A more-realistic vision of a sober and strong economy is coming into view.

BY WALTER T. MOLANO

Pride goeth before the fall, says the Book of Proverbs. Unfortunately, Brazil was a country that could do no wrong for more than a decade. The country started the millennium on the wrong foot. Argentina, the star of the emerging world, had defaulted on its foreign debt. Lula, the bête noire of the Brazilian political establishment, had been elected president, and the country was still reeling from the maxi-devaluation of 1998. Fortunately, the incorporation of China into the World Trade Organization (WTO) triggered a massive demand for commodities, and the combination of the millennium bug, as well as the attack on the Twin Towers, heralded a prolonged period of loose monetary policy that triggered an unprecedented demand for risky assets, such as emerging market bonds.

Brazil went from being a marginal developing country to becoming one of the leading nations of the new global economic order. As a major commodity producer, it became a magnet for foreign investment. Billions flowed into mines, farms and forests. Banks raised money abroad to recycle into the consumer credit sector and construction. The country conjured up a national dream of becoming a prosperous country and a leader of the emerging world. Millions of households were pulled out of poverty, as the level of economic activity accelerated. The aspirations of the society knew no bounds. There was a burning desire to join the ranks of the developed world, with all of the associated badges of honor. The government demanded a permanent seat on the U.N. Security Council and a larger say in the IMF. Likewise, the desires of the wildly ambitious also became reality, even though for some, it was only for a fleeting moment. Like in the past, the nation ignored the imbalances and bubbles that were forming in the external and credit accounts. It was only a matter of time until the wheels would come off the bus and the Brazilian Icarus would fall from the heavens.

CONFLUENCE OF SETBACKS

A confluence of setbacks soon began to multiply. It began with the bursting of the consumer credit bubble, and was followed by the collapse the commodity super cycle. Now, Mother Nature is adding to the woes, with a debilitating drought that is putting a great deal of stress on one of the most populous region's water resources.

An unending series of corruption scandals undermined the country's reputation and access to the capital markets. However, the country may be down, but it is not out. On the contrary, the crisis has served as a cathartic moment to push it into a new level of performance and development. While the so-called Car Wash scandal has marked one of its darkest chapters, it has also been one of its greatest triumphs. Brazil is now the envy of Latin America, with judicial authorities who have the power to prosecute the highest echelons of power. It has given new meaning to the rule of law, where society will no longer tolerate the insolence of the elite. No one has been exempt, from high-flying corporate executives, to judges, to senior politicians.

At the same time, the executive branch has learned to share power with the opposition, and empower economic technocrats to raise taxes and take an axe to government expenditures. A new spirit of pragmatism has come alive in Brasilia. Petrobras will be reduced in scale, and it will emerge a stronger and more efficient company. The central bank has demonstrated the willingness to tighten monetary policy in the face of a slowing economy and rising unemployment rate, while allowing the market to set the level of the exchange rate without depleting international reserves. Even though it faces serious challenges ahead, the government is determined to do whatever it takes to restore the impeccable reputation that went up in smoke.

A DIFFICULT YEAR

The Brazilian economy will face a difficult year in 2015. The level of economic activity will shrink more than 1 percent y/y. The unemployment rate will rise over 7 percent, and the current account deficit will approximate 4 percent of GDP. Fortunately, the worst is now behind us. Thanks to a relatively closed economy and a strong agro-industrial sector, the pass through inflation has been limited. Moreover, the Brazilian Real (BRL) reached nadir, when it touched 3.31. With such high interest rates, the BRL is one of the more expensive currencies to short. There is a good chance that the BRL will appreciate, making local rates a very attractive option.  Last of all, the massive devaluation of the currency is curbing imports and breathing new life into the exporting sectors.

Therefore, the over-inflated dream may be gone, but a new more-realistic vision of a sober and strong economy is coming into view.

Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development.