After two years of recession and continued political instability, Brazil seems to be headed toward economic recovery. President Michel Temer, though currently under investigation for corruption, has been steadfast in his efforts to implement financial reform and lead his country down a path toward economic liberalization. And though the Brazilian government's leadership woes will only grow, Latin America's largest economy seems to have become somewhat capable of decoupling itself from political issues.
The Necessity of Reform
Brazil's economic growth has long been constrained by strict regulations across almost every industry. And the recent recession, which caused the country's gross domestic product (GDP) to plunge by more than 7 percent, only further showcased the limitations of the government's restrictive approach. Thus over the past year and a half, at the urging of Temer and his ruling Brazilian Democratic Movement Party, the country's Congress has been approving a variety of reforms intended to encourage economic liberalization.
One of the main targets of these new policies is the Brazilian energy industry. The country's large pre-salt oil reserves, for example, are primed to attract significant outside interest. But for more than a decade, Brazil has required state-owned oil company Petroleo Brasileiro S.A. (Petrobras) to be the main operator of every pre-salt oil field, limiting the role of foreign capital and driving away potential investors. On Oct. 5, 2016, however, Brazil's Congress approved a regulatory change lifting that requirement, and on Oct. 27 of this year, Brazil will hold its first pre-salt oil auction since the change. In total, the country will hold eight oil auctions before the start of 2019, involving more than 300 oil and natural gas fields and potentially attracting more than $80 billion in investments. The auctions could add more than 2 million barrels per day to Brazil's oil production and increase foreign participation in the industry from its current 17 percent to 30 percent over the next decade.
The Brazilian government also decided to make some changes that affect the functionality of Petrobras. Currently the world's most indebted oil company, Petrobras has sold over $13 billion in assets since 2015, and the government has decided to further speed up the company's divestment plan. Petrobras is now set to sell an additional $18 billion in 2017 and 2018, allowing several new private companies to enter the Brazilian oil and natural gas market. (There are rumors that the government intends to fully privatize the company, but that likely won't happen before Temer's presidential term ends Dec. 31, 2018.) Additionally, Brasilia has eliminated its policy, established by previous administrations, of controlling fuel prices to tame inflation. This rule caused major economic damage to Petrobras, which for years was forced to purchase fuel abroad at high prices but sell it domestically for a loss.
Brazil's move toward economic liberalization, however, is not limited to the energy sector. The country's labor laws, for example, are famously rigid, and it is very difficult — not to mention expensive — for Brazilian companies to fire and hire workers. In fact, Brazil regularly takes the prize for having the world's highest number of lawsuits over firings, and in 2016 alone, there were more than 3 million labor lawsuits. But on Nov. 11, a new set of regulations will go into effect that will make labor laws more flexible. These rules will also make it easier for companies to outsource many of their activities, allowing employers the freedom to hire more workers as contractors.
Additionally, the government intends to implement a major privatization plan by the second quarter of next year, which will be critical for improving the country's infrastructure. Ultimately, the privatization plan will involve around 60 state-owned companies and assets, including port terminals, airports, roads and even the country's lottery. And some state-owned companies already have been sold. Last month, the government earned almost $4 billion from the privatization of four hydroelectric dams, and soon it plans to sell its largest power utility company, Eletrobras, which supposedly has a market value of more than $8 billion. This bold privatization plan will allow Brazil to attract more capital so that it can modernize and expand ports, airports and roads at a time when the central government does not have the financial capacity to make major investments.
On the foreign trade front, Brazil has been involving itself in an increasing number of free trade negotiations and recently requested membership in the Organization for Economic Co-Operation and Development. Brasilia has even agreed to adopt some of the organization's required measures, including lifting restrictions placed on foreign companies interested in participating in government procurement — historically one of its main sticking points in trade negotiations. Finally, the government has been working to reduce the amount of subsidized credit available through its Brazilian Development Bank, which some have argued creates unfair competition among companies.
Recovery Despite Political Instability
The many corruption scandals involving key Brazilian political figures have slowed the progress of economic recovery, but they have not entirely prevented it. Brazil's GDP is expected to increase this year by 0.7 percent. And even if Temer is felled by corruption probes before his term is up at the end of 2018, the economic reforms he is pushing will likely continue, since his ruling coalition in Congress would select his successor in an indirect election.
Where uncertainty will emerge is after the October 2018 presidential election. If the new president comes from the left or is also under investigation for corruption, the path to economic liberalization could be disrupted, either because of an opposing agenda or because of the continued focus on the corruption probe. According to the latest polls, former President Luiz Inacio Lula da Silva, who is currently under investigation, is leading the presidential race with the support of 32.4 percent of those polled.
However, even if the Brazilian political landscape remains a rocky one, there are signs the economy will continue its slow but persistent recovery. The annual inflation rate is projected to drop from more than 11 percent in 2015 to around 3 percent in 2017, and that development will give Brazil's central bank room to continue lowering interest rates. The result: an increase in domestic consumption after a two-year decline, which is good news for the Brazilian economy since it relies heavily on its internal market. The auto industry, for example, which has reported a decline in production for the past two years, is expected to see sales grow 7.3 percent in 2017 and more than 10 percent in 2018. Brazil's unemployment rate has stopped rising and, in fact, dropped from 13 percent in the first quarter of 2017 to 12.8 percent in the second quarter. All of these signs of progress have led financial institutions to revise Brazil's economic growth for 2018 to 2.5 percent, up from 2 percent.
There is little preventing Brazil's economy from moving further toward liberalization over the next year, and even after the 2018 presidential elections, the impact of government scandals will likely be minimized. As key economic indicators such as inflation and interest rates continue to improve, the country can expect more robust economic growth.
A previous version of this assessment misstated the size of Brazil's economy. The error has been corrected.