Brazil is facing a challenging situation due to weak investment and declining confidence. Economic growth, which had slowed significantly since mid-2013, came to a halt in 2014. This is largely due to reduced competitiveness, eroded policy credibility resulting from persistent fiscal deterioration and above-target inflation, and worsening external conditions. To maintain strong and sustained growth, Brazil needs to shift towards investment-led growth from consumption. The focus of policies should be on alleviating supply-side constraints and boosting productive capacity since the space for demand-boosting policies is limited.
The new economic policy team faces the challenge of restoring policy credibility and bolstering confidence in economic decision-making in a weakening domestic and external environment. Economic activity is expected to contract in the near-term, with risks significantly to the downside. Risks include adverse impacts from the ongoing corruption probe concerning Petrobras, the possibility of not meeting fiscal policy goals, and energy and water rationing. External downside risks come from a tightening of global financial conditions, geo-political tensions, and contagion from other emerging economies. These risks could threaten macro and financial stability if combined with domestic policy shortfalls.
To address these challenges, policies should focus on bolstering credibility and addressing supply-side constraints. Fiscal consolidation should proceed along the announced lines, while monetary policy should remain tight to bring inflation to target. Strengthening fiscal and monetary policy frameworks, alleviating structural bottlenecks, and targeting missing markets can boost investment, productivity, and competitiveness. The exchange rate should remain the primary external shock absorber, with limited intervention during episodes of excessive volatility. Public bank lending should play a complementary role, with a focus on missing markets. Targeted prudential measures to strengthen the financial system are advisable to deal with vulnerabilities in an environment marked by low growth, tighter financial conditions, and possibly rising unemployment.
In conclusion, Brazil faces significant economic challenges, and policymakers need to take decisive actions to restore policy credibility, boost confidence, and address supply-side constraints to ensure sustained growth. It is critical to implement structural reforms to enhance the economy’s productive capacity, preserve macro and financial stability, and achieve long-term growth.