The Bloom is Off the Rousseff

Today marks the seventh day of demonstrations in São Paulo; demonstrations that started as small protests expressing frustration with bus fare increases in the city but have now spread to major cities throughout the country. The protests have captured the imagination of the population and the media and have proven both resilient and spontaneous.

Frontier Strategy Group’s Latin American research team and expert advisory network are following the evolution of the demonstrations and would like to offer our clients analysis on how these developments have altered our FSG View on Brazil and how the events could impact our clients’ businesses.

FSG View on Brazil’s Economic Outlook:

FSG’s recently released Regional Overview for Latin America expresses our view that Brazil’s macroeconomic slowdown and generally weak business performance of the last year is due to the exhaustion of the demand-driven economic model popularized by the Lula government and employed by the current Dilma Rousseff government (see graph below).

  • We caution our clients that even though this economic model is less and less effective at generating broad GDP growth, it is still effective at maintaining wage growth and high employment. Positive real wage growth and low unemployment are great news for Dilma, and until very recently her approval ratings were the highest of almost any head of state in the world.
  • Our view is that low unemployment and positive wage growth should translate to a good chance of reelection in 2014, therefore little incentive for the current government to make politically painful changes to the demand-driven growth model in the short term.
  • Therefore, we caution our clients to be prepared for a low-growth environment and little progress on needed reforms that would spur growth through higher productivity and a lower cost structure until at least 2014.

The Exhaustion of the Demand Model

    What Prompted the Protests?

    Clearly not all of Brazil’s population is as pleased and complacent as Dilma’s recent approval ratings suggested. The protests, broadly, are a stunning manifestation of a social trend that has accompanied Brazil’s transition to a middle-class country; the demands the middle class makes of government are different from the demands the poor make. As 40 million Brazilians enter the middle class and become both consumers of government services and tax payers, their priorities and demands become more sophisticated. This is a dynamic FSG has been tracking for some time, not just in Brazil, but also in Colombia, Russia, Turkey, and many other emerging markets as this trend will have profound impact on governments’ spending priorities.

    • The initial protests were over not just the price of bus fare, but the quality of service as well; essentially a question of value for money. Likewise, the subsequent demonstrations have focused on government priorities, transparency, and efficiency. No one can argue that Brazil does not devote considerable resources to social programs and alleviating poverty. Rather, the demands are for more accountability, greater efficiency, and prioritization of public investment in higher quality education and health; again, a question of value for money.

    How has the Outlook Changed?

    Short Term:

    • Multinationals in the consumer space can expect some disruption in sales, as consumers stay home and foot traffic slows in major urban areas.
    • Some businesses may experience work stoppages in the form of sympathy strikes, absenteeism, or shuttering of stores.
    • Investor confidence, already sour on Brazil, will weaken, and the Brazilian real will remain at several-year lows, though the Central Bank will maintain a floor on the value of the currency to guard against excess volatility.
    • Latin America and Brazil-focused executives will face tough questions on the sustainability of Brazil’s growth from increasingly skeptical corporate boards and headquarters. Negative headlines can have immediate impact on corporate sentiment towards an emerging market.

    Medium Term:

    • President Dilma Rousseff still has good cards to play. She is still fairly popular, her opposition is fragmented and currently lacking much leadership, and she has considerable government resources at her disposal.
      • Furthermore, while some protest language has focused on her, she has not been an explicit target of the protests. Dilma may yet succeed in harnessing some of the protest’s energy and present herself as sympathetic and aligned with the protester’s aims. That said, there is always a chance skillful opposition politician could channel the protests into electoral popularity. Yet, though the demonstrations add an element of unpredictability into next year’s elections forecast, Dilma is still in a relatively strong position.
      • Interest rates are likely to continue to rise, as inflation concerns and the political implications of inflation has the Central Bank and the government spooked.
      • Further targeted tax cuts and credit incentives to try to stimulate demand. These are increasingly ineffective measures economically, but still prove popular with potential voters.
      • Suspension of subsidy roll backs are likely. Planned hikes in gasoline prices and proposed cuts to public subsidies are likely to be delayed. This is harmful for Brazil’s fiscal position, but will keep more spending cash in the pockets of consumers.

    Long Term:

    • The government of Brazil will shift priorities over time. The new priorities will be improving quality and sophistication of services, rather than simply expanding access. This has profound implications for firms selling goods and services in terms of the value proposition likely to be most of interest to federal, state, and local government.
    • There are potentially positive long-term benefits to the protests. Principal among them is greater accountability of government in general.
      • Similarly, greater efficiency is not just a demand, but a fiscal necessity. Brazil has deep pockets, but with citizens and corporations balking at the cost of public services, the government will be asked to do more with less. This may encourage reforms in the models employed to provide services to the public. Expect an accelerated move toward public-private partnerships and greater use of concessions in public projects.
      • Transparency will improve. Brazil has already made some inroads in prosecuting public corruption, but the demonstrations will embolden media and watchdog groups to push for greater transparency and accountability.

    In Conclusion:

    The slow death of Brazil’s demand driven growth model is coinciding with the growing assertiveness of the middle class. The government has been very slow to respond to either phenomenon. The short term chaos of the protests will disrupt some economic activity, while the mid-term economic doldrums will continue. The political picture becomes more volatile, yet Dilma is still in a relatively strong position and is unlikely to try to upset her political coalition or potential voters with radical reforms that won’t bear immediate fruit. Long-term, a political awakening could increase accountability and efficiency of government.

    As a long term investment opportunity, FSG remains optimistic and convinced of the attractiveness of Brazil’s fundamentals. The case for continued prioritization of investment in the market, however, becomes more difficult with each day of negative headlines. For this reason, FSG is releasing a new “Making the Case for Brazil” report and presentation materials at the end of June. The materials are designed to help senior executives focus stakeholders on long term opportunities in the market and reaffirm the underlying potential of Brazil’s future.


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