Goldman Sachs

CHAPTER FIVE
THE ëBí IN BRICS: UNLOCKING BRAZILíS GROWTH POTENTIAL December 2006The ëBí in BRICs: Unlocking Brazilís Growth Potential
THE ëBí IN BRICS: UNLOCKING BRAZILíS GROWTH POTENTIAL
While campaigning for his second term, which begins in January 2007, Brazilís President Lula da Silva promised to implement economic policies that would boost GDP growth rates to 5.0%. This growth targetsounds ambitious given that, since we published our first BRICs studies in 2003, Brazil has grown only at a disappointing 2.7% a year on average, compared with the 3.7% that we had estimated its long-term growth potential to be.
Brazil has underperformed not only relative to our expectations but also compared with all the other BRICs. Since 2003, real GDP growth rates in China, India and Russia haveaveraged 10.2%, 8.0% and 6.9%, in each case far exceeding our estimates of their long-term potential (4.9%, 5.8% and 3.5%, respectively).
The disparity in terms of growth performance between Brazil and the other BRICs raises three legitimate questions: (1) Were we wrong about our initial assessment of the growth prospects for Brazil? (2) Should Brazil still be part of the BRICs? (3) Can Brazilboost and sustain higher growth rates in the long term, say at or above a secular average of 5.0% a year?
We remain confident about Brazilís growth potential, at least in terms of what we have envisaged in our BRICs studies. The main reason for Brazilís underperformance is that, until now, the government had been in the process of implementing a stabilisation programme, with a view to achievingmacroeconomic stability. This is a key precondition for growth. Thanks to these adjustment efforts, macroeconomic conditions are more favourable now than they have been for decades. The large balance of payments surpluses have been used to prepay external debt and accumulate reserves, while a credible central bank (BACEN) has reduced inflation to 3.0% in 2006.
We believe that the Lula IIadministration will sustain sound macroeconomic policies and make some progress on structural reforms. Stability should allow real GDP growth rates to move gradually towards Brazilís potential rate of about 3.5%, which is near our BRICs potential growth rate of 3.7%.
We also believe that Brazil could grow much faster, perhaps at a secular growth rate of about 5.0%. For this to happen, the government willhave to tackle four difficult structural problems:
! Brazil saves and invests too little. To address this issue, the government will have to deepen and improve the quality of the fiscal adjustment.
! The economy should be opened to trade.
! The government must improve the overall quality of education.
! The government should implement structural reforms to improve institutions, with a view toincreasing total factor productivity.
We do not believe that the Lula II administration and Congress will be ambitious enough to implement this politically difficult agenda. Therefore, while Brazil has the potential to grow at or above 5.0%, this is unlikely to happen during the next four years.
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The ëBí in BRICs: Unlocking Brazilís Growth Potential
Nevertheless, Brazil will remain a valuableëout of the moneyí option on growth. In the meantime, it will be an important destination for fixed income and equity inflows, given the high carry trade, the embedded growth option for equities and the reassurance of stable macro policies and sound external credit fundamentals.
How Brazil Stacks Up Against the Other BRICs
One way to measure Brazilís progress is through the prism of our GrowthEnvironment Scores (GES). Among the BRICs, Brazil showed the largest gain in our 2006 GES scores, moving up seven places, to an overall score of 4.15. However, the increase was not large enough to enable Brazil to catch up with its peers in the BRICs, with China and Russia posting increases to 4.9 and 4.35, respectively.
While Brazilís growth has lagged, the other BRICs have outperformed our...