But there is a snag: known by the name “pre-salt”, these oil fields are located very deep underwater under a thick layer of salt. If exploited, however, they could double Brazil’s current oil reserves, placing the country within the top ten countries worldwide.
What would that mean for Brazil’s massive economy? How would resources across the economy adjust and policy respond? Traditionally, a resource boom has been seen as a mixed blessing, because it can generate so-called “Dutch Disease” effects, whereby discovering oil or gas leads to a real exchange rate appreciation, and possibly higher incomes, which in turn fuels imports and squeezes manufacturing output, employment and net exports.
Brazil’s currency, the real, has already appreciated steadily since 2003, apart from a temporary dip during the global economic crisis. The bilateral rate against the dollar rose by 74% from 2003 to 2010. During the same period, the effective rate, based on the relative importance of Brazil’s main trading partners, appreciated by around 63%. And rising real effective rates have started to affect price competitiveness. However, it seems likely that the extent of overvaluation is smaller than what might be inferred by simply looking at real exchange rate developments over time.
As a major emerging market, Brazil has attracted massive capital inflows, which have contributed to the currency’s strengthening, even if their effect has been somewhat offset by a favourable productivity differential between Brazil and its trading partners. There is also evidence that growing oil production has pushed up the real’s equilibrium exchange rate. The exploitation of the pre-salt fields would push this higher still.
In 2010 the currency appeared to be overvalued by between 3 and 20%. While the resource boom has made Brazilians better off, there are signs of de-industrialisation as commodity exports, especially of oil, crowd out other economic activity. Manufacturing production has declined, although largely in the aftermath of the financial crisis, and manufacturing employment has continued to rise, albeit at a slower pace than in the economy as a whole. On the trade side evidence of Dutch disease is more conclusive: net exports of manufactures have declined since 2005, while those of oil have grown at a robust pace (see chart). But other factors, such as strengthening trade relationships between China and Brazil, with Brazil exporting mostly commodities for manufacture from China, may also explain some of this trend.
All this does not mean the resource boom is making Brazilians any worse off. However, a growing offshore sector could mean a regime shift, and the exploitation of the pre-salt oil fields will have major implications for fiscal policy, notably by raising the sensitivity of tax receipts to oil prices and potentially aggravating any would-be bout of Dutch disease. Some of these changes are already visible. As has been the case in other countries with large resource exports—Chile and Norway for example—Brazil’s sizeable sovereign wealth fund (Fundo Soberano do Brasil) will help to smooth tax revenue oscillations while saving the revenue windfalls from the recent strong business cycle. In the end, policy makers should take advantage of the positive impacts of Brazil’s impending resource boom, but at the same time take action against undesired side-effects, and this includes facilitating a smooth reallocation of resources across sectors.
Lobão, E. (2010), Proposals for Pre-salt Legal Framework.
Mourougane, A. (2011), “Explaining the Appreciation of the Brazilian Real”, OECD Economics Department Working Paper, No. 901, October.
Ebrahim-zadeh, C. (2003), "Dutch Disease: Too much wealth managed unwisely", in Finance & Development Vol. 40, No. 1.
©OECD Observer No 287 Q4 2011