Brazil: Slow and Steady Wins

Since a team of Goldman Sachs economists popularized the term "BRIC" (Brazil, Russia, India and China) in 2003, this group of emerging-market countries has assumed ever-greater importance in the international investment community's collective imagination. There are plenty of good reasons to invest in each of them. But from a political-risk perspective, and leaving aside differences of scale in the four economies, Brazil's upside potential and limited downside risk suggest it may well emerge as the surest long-term bet of the BRIC states.

You wouldn't guess it at first. Brazil has by far the lowest growth rate of the four BRICs, driven by a tax burden of nearly 35 percent of GDP and slow movement on economic reform. But market-friendly macroeconomic policy and stable democratic governance have created a solid foundation for growth. Since 2002, the state has made its debt repayments on schedule. The economy has generated more than 4.5 million new jobs. Trade surpluses top $40 billion per year. Inflation is low, and an expansion of consumer credit has bolstered the purchasing power of millions.

Much of this is down to President Luis Inácio Lula da Silva. Known as a leftist, he is a pragmatist and dealmaker, not a Chávez-style ideologue, and has, for the most part, successfully balanced the needs of the poorest citizens with the demands of responsible economic policy. Easily re-elected last October, Lula now faces tougher political battles as he works to accelerate growth, create more jobs and raise educational standards. But Brazil has come a long way over the last half decade. The country's problems are now the sort that plague relatively mature free-market democracies. Brazil's growth trajectory depends on economic reforms, inflation and fiscal policy, rather than serious political instability or debt default. That's not the case in the other BRICs.

It will be a challenge for Lula to enact the difficult constitutional reforms necessary to reduce government spending and the country's tax burden. But politicians of the left and the right have finally acknowledged the need to cooperate on historically contentious pension reform—and fiscal reform more broadly. Leaders across Brazil's political spectrum are also beginning to recognize that the country's modest growth rate must be accelerated.

Brazil's legal and regulatory red tape will continue to generate inefficiencies, but this leaves significant room for reforms at the margins—steps that can slowly but steadily enhance growth potential. The Congress will most likely approve new legislation in 2007 to establish a more market-friendly regulatory framework for gas that further opens the sector to private investment, revamping the country's antitrust laws and environmental licensing procedures, and may well pass legislation that strengthens the authority of regulatory agencies to enforce clear rules of the road. None of these reforms requires constitutional change or faces insurmountable political obstacles. In addition, the government recognizes the need to attract private investment in energy and infrastructure, crucial for higher growth.

Energy in particular is Brazil's trump card: its independence on that front stands in sharp contrast to India and China, which are very much at the mercy of volatility in global energy markets. Growth potential for Brazilian biofuels is of course dictated by oil prices and the economic growth of countries like the United States, Japan and South Korea. But the government is committed to bolstering private-sector investment in both biodiesel and ethanol over the long term. Add to this Brazil's 1.7 to 1.8 million barrels per day of oil production, and it's clear the country is poised to profit from the current global energy picture.

Brazil will not match the growth rates in expanding China or energy-rich Russia any time soon. But its growth will likely top 4 percent in 2007, and there are good reasons to expect it will move toward 5 percent in 2008-2009 as these reforms take hold. In addition, Brazil faces nothing like the risks to longer-term political stability plaguing China, the dependence on high oil prices that will burden Russia for years to come, or the extreme decentralization of political decision-making that may stunt India's long-term growth prospects. Slow but steady progress on reform will combine with the maturation of Brazil's political institutions to make the country a sound long-term investment bet.

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