Brazil and Venezuela struggle with their economies

Rio cable Car

Since 2014 the output of the Brazilian economy has fallen by 9%, before starting a small recovery this year. Meanwhile in its smaller northern neighbour, Venezuela, the government has stopped producing official economic figures because the performance of the economy is so poor. The IMF thinks the Venezuelan economy contracted by 8% in 2016 alone, but it may have been more. There is no sign yet of any recovery.

Both countries have elements in common in their crises. Both have experienced serious corruption problems syphoning off state money for private and political purposes. Both have been governed by parties keen to promote greater equality by offering more free money and cheap goods to the poor. Both have plundered important nationalised or state influenced corporations in the oil sector to pay the bills. The combination of the decline of the oil price and the diversion of management attention from the necessary work to sustain and enhance oil output have worsened the position.

There are also important differences. Brazil is beginning to take policy measures which could start to turn things round economically. Brazil still has a functioning democratic system of parties and elections, with plenty of opposition forces at work to expose government error and to test out potential reform. Venezuela elected a government which has embarked on constitutional reform to try to curtail opposition. Opposition leaders have been arrested, a new Popular Assembly is working on a new constitution with the possible intention of removing power from the Opposition controlled Parliament. The economic hardship is much greater in Venezuela than in Brazil, with food shortages, medicine shortages, higher unemployment and much higher inflation.

Venezuela has become the centre of considerable international attention thanks to President Trump. He has stated that the US may have to intervene, as he sees Venezuelan democracy under threat. This comment was unpopular with other governments in South America. It has also allowed the Maduro government in Caracas to claim that their hostility to the US is well founded. The US has always been one of the forces the government there blames for their problems. Venezuela is also now being used as a proxy for wider arguments between western socialists and western advocates of free enterprise. The former accept the Venezuelan government’s arguments that the Opposition in that country have turned violent and have gone too far, requiring firm government responses. They liked President Chavez’s policies of tackling inequality by large handouts to the poor, with price controls on the basics so more people could afford them. The more conservative or liberal parties of the west are critical of these same policies, claiming that price controls, nationalisation and hostility to free enterprise has slashed output of food, oil and much else and lies behind the economic collapse. They see the government’s response as anti-democratic, condemning the abuses of human rights that many observers allege.

The relevance of all this to investors is twofold. Venezuela, with huge oil reserves is no longer able to produce as much as it used to thanks to incompetent management at the state oil company. This is a factor keeping oil prices a little higher than they otherwise would be. It also still distributes petrol to its citizens at ultra-low prices, reducing the amount available for export. The failure of the Venezuelan economic policy is a modest destabiliser of the Latin American economy, reminding people of political risk and the vulnerability of the area to extreme events like debt default, and hyperinflation. So far Venezuela has the latter but is avoiding international debt default by strict rationing of all the imported food, medicines and the resat which it needs to provide a decent lifestyle for its citizens. This is not a stable model, and leads to food riots and pressure to change the regime.

Brazil is struggling to get to grips with the full magnitude of their corruption scandal called Operation Car Wash. Many politicians and more than one party were involved in the vast frauds that led to the payments of bribes and political bungs on a huge scale. Some say more than $5bn was involved. Construction companies were awarded overpriced state contracts in return for making illicit payments to executives, officials and politicians favoured by those in power. Governments needed opposition parties within their coalitions, bringing them into the corruption machine. Many in the public are keen for all this to be exposed and for the perpetrators to go to prison. Meanwhile politicians from the corruption era try to put together more stable government whilst fending off allegations about themselves.

The investment consequence of all this is to remind us there is still a lot of economic and political risk in Brazil. Democracy and transparency in a way is flowering as the investigations proceed. The magnitude of the task of reform is made more difficult by the many compromises politicians make owing to the splintered party system and their way of life when corruption was the official business model of many. We prefer emerging Asia where more reliable economic growth can be found.

 


The above article  was first published by Charles Stanley on 15th August 2017