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Brazil, a case study in squandered potential

Little seems to be going right for Brazil these days. The former darling of emerging-market investors is suffering through mounting woes, including plunging investment, high inflation, a worsening current account deficit and a faltering currency, despite determined intervention by the central bank.

Latin America's biggest economy failed to reach analysts' modest forecasts in the third quarter, shrinking 0.5 per cent, seasonally adjusted, from the previous quarter. The consensus call was for a decline of 0.2 per cent. It was Brazil's worst performance since the height of the global recession in early 2009.

And despite a much stronger than expected trade surplus in November, observers expect that weaker foreign demand, bottoming commodity prices and rising consumer imports pretty much ensure that the country will post its first annual trade deficit in more than 10 years.

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"With the economy reaching the limits of its consumer-led growth model, and investment unlikely to pick up in the absence of significant supply-side reforms, GDP growth will probably continue to disappoint," David Rees, emerging markets economist with Capital Economics, said in a note.

As if all that isn't bad enough, a potential property bubble still looms in major centres, although higher borrowing costs and the souring of foreign investors on the country should take care of that.

Construction earmarked for the soccer World Cup next year and the Summer Olympics in 2016 will boost the fortunes of such sectors as construction and tourism. But those effects rarely last. And the country remains woefully behind when it comes to upgrading its transportation and electricity infrastructure, improving labour mobility and increasing efficiency.

Indeed, Brazil could serve as a case study for the emerging world of what happens when the torrents of Chinese cash turn to a thin stream and governments fail to accompany costly stimulus efforts with structural reforms to boost competitiveness, tackle corruption and attract capital. Higher public spending may get the patient off the sickbed for a little while, but the symptoms soon worsen and the problems multiply.

Brazil is riddled with them. But most notable has been the sharp drop in investment, which declined 2.2 per cent in the quarter, as borrowing costs climbed and economic conditions deteriorated. The central bank last week raised the benchmark rate to 10 per cent, the latest of half a dozen hikes since April, when it stood at a record low 7.25 per cent and housing was getting bubbly. Rising rates will hit consumer spending, which rose by only 1 per cent in the latest quarter.

Foreign money was already disappearing thanks to government directives designed to cap returns for investors in such important sectors as power generation, energy, financial services and agribusiness. That's a bad move for a country burdened with rising current account and budget deficits.

Some political analysts suggest that a disappointed middle class has grown weary of President Dilma Rousseff and her governing Workers' Party. But she remains favoured to win re-election next fall, which potentially means five more years of a populist agenda that is decidedly unpopular with foreign and domestic investors alike.

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"It's not a very pretty picture," said David Riedel, president of Riedel Research Group Inc., which focuses on emerging markets.

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