According to an old Wall Street adage, when the winds are strong even turkeys can fly. In more prosaic terms, when money is easy to borrow, even countries with poor economic fundamentals can finance themselves. But when global liquidity conditions become less favorable, those countries’ economies come crashing down to earth.
Thanks to weak fundamentals and the shock of the coronavirus pandemic, Brazil may soon find itself on a collision course with the ground, beak-first, once the winds of easy liquidity die down.
Despite being the world’s second-largest emerging market economy after China, with an economy roughly the same size as that of Italy, the Brazilian economy lacks many of the qualities associated with long-term, stable growth. Brazil is also now the newest and hottest hotspot of the coronavirus pandemic. A full-blown currency crisis in Brazil could have important spillovers to the rest of the world economy.
Even before the coronavirus pandemic, Brazil was characterized by political dysfunction and a weak economy. Largely as a result of a drawn-out corruption scandal at Petrobras, the quarter-trillion-dollar state-owned oil company, Brazilian president Dilma Rousseff was impeached and removed from office in 2016 and much of the country’s political class was seriously tainted. The loss of public trust in the political establishment has made it especially difficult for Brazil to recover from its 2014-2015 recession—the worst in the worst post-war period—or to repair its public finances.
It would be a gross understatement to say that the government of populist president Jair Bolsonaro, which came into office in January 2019, has squandered whatever opportunity it might have had to correct course. Committing to a policy of total denial about the seriousness of the coronavirus epidemic was a bad start. The lack of a national strategy to combat the pandemic has contributed to Brazil now having more than 1 million COVID-19 infections and around 50,000 fatalities, making it the second-hardest hit country after the United States. Bolsonaro’s atrocious public health management has understandably undermined political support for his government, frustrating his tentative efforts to reform the economy.
But the direct effects of the pandemic are not the only dangers facing the Brazilian economy. International commodity prices have collapsed, capital flows have reversed, and foreign demand for Brazilian exports has dwindled, especially in a slowing China.
According to the Organization for Economic Cooperation and Development, in the likely event that Brazil will be hit by a second wave of the pandemic later this year, its GDP could decline by as much as 9 percent in 2020 before recovering by a modest 2 percent in 2021. Were that to happen, its budget deficit would balloon to 15 percent of GDP in 2020 and its public debt would skyrocket to over 100 percent of GDP by the end of 2021.
When the world financial markets again move to a risk-averse mode, foreigners may be reluctant to finance the Brazilian government’s gaping budget deficit or to roll over their large Brazilian debt holdings. Even Brazilians themselves might seek the safety of the U.S. dollar out of fear that the Brazilian government will once again resort to the central bank’s printing press to inflate away its debt. This would not be the first time Brazil had experienced a currency crisis or hyperinflation.
Early warning signs from the Brazilian currency market suggest another such crisis might be on its way. Since the start of the year, the Brazilian real has depreciated by more than 25 percent despite sizable foreign exchange intervention.
A crisis in an economy as large as Brazil’s is never good for the global economy. But now would be a particularly inopportune time. The world is in its deepest recession in nearly a century, and other major emerging market economies are also facing severe coronavirus-induced shocks.
Maybe the Bolsonaro government will reconsider its direction in light of the economic, political, and human damage that the coronavirus pandemic is inflicting on Brazil. Maybe an about-face on the pandemic will also win Bolsonaro the popular support and political allies he needs to reform the economy.
Maybe turkeys will fly.