The Petrobras Scandal: Will Brazil Sink Deeper — or Emerge Stronger?

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Felipe Monteiro and William Burke-White discuss the recent unrest in Brazil

Within three months of assuming office after being reelected, Brazilian President Dilma Rousseff’s administration has become embroiled in thickening corruption scandals that threaten to turn off domestic and foreign investors, derail an austerity program and undermine the country’s economy. Yet, Brazil has a fighting chance to emerge chastised and stronger from the crisis, say experts from Wharton and the University of Pennsylvania Law School.

At the heart of the scandal are allegations that politicians, including some from Rousseff’s own Workers’ Party, received hundreds of millions of dollars in kickbacks from contracts awarded by the state-run oil company, Petrobras. Rousseff was chair of Petrobras between 2003 and 2010, and has stoutly denied any knowledge of the corruption. Investigations underway cover 20 companies for allegedly forming a cartel to inflate contract values and nearly 50 politicians, including Senate chief Renan Calheiros. The crisis widened as the government last week announced investigations into its health ministry and the state-owned bank, Caixa Econômica Federal (Caixa).

“It is serious, endemic and one of the largest corruption cases we have, but I don’t think the whole Brazilian economy is compromised,” said Felipe Monteiro, professor of strategy at INSEAD in France and a senior fellow at Wharton’s Mack Institute for Innovation Management. With increasing pressure from Brazil’s civilian population and its press, he predicted a “potential good outcome of increased transparency and strong institutions,” but wasn’t willing to bet on it. “I see the potential. I don’t think it is a given.”

William Burke-White, deputy dean and professor at University of Pennsylvania Law School and an expert on international law and global governance, also saw the potential for Brazil to turn the crisis into a positive push. “Brazil has built a strong democracy with good institutions, good court systems, good investigative ability, and paralleling that, a strong civil society with freedom of the press, freedom of expression and transparency,” he said.

“If you were to think of this crisis happening in most of the BRICs [Brazil, Russia, India and China] would it look like this?” Burke-White continued. “No. You would either have a government cover-up, or you would have a coup or you would have politicized investigations of corruption.” He lauded Brazil for the unchallenged power of its administrative machinery to put the government on trial.

“It is serious, endemic and one of the largest corruption cases we have, but I don’t think the whole Brazilian economy is compromised.” –Felipe Monteiro

Monteiro and Burke-White discussed the scenarios that will likely unfold in Brazil as the investigations gather pace on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Economic Impact

How badly could the unrest hurt Brazil’s economy? The Petrobras scandal is damaging to economic growth, but that is less the case with the other scandals, said Monteiro. “Nobody expects a good year for Brazil, but if … they are doing their homework and getting things organized for next year, it is less of a problem,” he noted.

As for the fortunes of Petrobras, Monteiro expected the Brazilian government to walk the extra mile to protect it from too much damage from the scandal. Burke-White said the real problem for the company is “the lost opportunity in this period” as it is distracted from making long term investments in oil exploration.Burke-White suggested the probe into the state-run bank Ciaxa could have far-reaching implications. “If it suddenly turns out that the banking sector has been engaged in a widespread corruption scandal similar to Petrobras, then you have [Brazil’s] biggest company [Petrobras], the banking sector and a public enterprise all implicated. If the banking sector starts to collapse, that would be a real concern.”

Monteiro said he was “less pessimistic” about the impact of the scandals on Brazil’s economy. “The crisis is serious, and we have to change the way the economy is going Twitter .” However, he described the country’s banking sector as “quite solid” with many large private banks and a “pervasive penetration” across the country. “So I see less of that imminent crisis on the overall economy.”

Rousseffs Troubles

Meanwhile, Rousseff has seen her disapproval ratings soar to 60% (from the 51% in-favor vote she won last October). Even as the public outcry for Rousseff’s resignation grows, it seems unlikely that she will resign or be impeached, according to both Burke-White and Monteiro. Burke-White pointed out that under Brazilian law, Rousseff cannot be impeached for crimes committed before she was re-elected.

“Brazil has built a strong democracy with good institutions, good court systems, good investigative ability, and paralleling that, a strong civil society with freedom of the press, freedom of expression and transparency.” –William Burke-White

“You have to commit a crime during the current term in office [to face impeachment],” Burke-White said. “So it is extremely unlikely [that Rousseff could be impeached], unless she actively engages in a cover-up since [her] new term began a few months ago.” Here, he recalled that former Brazilian president Fernando Collor de Mello was impeached for corruption in 1992.

Moreover, the stakes are higher than simply fears of impeachment, according to Burke-White. “The question is much less [if Rousseff is] going to be impeached, but rather how does Brazil survive a political quagmire and instability for the rest of her current term?” He noted that Rousseff’s relationship with the U.S. and President Barack Obama became strained after she severely criticized the country a few years ago for spying on her. “They have never been able to repair and rebuild that relationship.”

Rousseff’s top challenge is not foreign policy, however, but back home where she needs to hold her coalition government together, Burke-White said. “Brazil has a large number of political parties, highly fragmented and fractured,” he explained. “The president is the person who has to pull those parties together and get them to talk to one another. And she doesn’t have the political capital to do that at the moment.”

“The good news is there are not many emerging markets where a crisis of that magnitude happens and still institutions continue to work and have a lot of transparency.” –Felipe Monteiro

According to Monteiro, the person credited with holding the government together is Vice President Michel Temer, who belongs to the Brazilian Democratic Movement Party or PMDB, which is a rival to Rousseff’s political party. Burke-White felt that the government may stay intact, unless Finance Minister Joaquim Levy is forced out (he is currently under pressure to quit), or if the country’s credit rating drops or if another big piece of the scandal unfolded.

Opportunity Ahead

All things considered, Monteiro saw opportunity ahead for Brazil. “The good news is there are not many emerging markets where a crisis of that magnitude happens and still institutions continue to work and have a lot of transparency.” Yet, he noted that Brazil has on earlier occasions “wasted those chances.”

Burke-White shared Monteiro’s optimism. “Right now, every politician in Brazil, [and] every business leader is on notice that they are being watched.” If one were to look back on the current scandal five or 10 years later, one would see proof that “the institutions of governance are stronger than either politicians or corruption itself.”

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