It would be too easy to just blame the current problems on corruption. The system as a whole has failed. The priority of the governments of Presidents Lula and Dilma has been to reduce social inequality; the obvious choice given the wide disparities between rich and poor Brazilians, between southern and northern Brazil. But then the implementation of the socio-economic policy has been counterproductive. A tangled mass of new subsidies and a rapidly growing government intervention have led to an excessive consumption growth, resulting in rising current account and budget deficits. The ever-increasing state banks essentially financed investments that were politically important, but economically irrational. Brazil thus, in fact, embraced the Chinese model.

During the years of increasing government intervention, the investment climate has deteriorated dramatically. Private investment growth has been negative for four years and a radical change in Brasilia is urgently needed to rotate the negative trend. The economy has not been this bad for a long time. After years of low growth, the country has now re-entered a recession. Meanwhile, inflation is going up fast, budget and current account deficits are growing, the real has depreciated by a whopping 45% since August and the interest rate, which was already considered one of the highest in the world, is moving up fast.

On top of this economic misery comes a serious political crisis. President Dilma is under great pressure because of the major corruption scandal involving state oil company Petrobras. Many political leaders are suspected of being involved, leaving the political system largely paralyzed. Extensive reforms are urgently needed to break the downward spiral. A paralyzed government is the last thing the country needs. Social unrest and mass demonstrations can eventually lead to the overthrow of President Dilma. It seems, though, that the crisis should deepen first before the market pressure will be high enough to force reforms. In this environment, Brazilian equity, bond and especially currency markets are vulnerable. The rest of the emerging world is holding its breath. For the first time since 2002, there is substantial risk of contagion. And history repeats itself: thirteen years ago, Brazil was the main problem as well.


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