Analysis: Brazil's economy goes from "great" to "good"

By Brian Winter and Stuart Grudgings

BRASILIA/RIO DE JANEIRO (Reuters) - Brazil's long boom appears to be over.

After several dynamic years that saw it earn a reputation among some Western investors as "the near China," Brazil now looks to be downshifting into a pattern of economic growth of around 3 percent to 4 percent for the foreseeable future.

While that is still good by the depressed standards of Europe and the United States, it puts Brazil behind most of its true peers -- fellow members in the BRICS group of large emerging markets and most major economies in Latin America.

The cooler outlook is reflected in Brazil's stock market, one of the world's worst-performing indexes this year. Several companies are scaling back investment plans in the face of disappointing profits. Wall Street economists have been slashing forecasts for 2011 and years to come.

Other restraints include Brazil's poor business climate relative to its peers; left-leaning President Dilma Rousseff's inability to push major reforms to the tax code or other changes to help lift growth; and the global economic crisis, which translates into uncertain prospects for Brazilian commodities such as iron ore in China and elsewhere.

Many Brazilians are proudly optimistic about their country's recent rise to prominence and talk of a less glorious future is still treated like heresy in some circles.

Indeed, Latin America's largest economy still enjoys near-full employment. Even moderate growth may be enough to secure Rousseff's goal of lifting another 16 million people, or nearly a tenth of the population, from poverty by the end of her term in 2014. Certain areas of the economy such as offshore oil and civil construction are likely to keep booming. Factors such as demographics and a relatively low national debt will continue to work in Brazil's favor.

Some welcome slower growth, saying it could help calm high inflation and prevent a more painful collapse later on.

Yet a growing number of corporate leaders, investors and government officials already express nostalgia for the boom years. They will have to scale down their expectations to make way for a more mediocre Brazil.

"A slowdown of the economy is a fact," said Claudio Bergamo, chief executive officer of Hypermarcas <HYPE3.SA>, the largest Brazilian maker of disposable consumer goods such as beauty care and pharmaceutical products. "It's like a wave that's hitting some people harder than others."

About two-thirds of major companies on the Bovespa stock index failed to meet earnings expectations in the second quarter, according to a Reuters analysis.

Brazil's leading industry group FIESP expects manufacturers to postpone about 17 billion reais ($10.6 billion) in investments this year, with demand-sensitive sectors such as food and machinery suffering the most. That would put investment by industries about 10 percent lower than levels seen in 2010, Fiesp said.

Several economists have recently cut their forecasts, including closely watched Gray Newman of Morgan Stanley who on Wednesday cut his outlook for 2012 growth to 3.5 percent from 4.6 percent. Capital Economics now sees growth as low as 2.5 percent by 2013. In the shorter term, Credit Suisse says Brazil's economy could even contract during the third quarter, before resuming a slower expansion toward the end of the year.

COMING BACK TO EARTH

That would be quite a letdown for a country that enjoyed average annual economic growth of 4.4 percent from 2004 to 2010, even when accounting for the global financial crisis that erupted during that period. Growth peaked at 7.5 percent last year, its fastest pace in 24 years.

Virtually no one expected the pace of 2010 to continue. Hardly anyone foresaw such a heavy hangover from that boom in terms of above-target inflation and one of the world's most overvalued currencies. The pain may be felt for years.

For example, the central bank has been forced to raise interest rates five times this year to 12.5 percent, giving Brazil one of the world's highest costs of credit. Even though the economy is now slowing, most economists expect inflationary pressures to remain high due to indexation of contracts and workers' expectations handsome salary increases of recent years will continue -- meaning the bank will likely be constrained in how fast it can cut rates.

"We have some local issues here -- high interest rates, a high deficit -- that don't let you grow at the pace" seen last year, said Marco Paulo Costa, vice president of CR2, a bank that lends mostly to small and medium-sized businesses.

Rising interest rates seem to have been the coup de grace for many Brazilian consumers, especially the so-called "Class C". These lower-middle class consumers earn between $650 and $2,800 a month. They quintupled spending on domestic goods from 2002 to 2010 and are the poster children of Brazil's recent boom.

Many of those consumers failed to fully understand what they were getting into. Some recently emerged from poverty and were gaining access to credit for the first time.

Interest rates on consumer debt average more than 45 percent in Brazil and debt payments have ballooned to account for about a quarter of Brazilians' income. That compares with a peak in the United States of less than a fifth before the 2008 financial crisis.

High reserve requirements and other safeguards at Brazilian banks mean there is a reduced risk of a debt bubble exploding the way it did in the United States. But the long spending spree is clearly ending.

"There is no more space to get new (consumer) debt. That will put growth on a slower pace," said Pedro Mariani Lacerda, who manages about $80 million for Horto, a fund that handles investments and mergers and acquisitions in Rio de Janeiro.

Defaults on personal loans rose 22 percent in the first half of the year, the biggest jump in nine years, according to Serasa Experian, a credit research firm.

In virtually any bakery or bar, especially in working-class neighborhoods, tales of woe are suddenly everywhere.

"I didn't know what I was doing, honestly I didn't," said Reynaldo Ruiz, a carpenter, who bought an $800 flat-screen TV with a credit card in January but now says he can't afford the payments. Others standing next to him at a juice stand in Brasilia nodded in sympathy, and one woman sipping water from a coconut claimed her nephew had fled the city to escape bill collectors last month.

DISAPPOINTMENT IN GOVERNMENT

Brazil's economy was already running without one of its main engines as industries struggled with the strong exchange rate and high logistical costs kept production flat for the better part of the last two years.

The apparent slowdown in household spending -- which accounts for more than 60 percent of Brazil's economy, compared to 36 percent in China -- is diminishing the strength of another big engine, with a toll on corporate bottom lines.

Many industrial leaders have been disappointed by President Rousseff's inability to reduce Brazil's tax load, which is among the world's highest. Rousseff has ruled out a major fiscal reform that could open up more money for investment, which is low by emerging-world standards.

Prospects for reforms to help improve growth are dimming rapidly as Rousseff faces a rebellion by allies in Congress who are upset by her efforts to control costs and uproot corruption in ministries.

Meanwhile, the government's prized infrastructure program, which includes projects related to the 2014 World Cup and 2016 Olympics, has struggled to execute construction in recent months, leaving long lines on the country's highways and at ports.

"Brazil's industry has lost the ability that it should have to compete," said Humberto Barbato, president of The Brazilian Electrical and Electronics Association. "Brazil is full of costs and we are competing against countries that don't have these costs."

Disappointment over the economic outlook has contributed to a sell-off in Brazil's stock market <.BVSP> as investors see more attractive returns elsewhere in Latin America.

Among the region's top seven economies, only Venezuela will grow more slowly than Brazil this year, according to the International Monetary Fund's latest forecasts. In 2012, Brazil will likely come in last place in the region, with growth of just 3.6 percent, according to the IMF.

Many say they have already started to change strategies.

Torgny Krook of Nordea, a Scandinavian bank, was part of a delegation of European investors that traveled to Brazil to meet with government officials and company executives in March, "when there was still a euphoria ... and it seemed to some people like you could gain almost any exposure to Brazil" and reap dividends from growth, he said.

Now, another delegation of executives is due to return in September, he said, with narrower objectives. "We're still very excited about offshore oil...some of the optimism in other sectors has gone away," Krook said.

Some business leaders say they are comfortable with the new outlook and it could be a blessing. They point to distortions caused by the boom years and remain confident Brazil will remain a good bet with growth and interest rates at zero or low single-digits in Europe and the United States.

Others wonder why Brazil should be content with relative mediocrity after tasting so much success.

"Three percent growth is not a disaster, but Brazil could do much better," said Neil Shearing, an economist for Capital Economics. "It's going to disappoint a lot of people."

(Additional reporting by Guillermo Parra-Bernal and Vivian Pereira; Editing by Andrew Hay)