Brazil’s oil windfall raises risk of Dutch disease

September 14, 2010

Petrobras’ planned $32 billion capital-raising is just the start of an influx of foreign cash that could over-inflate the Brazilian currency and strangle manufacturers. Soaring oil output will add to the problem. Chilean or Norwegian discipline is needed.

Rather than spurring economic development, resource windfalls have often sucked investment from other sectors and stunted industrialization — the so-called Dutch disease,  a term coined in the 1970s after revenue from large natural gas finds in the Netherlands ended up constraining the nation’s manufacturers. A resource bonanza also encourages politicians to lock in high government spending, sparking inflation and linking the nation’s fate to commodity prices.

Brazil is vulnerable. Vast reserves of deep sea oil discovered in recent years promise to catapult it from a bit-player to one of the world’s top 10 producers. State-controlled energy group Petrobras alone hopes to double oil production to 5.4 billion barrels a day by 2020. At current oil prices this would mean an added inflow of around $80 billion a year, equivalent to around half last year’s total exports. And that’s without considering output from rival oil majors and smaller domestic upstart OGX.

That could easily create a surge in the real, already 40 percent up against the dollar since the end of the financial crisis. That in turn could threaten the real strides Brazil has made in areas beyond oil, particularly in manufacturing. The nation has quietly accumulated just over 1 percent of the global export market for cars and 3 percent for aircraft.

The country’s leaders are not blind to this danger. A planned social fund could stash oil revenue in foreign assets, partly neutralizing currency inflows and reducing the temptation for the government to splurge. Yet even countries that have established such funds — including Chile and Norway — have come under heavy pressure to raid the cookie jar.

Brazil’s economy has been well run for the past decade. But before that there is a much longer history of governments succumbing to populist pressures. It will test the country’s political maturity to ensure its oil endowment, which President Luiz Inacio Lula da Silva has called a “gift from God,” keeps on giving.

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Brazil’s economic advance under Lulu was certainly influenced by a key decision Brazil made 30 years ago to shift vehicle use to Ethanol and more recent Brazilian choices of flexible cars that can run on on any proportion of gasoline (E20-E25 blend) and hydrous ethanol (E100). Brazil requires not less than 25% alcohol in light vehicle fuels.

To put Brazil’s decision in perspective, in spite of everything U. S. Consumers buy from China and the rest of Asia, the import of oil is over half of the U. S. trade deficit.

Americans can all hope that the push now for greater reliance on alternative fuels, including solar, wind, and even tidal power, will give the U. S. economy the same push it gave Brazil because we cannot produce enough ethanol domestically to meet our fuel needs, yet we have the greatest wind power potential.

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[…] to prevent these potential problems. Income from the new reserves will most likely be saved in a sovereign fund, which will prevent excessive spending. Such a fund could help prevent rising inflation, but […]

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