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Friday, November 24, 2006

OECD Brazil Survey

The OECD has a new survey out on Brazil. Bloomberg have a rough summary here:

"Brazil's economy will slide further behind its peers unless the government limits spending, especially on pensions, the Organization for Economic Cooperation and Development said today in a report."

Of course the interesting question that this raises is who exactly Brazil's peers are?

If we look at the key demographic indicators the counry which most resembles Brazil in its present profile is Turkey. Both have fertility levels which are rapidly approaching replacement level - and of course may well soon follow the global pattern of below replacement fertility - since both currently have a 2.4 TFR (and dropping fast). In terms of life expectancy Brazil is around 71 and Turkey 72, and of course these ages are rising comparatively rapidly as economic conditions improve. As far as median age goes both countries are now entering the age range during which the phenomenon known as the 'demographic dividend' can be expected to operate (Brazil 27.81, Turkey 27.7, for the importance of median ages in macroeconomic analysis see this post here). So the similarity at this level between these two countries is in fact striking and remarkable. Turkey in recent years has enjoyed far stronger rates of economic growth when compared to Brazil, but it is not clear to what extent the 'anchor' of the EU accession process (and the consequent surge in domestic investment) has been responsible for this, and equally how this process might be affected by any distancing between Turkey and the EU which could result from 'enlargement fatigue' or a worst case scenario in Iraq might impact on this.

In cultural terms the countries which most resemble Brazil would of course be the other two Latin American 'tigers' Chile and Argentina. And again, these countries, possibly for different reasons, have enjoyed rather higher growth rates than Brazil. So in this sense the OECD may well be right to describe Brazil as something of a laggard. The key question is just how long this position will continue.

In these terms the OECD report is revealing. At a superficial level the OECDs key point would seem sound enough:

``Brazil's growth performance needs to improve to close a widening income gap relative'' to other countries in the group, the OECD said in the report. ``Despite reforms implemented since 1998, the deficit of the social-security regime for private- sector workers continues to rise.''

Clearly this is the case, though I doubt the validity of making a direct comparison with the OECD 30 at this point. Brazil is a relatively poor developing country, it is starting on the round to becoming a developed economy, but this road is likely to be a long and hard one. As has already been noted the population is still comparatively young - Brazil is just entering the demographic dividend range - and the still fairly large young cohorts undoubtedly place special pressures on the labour market, and exert a somewhat negative influence on employment rates and income growth. This position will to some extent correct itself automatically as the shape of the pyramid changes, however the OECD is undoubtedly right in stressing the need for a balanced policy environment so as to leverage this process to the maximum.

Brazil is the biggest debtor among emerging market nations with about 1.06 trillion reais ($494.2 billion) in public federal debt in October. The country's 2.5 percent annual growth rate since 1995 lags the global average by more than a third.

Obviously it is clear that Brazil needs to get a better hold on its public finances and that increased taxes are not the best solution, but I do feel that both the above statistics are a little misleading since in the first place Barzil is a large country and hence proportionally the debt is not as big as this makes it seem, and secondly Brazil has only really started to take off in the last couple of years, so the average growth rate since 1995 is not a particularly informative number.

In fact the OECD says the following:

Fiscal performance remains strong. The consolidated primary budget surplus target – which has been raised repeatedly since 1999 to ensure the sustainability of the public debt dynamics – continues to be met and sometimes exceeded by wide margins. The net public debt has fallen in relation to GDP since the 2003 peak and has now stabilised, albeit at the comparatively high level of around 50% of GDP by emerging market standards. The government has been able to sustain fiscal adjustment, despite the limited room for manoeuvre caused by a ratcheting up of current spending over the years and Brazil’s notorious budget rigidities. Nevertheless, fiscal adjustment has been achieved at the expense of cutting back on public investment and by increasing the tax burden. The revenue-to-GDP ratio rose by about 5 percentage points during 2000-05 to nearly 37.5% in 2005 – a level that is one of the highest among countries with comparable income levels. A durable reduction in public indebtedness on the back of a retrenchment of current expenditure, rather than tax hikes, would serve to facilitate a swifter fall in real interest rates and to permit the channelling of domestic saving to finance growth enhancing investment. It would also lay the groundwork for removing distortions in the tax system, including by broadening tax bases.

So progress is being made on the deficit front, and the real issue is about the structure of public spending with more emphasis needed on infrastructural investment rather than on current spending. The politics of this are, however, complex.

Also on the monetary policy front the OECD is fairly positive:

The perception that the authorities are committed to a monetary policy framework combining inflation targeting and a flexible exchange-rate regime appears to be suitably well entrenched. The central bank enjoys de facto, but not yet de jure, operational autonomy. The policy regime has been working well, delivering continuous disinflation since 2003 and anchoring expectations. Notwithstanding these achievements, which should not be underestimated, the conduct of monetary policy is complicated by cumbersome regulations on the allocation of credit to selected sectors, especially agriculture and housing, including through mandated saving arrangements. Compulsory reserve requirements on commercial banks are also burdensome for a variety of deposit categories, although most countries that have adopted inflation targeting as the framework for monetary policymaking have now reduced or eliminated such requirements. These restrictions act as an implicit tax on the financial sector, against the backdrop of an already relatively high tax burden on financial transactions, including that of the bank debit tax (CPMF).

So changes are needed:

Consideration should be given to gradually removing the extant directed credit and reducing compulsory reserve requirements so as to improve the efficiency of the financial sector and adequately reward long-term saving, an aspect of the problem that is often overlooked. The favourable domestic macroeconomic environment, with falling inflation and improving growth prospects, appears propitious for further liberalisation in this area. At the same time, the consolidation of macroeconomic stability not only creates a need to move forward but also provides an opportunity to go beyond the current policy achievements as a means of eliminating the remaining distortions inherited from the pre-stabilisation period. The payoff from reform in this area can be considerable in terms of reducing Brazil’s stubbornly high real rates of interest, which weigh heavily on growth.

Essentially the real rate of interest needs to come down.

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