Dilma's Gamble for Resurrection

December 21, 2015 2:30 PM

Political expediency often conflicts with sound economic policy. In the case of Brazil, the two look bound for a head-on collision.

Faced with the threat of impeachment, a sinking economy, and a ruptured political coalition, Brazilian President Dilma Rousseff is likely to double down on the ideological policymaking that marked her first term in office and brought the country to its knees. Following sovereign ratings downgrades by S&P and Fitch, the embattled leader seems to be gearing up to a back-to-the-past policy shift as evidenced by the recent decisions to lower the fiscal target for 2016, giving greater leeway for state governments to borrow—thus adding to already burdensome subnational debt—and reinstating public lending programs for the purchase of machinery and equipment via the deployment of credit from the Brazilian Development Bank (BNDES). The decisions culminated in the resignation of Finance Minister Joaquim Levy, who had been the bulwark of fiscal adjustment since the start of Rousseff's second term.

Levy's voice had already been largely silenced in the government even before his departure. During the latter half of her first mandate, Rousseff instituted price controls, introduced haphazard tax breaks, and boosted subsidized lending by public financial institutions, which had already been on the rise since the 2008 financial crisis. Driven by a desire to prop up growth at any cost, and believing that investment would react positively to these initiatives, Rousseff systematically disregarded warnings that her policies would lead the country to a severe fiscal problem coupled with mounting inflation. Problems came to a head at the end of 2014, when the government posted its first primary deficit in two decades, forcing the president to appoint a fiscally prudent and market-oriented finance minister. Soon thereafter, price controls were finally lifted and inflation soared.

Brazil's problems, however, were just beginning. Widening investigations into the Petrobras graft scheme tarnished both Congress and several prominent businessmen. The scandal exacerbated the recession and led to an unprecedented political stalemate. In the meantime, Rousseff's inability to convince markets that she had become a stark defendant of fiscal adjustment led to the demise of Levy's credibility. There were countless instances in which the president went against her minister's recommendations, most notably when she signed off on a negative fiscal target for 2016, a contributing factor to the earlier S&P downgrade. A rebellion among factions of her coalition partners finally led to the initiation of an impeachment process against her in late 2015. This process is now likely to last well into next year.

In view of her ideological convictions regarding macroeconomic policies, as well as the impeachment proceedings against her, Rousseff's most likely course of action now is a last-ditch gamble for resurrection. By reenacting expansionary policies, including the deployment of subsidized public credit, she would be hoping to revive the economy long enough to stave off impeachment and growing popular discontent. As a result, next year may yet bring additional economic strife, possibly culminating in a balance of payments crisis if local investors decide to flee.

Ironically, Rousseff's drive for a political comeback may force the country into the very position she and her party have adamantly repudiated: having to ask the International Monetary Fund for help.