In 2014, Brazil’s previously steady economic growth came to an abrupt halt, with GDP contracting by around 8 percent during 2015 and 2016. This economic malaise, along with a high-level government corruption scandal, opened the door for far-right candidate Jair Bolsonaro to win the presidency in 2018. However, his economic policies have failed to turn things around, and the economy shrank again in the first quarter of 2019. Brazil is one of the largest economies in the world, and the rise of a right-wing leader with authoritarian tendencies unable to arrest its economic struggles is troubling. Where did Brazil go wrong?
A look at Indonesia’s economy during the same time period can help answer that question. Both countries share many similar structural features – large populations in excess of 200 million, big current account deficits, a dominant role in the economy for state-owned companies, and significant commodity export sectors. Moreover, their respective currencies both came under pressure during the Taper Tantrum of 2013, when the U.S. Federal Reserve began winding down its quantitative easing program and sparked capital flight in emerging markets.
Yet their fates have been very different. Since 2014 Indonesia’s economy has grown steadily at around 5 percent per year. This led to the comfortable re-election of the incumbent president Joko “Jokowi” Widodo on the back of his popular pro-growth economic policies in April 2019, and he looks set to have a decent legislative coalition backing his second term in office. The economy is growing and the political environment is relatively stable. How did Indonesia manage to avoid Brazil’s fate, despite being exposed to many of the same potential weaknesses?
One way was better allocation of foreign investments. After the Global Financial Crisis, as central banks in developed countries slashed interest rates to near zero, foreign investment began to flow into emerging markets like Brazil and Indonesia as they offered higher rates of return. In Indonesia, much of this took the form of more stable and productive foreign direct investment, which was channeled into productive long-run investments like expanding the country’s stock of fixed capital.
Foreign investment in Brazil meanwhile went primarily to more volatile portfolio investments, such as stocks and bonds. As these instruments are more liquid, they can be sold off more quickly during times of capital flight. Brazil also saw a large expansion of domestic debt, eventually exceeding 100 percent of GDP despite no increase in domestic savings. This means the higher debt load was likely financed by inflows of foreign cash, and when the currency came under pressure servicing that debt became a struggle.
The fiscal dimension also played an important part. When Jokowi took office in 2014, he immediately embraced expansionary fiscal policy, pouring tens of billions of dollars into building roads, hospitals, airports, and power plants. Some of this took the form of direct government outlays, but state-owned companies have also tapped capital markets to finance their efforts and investment inflows from abroad have remained strong. This helped offset contractionary pressure from Taper Tantrum-induced capital flight, and it has also significantly upgraded the country’s lagging infrastructure.
Brazil, by comparison, did the exact opposite. Not only did the government not try to spend its way out of the recession, it imposed heavy-handed austerity measures that effectively froze public spending at 2016 levels. The result has been years of painful economic contraction, political upheaval, and no clear path out of the situation.
The experience of these two countries contains important lessons for emerging markets. Running a current account deficit is not inherently a kiss of death, as long as capital inflows are being directed toward productive purposes like increasing output, and not into speculative liquid financial instruments and the expansion of domestic debt. It also provides solid evidence that in the face of currency volatility and contractionary pressure, the state that embraces expansionary fiscal policy has a better chance of weathering the storm and coming out intact.
As fears of global recession rise, Indonesia’s experience in side-stepping Brazil’s fate is a timely lesson for both emerging and developed economies.
James Guild is a Ph.D. Candidate in Political Economy at the S. Rajaratnam School of International Studies in Singapore. His work has previously appeared in The Diplomat, New Mandala, East Asia Forum and Jakarta Post. Follow him on twitter @jamesjguild