Brazil has 2 kinds of problems, and they're both bad

Only a year before it hosts the Summer Olympics, Brazil is struggling with the confluence of two separate, but interrelated crises: one economic, and the other political.

Demonstrators protest against Brazilian President Dilma Rousseff, calling for her impeachment, in Sao Paulo.
Paulo Whitaker | Reuters

Five years ago, Brazil was growing at 7.5 percent. Today, it's struggling with a 9.56 percent inflation rate and a fiscal deficit. Unemployment hit a five-year high of 7.5 percent this year, and experts say that number will keep climbing. Next year the economy, the world's eighth largest and the biggest in Latin America, is expected to contract 2 percent, and Brazilians are feeling the pain.

"Everything is really expensive now. One year ago, I would spend 200 reals (about $60) at the supermarket. Now I spend double," said Juliana Bueno, a Brazilian nutritionist who's seen her income drop as clients cut back on visits and on spending. "It's a really difficult situation, and I don't see when it will end."

In the past 12 months, the Brazilian stock index has plunged 21 percent. The has lost half of its value against the dollar in the same time period.

Brazil's economic troubles only paint half the picture. A corruption scandal around the state-controlled oil company Petrobras, which has led to the arrests of high-profile business and political leaders, has shattered President Dilma Rousseff's credibility with the Brazilian public. Her approval ratings have dropped to a record low, hovering near 8 percent.

Although Rousseff has not been directly implicated in the scandal, she's been scrutinized because the bribery scheme occurred when she served as chair of the company's board. On Sunday, hundreds of thousands of Brazilians turned to the streets calling for the impeachment of Rousseff, who began her second term seven months ago.

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Brazil is also getting crushed by a global bust in commodity prices, spurred by an economic slowdown in major commodities consumer China.

"Commodity prices are dropping globally as China's economy evolves. The need for the massive amounts that they were importing 10-12 years ago isn't there anymore, and there are very few alternative markets for Brazilian products," said Riordan Roett, professor and director of the Latin American Studies Program at Johns Hopkins.

Brazil has faced simultaneous political and economic crises in the past, most recently from the mid-1980s to the mid-1990s, when it dealt with hyperinflation and a president who was impeached for corruption.

"Brazil, in worse (times) than where it is today, has shown a lot of resilience in getting out of crisis, so my take is (this is) just another crisis," said Alan Gandelman, CEO of ATS Brasil, a Brazilian company jointly owned by Americas Trading Group and the New York Stock Exchange.

Crises usually present opportunities for investors, Gandelman said. Before former President Lula da Silva was elected, investors feared that the leftist politician would default on the country's debt if elected. That uncertainty destabilized Brazil's markets and put a brake on the economy. But the fear was unfounded: During da Silva's term, the South American economy boomed and became a darling of investors.

"It was a cycle. Everybody who managed to get in the acute phase of the crisis, which was the pre-election of Lula, benefited a lot," Gandelman said.

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But for Brazil to get back on the track of growth, it needs major fiscal reforms, which have been politically difficult to implement, experts told CNBC. The current market-friendly finance minister, Joaquim Levy, has tried to cut spending and increase revenue, but his measures face major opposition in congress. The legislative body recently approved a bill to raise government wages, making it more difficult for the government to balance its public accounts.

"It's a constant struggle between the finance ministry, central bank and the Brazilian congress, which is a very fractured congress, which doesn't believe in fiscal discipline and doesn't understand fiscal discipline," Roett said.

On Wednesday, after months of disagreements, Brazil's Senate passed a key austerity bill that would raise taxes on companies—a big win for Rousseff's government, which is trying to maintain the country's investment grade.

Standard & Poor's cut its outlook on Brazil's rating to negative from stable this month, putting the country's credit rating at near-junk status. If Brazil's credit rating is downgraded to junk, then "Many mutual funds, for example, wouldn't be able to invest in Brazil and the cost of Brazil borrowing in the global markets would increase," Roett added.

Reasons for optimism

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Despite the grim situation in Brazil, some see the potential for the country to get back on track.

"Brazil is a rich country. It has potential for tourism, potential for the agriculture sector. It's a very powerful country. The question is, can they get their act together," said Lourdes Casanova, academic director of the Emerging Markets Institute at Cornell University "Sometimes it has to get really bad before it gets better."

And some political watchers have pointed out that the scandals swirling within Brazil are actually a sign of positive change: the country is demonstrating rising rule of law and healthy civil institutions. Powerful, monied interests such as oil companies and presidents are often untouchable in the news media and even the courts in much of Latin America.

"I think it shows a maturity of the country itself. It shows independence of the institutions. You can actually see an independent legal system," said Gandelman of ATS Brasil. "The press can say whatever they want. It's very free for the press. The legal system is working, unattached to the congress, unattached to the president."

"People are going to jail for corruption. Five years ago, that wouldn't have been a thought, and now an ex-president might be prosecuted," said Andres Garcia-Amaya, macro research analyst at JPMorgan Asset Management. "The market forces are actually doing what they do best—fix the imbalances."

The looming Olympics have put Brazil even more under the microscope. A recent report by The Associated Press, for example, revealed that a high level of water contamination could make swimmers "violently ill." And the Petrobras corruption probe could also have ripple effects on the event next year. Major construction companies involved in the preparations for the Olympics have been indicted, which could slow construction for the games.

Gandelman is optimistic about the games.

"Everything will be ready for the Olympic Games, and it's going to leave a legacy after the games for the city" of Rio de Janeiro, Gandelman said. "In general when Olympics do well, it has a very positive effect on the economy."