Why Brazil’s economy is losing its shine

July 30, 2016

By Catherine Boyle, CNBCGlobalPost Writer

A man arrives at the branch of a bank closed due to a nationwide strike by bank workers who demand higher pay in downtown Rio de Janeiro, Brazil.
VANDERLEI ALMEIDA

Brazil, long viewed as one of the most promising emerging markets, has seen its crown slip slightly in recent months. The country has been enshrined as Latin America's economic powerhouse for more than a decade, fuelled by vast resource wealth and investment from China.

Yet its dominance is under threat as other emerging markets compete fiercely on cost.

"The last decade was very good for Brazil," James Lockhart Smith, head of Latin America, Maplecroft, told CNBC.

"Now, Brazil is having to compete with a lot of other countries and it has an Achilles heel in the cost of doing business, so it's much more complicated to generate growth."

After roaring to growth of 7.5 percent in 2010, gross domestic product is expected to grow by 3.2 percent in 2013 by the Banco Central do Brasil, the country's central bank. Of course, these figures are still much higher than the slow or negative growth forecast in the US and Europe.

Brazil's stock market has also been moribund. The benchmark index, Bovespa is up just 4 percent over the past year and only $7.6 billion was raised by companies listing in Sao Paulo last year, compared to almost $50 billion in 2010, a record year.

Inflation hit a 10-month high of 5.8 percent in December, despite a decline in the food price inflation which the country suffered from earlier in 2012. Wages are continuing to rise, which is good news for the country's emerging middle class and for consumption, but that is also causing concern about competitiveness.

The central bank has already cut interest rates from 10.5 percent at the start of 2012 to the current rate of 7.25 percent. But it can't cut much further because of the threat of inflation.

Late on Wednesday, the country's central bank left rates on hold even as it warned that the country's domestic recovery had been less intense than expected.

The central bank also acknowledged inflation had worsened in the short term.

"Rates aren't particularly high in historical terms as inflation is so high. The central bank has been extremely aggressive in lowering rates," Julian Thompson, global head of emerging markets at AXA, told CNBC. "Repeated government intervention is undermining confidence and investment has been weak. Labor costs are quite high and Brazil's a pretty protected market."

He expects the central bank to keep rates on hold until March and then cut again if disappointing growth continues.

Inflation is also expected to be dampened by cuts to energy tariffs – although Neil Shearing, chief emerging markets economist at Capital Economics, cautioned that severe droughts last year could delay plans to cut the tariffs. The majority of Brazil's power comes from hydro-electricity.

There are some hopes that China, one of the biggest investors in Brazil, may provide more investment, as it did before the global financial crisis. Yet relatively subdued growth in China itself may limit the country's capacity to invest in Brazil, Thompson said.