CAMPAIGNING for a second term as Brazil’s president in an election last October, Dilma Rousseff painted a rosy picture of the world’s seventh-biggest economy. Full employment, rising wages and social benefits were threatened only by the nefarious neoliberal plans of her opponents, she claimed. Just two months into her new term, Brazilians are realising that they were sold a false prospectus.

Brazil’s economy is in a mess, with far bigger problems than the government will admit or investors seem to register. The torpid stagnation into which it fell in 2013 is becoming a full-blown—and probably prolonged—recession, as high inflation squeezes wages and consumers’ debt payments rise (see article). Investment, already down by 8% from a year ago, could fall much further. A vast corruption scandal at Petrobras, the state-controlled oil giant, has ensnared several of the country’s biggest construction firms and paralysed capital spending in swathes of the economy, at least until the prosecutors and auditors have done their work. The real has fallen by 30% against the dollar since May 2013: a necessary shift, but one that adds to the burden of the $40 billion in foreign debt owed by Brazilian companies that falls due this year.

Escaping this quagmire would be hard even with strong political leadership. Ms Rousseff, however, is weak. She won the election by the narrowest of margins. Already, her political base is crumbling. According to Datafolha, a pollster, her approval rating fell from 42% in December to 23% this month. She has been hurt both by the deteriorating economy and by the Petrobras scandal, which involves allegations of kickbacks of at least $1 billion, funnelled to politicians in her Workers’ Party (PT) and its coalition partners. For much of the relevant period Ms Rousseff chaired Petrobras’s board. If Brazil is to salvage some benefits from her second term, then she needs to take the country in an entirely new direction.

Levy to the rescue?

Brazil’s problems are largely self-inflicted. In her first term Ms Rousseff espoused a tropical state-capitalism that involved fiscal laxity, opaque public accounts, competitiveness-sapping industrial policy (see article) and presidential meddling in monetary policy. Last year her re-election campaign saw a doubling of the fiscal deficit, to 6.75% of GDP.

To her credit, Ms Rousseff has at least recognised that Brazil needs more business-friendly policies if it is to retain its investment-grade credit rating and return to growth. This realisation is personified by her new finance minister, Joaquim Levy, a Chicago-trained economist and banker and one of the country’s rare economic liberals (see article). However, Brazil’s past failure to deal promptly with macroeconomic distortions has left Mr Levy to grapple with a recessionary trap.

To stabilise gross public debt, he has promised a whopping fiscal squeeze of almost two percentage points of GDP this year. Part of this is coming from the removal of an electricity subsidy and the reimposition of fuel duty. Both measures have helped to push inflation to 7.4%. He also plans to curb subsidised lending by public banks to favoured sectors and firms.

Waxing and waning: Brazil's economic woes, in charts Ideally, Brazil would offset this fiscal squeeze with looser monetary policy. But because of the country’s hyperinflationary past, as well as more recent mistakes—the Central Bank bent to the president’s will, ignored its inflation target and foolishly slashed its benchmark rate in 2011-12—the room for manoeuvre today is limited. With inflation still above its target, the Central Bank cannot cut its benchmark rate from today’s level of 12.25% without risking further loss of credibility and sapping investor confidence. A fiscal squeeze and high interest rates spell pain for Brazilian firms and households and a slower return to growth. What makes this adjustment perilous is the political fragility of Ms Rousseff herself. On paper she won a comfortable, though reduced, legislative majority in the October election. Yet the PT is already grumbling about Mr Levy’s fiscal policies—partly because the campaign did not lay the ground for them. Ms Rousseff suffered a crushing defeat on February 1st in an election for the politically powerful post of head of the lower house of Congress. Eduardo Cunha, who vanquished the PT’s man, will pursue his own agenda, not hers. Not for the first time, Brazil may be in for a period of semi-parliamentary government. The country thus faces its biggest test since the early 1990s. The risks are clear. Recession and falling tax revenue may undermine Mr Levy’s adjustment. Any backsliding may in turn prompt a run on the real and a downgrade in Brazil’s credit rating, raising the cost of financing for government and companies alike. Were Brazil to see a repeat of the mass demonstrations of 2013 against corruption and poor public services, Ms Rousseff might be doomed.

From weakness, opportunity

Yet the president’s weakness is also an opportunity—and for Mr Levy in particular. He is now indispensable. He should build bridges to Mr Cunha, while making it clear that if Congress tries to extract a budgetary price for its support, that will lead to cuts elsewhere. The recovery of fiscal responsibility must be lasting for business confidence and investment to return. But the sooner the fiscal adjustment sticks, the sooner the Central Bank can start cutting interest rates.

More is needed for Brazil to return to rapid and sustained growth. It may be too much to expect Ms Rousseff to overhaul the archaic labour laws that have helped to throttle productivity, but she should at least try to simplify taxes and cut mindless red tape. There are tentative signs that the government will scale back industrial policy and encourage more international trade in what remains an over-protected economy.

Brazil is not the only member of the BRICS quintet of large emerging economies to be in trouble. Russia’s economy, in particular, has been battered by war, sanctions and dependence on oil. For all its problems, Brazil is not in as big a mess as Russia. It has a large and diversified private sector and robust democratic institutions. But its woes go deeper than many realise. The time to put them right is now.