Jan 31, 2017 | 09:00 GMT

5 mins read

A Corruption Investigation Clouds Brazil's Prospects for Economic Reprieve

Demonstrators in Rio de Janeiro hold up a life-size cutout of the judge who oversees Brazil's corruption probe, Operation Car Wash.

The past few years have been difficult for Brazil's economy. But after two straight years of recession, things are looking up. By mid-January, the country's inflation rate had fallen to just below 6 percent, its lowest level since March 2014. Reduced inflation prompted the central bank to start cutting interest rates, which now stand at 13 percent. (Economists expect the rate to be under 10 percent by the end of the year.) Confidence in Brazil's manufacturing sector is on the rise, meanwhile, and its current account deficit dropped to $23 billion in 2016, down from $104 billion two years earlier. The Brazilian economy could even start growing again this year — so long as its domestic political affairs don't get in the way.

Brazil badly needs its economy to start growing again. A crash in commodity prices in 2014 diminished the country's export revenues and caused its real gross domestic product to contract by 3.8 percent in 2015 and by 3.5 percent in 2016, according to the International Monetary Fund. At the same time, rising fuel and electricity costs following years of government price controls sent inflation into the double digits over the past two years. The central bank also bumped interest rates up to 14.25 percent in early 2015.

To make matters worse, a corruption investigation dubbed Operation Car Wash plunged the country into turmoil when it was launched in 2014, ensnaring many of Brazil's top corporations, along with some of its most prominent politicians. Many of Brazil's biggest companies have had to pay billions of dollars in penalties over bribery cases uncovered in the investigation. The corporations have suffered other hardships as well, losing government contracts and access to credit. This has brought work on major construction projects, including refineries, nuclear power plants and roads, crashing to a halt. Adding to the upheaval, the investigation has brought down several political officials, such as former President Dilma Rousseff.

Turning a Corner?

But now, projections suggest that Brazil's economy will grow this year — for the first time since 2014 — by 0.2 percent. Acting President Michel Temer has been instrumental in turning the economy around. Despite his low public approval ratings, Temer has managed to pass critical economic measures, including a bill to cap spending and a regulation on pre-salt oil. In addition, the legislature is reviewing proposals for labor and pension reforms. Though the initiatives are unpopular with Brazilian voters, lawmakers have rallied behind them for fear that the necessary reforms would fall by the wayside once the next administration takes over in January 2019. Other factors bode well for Brazil's economy, too. For instance, Brazil will probably experience less fallout from the new U.S. administration's potential protectionist policies than Mexico will. Brazil has much lower trade and immigration exposure to the United States than does Mexico, and trade accounts for a lower portion of its GDP.

Still, a recovery is far from guaranteed, and new twists in the Operation Car Wash scandal could cloud Brazil's economic and political outlook this year.

Construction firm Odebrecht — one of the largest enterprises not just in Brazil but in all of Latin America — was among the companies swept up in the investigation. After Brazilian, U.S. and Swiss authorities sued the firm for making illegal political donations and manipulating government contracts, the company agreed Jan. 21 to pay more than $2.5 billion in damages, the largest anti-corruption settlement in history.

Another Snag

Odebrecht's massive settlement is the least of the Brazilian government's worries, though. A plea bargain related to the case could implicate Temer, along with roughly 25 percent of Brazil's congress members, in accepting illegal donations from the firm. Testimony from the company's executives may well lead the Superior Electoral Court to rule that Temer received illegal funds for his vice presidential campaign and could take down essentially all of Brazil's mainstream politicians. If the court rules against Temer, he will have no choice but to resign, which would plunge Brazil back into political uncertainty and delay the economic measures that his administration has pursued. The decision would also change the playing field for Brazil's 2018 presidential election.

The recent death of Supreme Court Justice Teori Zavascki, who was overseeing the investigation, gave the government some hope that the court would delay its plans to make the Odebrecht testimony public in mid-February. In the meantime, Temer and Chief Justice Carmen Lucia began the process of replacing Zavascki on Jan. 23. (Presidential aides have said Temer will wait for a new rapporteur to be appointed before picking someone to fill the vacant seat.) On Jan. 30, Lucia ratified the plea bargain deal, though she ruled to keep the testimonies involved secret. Now the general prosecutor will review the testimonies to decide whether to open new cases.

Whatever the court decides, Brazil's political order and economic prospects hang in the balance. If Temer emerges unscathed, the resulting political stability would bode well for a return to growth. If, on the other hand, the acting president is implicated and forced to resign, the country will probably spend another year in recession.

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