose workforce had fallen from 60 to eight. “We saw the perspective was bad,” said Soares, 65. “That’s why we took this drastic decision.”
He was proved right. Brazil’s economy is tanking — and it’s not just China, its principal trade partner, that is to blame. South America’s biggest economy fell into recession in August and is expected to shrink by 2 to 3 percent this year. Inflation is pushing 10 percent, its highest since 2003, unemployment has climbed to over 8 percent, and the Brazilian real has lost about a third of its value against the dollar this year.
Just a few years ago, Brazil was a favorite of investors — one of the “BRICS” group of emerging markets named for Brazil, Russia, India, China and South Africa. Its economy grew more than 7 percent in 2010. Yet last week, ratings agency Standard & Poor’s reduced Brazil’s credit rating from investment grade to junk.
In a rare front-page editorial Sunday, the Folha de Sao Paulo newspaper reacted by attacking President Dilma Rousseff, who was narrowly reelected in October, for the “generalized irresponsibility” of recent years, during which public spending soared.
[Thousands turn out across Brazil to demand president’s ouster]
Under Rousseff's mentor and predecessor, two-time president Luiz Inácio Lula da Silva, Brazil combined social policies that reduced poverty with market-friendly economics. A global commodities boom helped spur the economy — with a hungry China in the forefront, eagerly buying iron ore, oil and soya beans from Brazil.
Rousseff has blamed global factors for her country’s current economic woes. China’s growth has slowed and commodities prices have tumbled — a double hit for Brazil.
But critics say she shares responsibility. Antonio Porto Gonçalves, director of business studies at the Getulio Vargas Foundation in Rio, blamed the government’s “extreme incompetence.” Exports, he noted, represent just 10 to 12 percent of Brazil’s economy.
In a statement explaining the downgrade, Standard & Poor’s cited the government’s “internal disagreement” over how to address its deficit, and the shifts in its target for the budget. In July, the government revised the target for 2016 to a budget surplus amounting to 0.7 percent of GDP. Then, last month, it changed that to a 0.3 percent shortfall.
While that kind of budget gap wouldn’t be unusual in the United States, deficits can drive away foreign investors from an emerging market such as Brazil, which battled a debt crisis in the 1980s and hyper*inflation in the 1990s, and was bailed out by the International Monetary Fund as recently as 2002. Standard & Poor’s first awarded Brazil investment grade status in 2008, under Lula.
A political crisis is also weighing on Brazil’s economy. Standard & Poor’s said a factor in its decision to downgrade Brazil was Rousseff’s plunging popularity — at just 8 percent — and the political fallout from a multi*billion-dollar corruption scam at state-controlled oil company Petrobras. High-ranking executives and politicians from Rousseff’s Workers’ Party and its allies are being investigated. Rousseff has had fallouts with her coalition partners, who have derailed or weakened government proposals.
Meanwhile, heavily indebted Petrobras has slashed investment and spending. And with many of Brazil’s biggest construction and engineering companies also being investigated in the scandal, and key executives jailed, there is a slowdown in many businesses. The cumulative impact on the Brazilian economy could be significant — with $37 billion in lost production alone, according to a Sao Paulo consulting firm, GO Associados.
Rousseff’s cabinet has been divided over how to resolve the budget crisis. Finance Minister Joaquim Levy — a former banker popular with financial markets — argues for austerity and budget cuts. Planning Minister Nelson Barbosa is seen as supporting state-led development and wants to protect social benefits.
Levy told foreign journalists last week that Brazil needed to become more competitive to secure the social benefits achieved during the commodities boom. “Of course, it’s not easy to reduce expenditures,” he said, but added that strong actions — including possibly raising tax rates — were required.
On Monday, Levy and Barbosa presented a package of measures to balance next year’s budget, including a six-month freeze on pay increases for public servants, who have enjoyed generous salaries and pensions, and the temporary re*introduction of an unpopular financial transfers tax. It will be tough to get these measures through Congress, however, with leaders of the House of Representatives already saying it is unlikely to approve the new tax.
Lula has argued for more spending. During his two mandates, as China boomed, spiraling prices for Brazil’s commodities boosted tax revenue. A government cash-transfer program helped 30 million Brazilians escape poverty — nearly 15 percent of the population. Consumer spending in this new lower-middle class expanded.
“The poor helped save Brazil,” Lula said during a visit to Paraguay this month. “And today I say that to take care of the poor is the solution.”
Porto Gonçalves said that Rousseff’s economic stewardship has been erratic, exacerbating the crisis. In 2012, she took to national television to announce steep cuts in electricity rates, which panicked investors in the privatized electricity market. A plan that year to attract private investors for much-needed infrastructure faltered, with critics saying it didn’t offer enough potential for profits.
The Sao Paulo and Rio state federations of industry released a statement following the credit rating downgrade that called for spending cuts rather than tax increases. “Small and medium companies are suffocated. Many are fighting to survive. Others are closing their doors,” the note said.
What both Lula’s and Rousseff’s governments failed to do was introduce reforms to make doing business easier. “It’s never been easy to be a businessman in Brazil — bureaucracy, a ton of taxes,” said Muchinelli. “Now they want more taxes.”
To add to her problems, Rousseff faces two court processes that could lead to impeachment. Hundreds of thousands of Brazilians took to the streets last month to demand her impeachment.
Now the question is whether a second rating agency will downgrade Brazil. If that happens, the impact could be dramatic.
“You will see many pension funds pulling out of Brazil,” said Pablo Gonzalez, Brazil senior analyst at Frontier Strategy Group, an emerging markets research company, in Washington. He said many people had expected the economy would recover by 2017. “This downgrade will extend the recession even more.”
Sitting in the small home office where he now runs a company supplying minibuses for tourists, Soares, 65, was not optimistic. His services had not been contracted for a week. “People are not traveling,” he said. His cellphone rang.
“I’m here waiting for someone to call with some work,” he told the caller. “Is it you?”
Dom Phillips is The Post's correspondent in Rio de Janeiro. He has previously written for The Times, Guardian and Sunday Times.