The more you look at Brazil’s fundamentals, the more shaky the country looks. And we are not talking about the defensive prowess of David Luiz here. It is the country’s economic backline that risks tumbling down like a set of dominoes.

When a Latin American economy is in trouble a good place to start is its inflation rate. Brazil’s is today running at 7.5%. While this is nowhere near the 2,000-3,000% of the early 1990s, when the price of everything went up several times a week, it is far higher than the central bank’s mid-point target of 4.5%.

On Wednesday, in an effort to bring inflation down, Brazil’s central bank raised interest rates to 12.75%, a six-year high.

The problem is that the country is hiking interest rates – and trying to curb high prices – at a time in which its economy is on the brink of recession.

Between 2002 and 2008, Brazil’s economy expanded at 4% a year. It has since averaged less than 2%. GDP is expected to contract 0.5% this year.

High inflation makes matters worse in at least two ways. First, high prices hinder shoppers’ purchasing power. The Economist calculates that about half of the country’s growth over the past decade was driven by consumption.

A drop in purchases will not only dampen economic prospects but would lead to a recession that would freeze the pay of millions because the minimum wage is linked to GDP and inflation.

Elsewhere, salaries in both the public and private sector have grown above GDP for the past decade and are now unlikely to keep pace with inflation. Tax hikes and fare rises will not help either.



It is therefore not surprising that consumer confidence is at its lowest since records began in 2005.

Second, next to rising prices, the real is sinking. Despite the rate increase, Brazil’s currency hit R$3 to the US dollar on Wednesday for the first time in more than a decade. This puts further pressure on prices: the cost of imported goods goes up – more bad news for shoppers.

The foreign outlook isn’t much rosier

Across the Atlantic, many proponents of a Greek exit from the euro argue that the reintroduction of a domestic currency would allow for devaluation – and this in turn would boost exports. It’s economics 101, they say. Under textbook circumstances it would be safe to assume that, broadly speaking, a weak currency does indeed aid exports.

Things are a little more complicated in a global economy. According to The Economist, nearly half of Brazil’s exports are bought by five countries — China, the US, Argentina, the Netherlands and Germany - and average GDP growth in these countries has now halved compared to 10 years ago.

Government subsidies are less sustainable

One problem that Brazil increasingly shares with many EU countries is debt. Brazil holds nearly $250bn worth of dollar-denominated debt, up from $100bn just five years ago. A weak real means that the debt-pile is getting more burdensome. Around $40bn of it is due this year alone.



Officially, Brazil’s direct public debt is around 65% of GDP - the highest among Bric nations. However, according to the credit ratings agency Moody’s, once indirect debt is factored in, the figure reaches 100%. This is due to guarantees for state-owned companies.



In the first two months of this year, 27 Brazilian companies suffered a rating downgrade. There were zero upgrades. Unable to borrow from private markets, companies need government funding.

However, Brazil’s own sovereign credit rating is only a notch above junk, which combined with a weak real, means that borrowing is costly – and getting more so by the day. Spending on interest payments, which amounts to roughly 6% of Brazil’s GDP, already increased 25% last year compared to 2013. Ten-year bond yields are at 13% – the same level as sanction-hit Russia.

In order to finance companies and banks, the government and government-bank entities often lend at a loss. As debt increases, and with interest rates so high, this system of state subsidies becomes more difficult to sustain.

No company better exemplifies the direness of affairs than Petrobras, the state-controlled energy giant. Mired in a corruption scandal, which has engulfed both company executives and high-profile politicians, the company accounts have been frozen and its credit-rating lowered to junk.

Petrobras is Brazil’s largest investor, accounting for more than 10% of the country’s investments and employing tens of thousands of people. Even President Dilma Rousseff has gone as far as acknowledging that the scandal may change the country forever.

Rationing brought Lula to power, it may topple Rousseff

Although Brazil is a very different country to what it was in the 1990s – it has, for example, a significant $360bn in reserves - the conundrum for Rousseff’s government goes beyond a flat economy for a year or two.

The worry is that Brazil ends up stuck in a place where both monetary and fiscal levers prove incapable of pulling the country out of the mess it is in. The wheels turn, but nothing moves in the right direction, and the country eventually sinks.

One of the main contributing drivers to Brazil’s rising inflation has been a severe drought. The driest months in decades have not only fuelled a sharp rise in food prices, but have led to water shortages that are grinding São Paulo, the country’s most populous region, to a halt.



An energy shortage in 2001 led to electricity rationing. In the following year’s elections, the discredited government was swept aside by Luiz Inácio Lula da Silva.

It is hard to predict what causes the first domino to fall. Once they start crashing down, however, halting the tumble of one piece after another is even harder. Just ask David Luiz.