Former Brazil Central Banker Says `Political Clouds' Slow Growth

(Bloomberg) -- Brazil’s corruption scandals are casting a cloud over the political landscape that’s preventing a full-fledged economic recovery, former central bank chief Arminio Fraga said.

It would be unheard of for a recession to be this extreme and not be followed by a large rebound, “but right now it feels like a small bounce,” Fraga, a partner at hedge fund and private equity firm Gavea Investimentos Ltda, said in an interview. “The only reason we don’t have a strong rebound is because of the uncertainty still ahead of us.”

Despite more than two years of economic contraction that reached almost 10 percent -- a downturn Fraga called a “depression” -- many entrepreneurs still have excess capacity and are waiting before investing in more production, he said. Questions still unanswered include whether the government will increase taxes, reduce subsidies or cut spending, and whether the next president will change Brazil’s economic direction in coming years.

New revelations in the three-year-old Carwash corruption probe are also increasing discontent and uncertainty, according to Fraga.

“What we are seeing is this amazing display of completely widespread corruption, and this is poisonous,” Fraga said, adding that it’s also fertile ground for a sort of populism that would end up undermining attempts to balance the federal budget. Such an outcome would be “more painful than adjusting,” he said.

Odebrecht Case

Hours of videos released this month show owners of Odebrecht SA, Latin America’s biggest construction company, explaining how they bribed officials to win lucrative contracts, tales that go back decades and mention almost 100 politicians, including all five of Brazil’s living presidents.

“At the moment there is no visibility, there is a massive lack of trust in politics, on politicians,” Fraga said.

Brazil President Michel Temer’s popularity has fallen into the single digits as he fends off corruption allegations and backs unpopular austerity measures, local newspaper Estado de S. Paulo reported on April 17, citing an Ibope poll. Temer was rated “good” or “very good” by 9 percent of respondents. In the prior Ibope survey carried out in March, the president’s approval rating was 20 percent.

In this already difficult political environment, the government will try to pass unpopular reforms aimed at reducing the fiscal deficit by cutting benefits for retirees. And it will also probably have to increase taxes, Fraga said.

“The former government blew up the biggest hole in the budget ever, a deterioration of 6 to 7 points of GDP,” said Fraga, the finance-minister designate for PSDB candidate Aecio Neves in the 2014 elections. Neves lost to Dilma Rousseff, who gave her seat to Temer in April 2016 in an impeachment process. Fraga was nominated president of the Brazilian central bank in 1999 for then-President Fernando Henrique Cardoso, also from the PSDB.

More Needed

A quarter of the deterioration in the budget can be attributed to declining revenue because of the recession, and that could come back easily, according to Fraga. “If you undo the tax breaks, and all the subsidies that were granted, that would help as well, but much more will be needed,” he said.

It won’t be easy to cut expenditures because so much of the budget is earmarked, Fraga said, meaning taxes will have to go up to avoid pushing the debt-to-GDP ratio higher.

“I’ve been preaching the need to stop the growth in government expenditures for a long time, but the government has decided not to front-load things on that front, and we are left with a kind of back-loaded adjustment that may in the near-term require some higher taxes," he said. “This is going to drive everybody up a wall.”

“Still, I think this at the moment is the lesser evil."