The recent arrests of prominent figures in Brazil -- including Andre Esteves, who stepped down Sunday as chairman and chief executive officer of Grupo BTG Pactual, the largest investment bank in Latin America -- highlight the deepening of the corruption scandal gripping that country. The significant political implications are attracting much attention. The economic implications warrant equal consideration.
Brazil is mired in ugly stagflation that is aggravating financial, political and social tensions. The economy contracted 1.7 percent in the third quarter, according to data released Tuesday. This third consecutive quarter of GDP decline constitutes the worst annualized hit to the economy in almost 20 years. Meanwhile, the consumer price index increased 9.9 percent in October compared with a year earlier, the highest level of inflation in 12 years.
In addition to aggravating the plight of the most vulnerable segments of the population and worsening unemployment, which already is the highest since 2009, the recession is sure to cut into tax receipts and widen a budget deficit the government is struggling to keep in check. These troubles, along with a monetary policy that must contend with high inflation, limit the flexibility of macroeconomic policies to deal with the deepening crisis. Meanwhile, the corporate sector is experiencing a rapidly worsening domestic credit crunch, having already lost much of its access to foreign bond financing.
The policy response, and particularly the critical component of structural reform, is further undermined by deep political divisions, including those over President Dilma Rousseff's tenure. The intensifying polarization and political paralysis are fueling popular dissatisfaction, increasing the possibility of disruptive social tensions.
This is the overall context for the recent arrests that have ranged from the top echelons of the private sector highest to the highest reaches of politics, including the government’s leader in the Senate.
On the positive side, this phenomenon demonstrates the desire of Brazilian society to determine the true magnitude of corruption and demand accountability from those responsible. In time, and provided it is implemented well, this house cleaning will help address one of the major impairments to the functioning of Brazil's public and private sector institutions, causing tremendous waste, adding to already excessive inequalities, and holding back the country's considerable potential for growth and prosperity.
In the short-term, however, the turmoil will act as a further headwind to growth. The political environment will become even more inhospitable to the type of comprehensive adjustment and reform efforts that Brazil needs. And Brazil's central bank, which already is burdened with a long list of policy worries, now has to take steps to minimize potential spillover damage to the broader financial system of a possible run on BTG Pactual after Esteves' arrest.
Brazil often is described as the economy of tomorrow (that is, it always has been and always will be). The developments of recent weeks only add to the sense of foregone opportunities and damaged potential.
By further undermining an already fragile situation, the widening of the corruption scandal will cause greater short-term economic and financial pain. But by helping to bring more transparency and accountability to the cancer of graft that is eating at the country's economy, politics and society, the turbulence could ensure a better tomorrow.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author of this story: Mohamed A. El-Erian at [email protected]
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