By Brian Winter
SAO PAULO (Reuters) - President Dilma Rousseff took office last year convinced that Brazil could keep growing at almost China-like rates without making big changes to the economy.
That confidence now looks a lot like complacency. Rousseff's inability to push ambitious economic reforms has left Brazil an expensive and increasingly stagnant place to do business, meaning the economy is now likely stuck in a mediocre pattern of around 3 percent growth for the next few years.
Some of the same officials who just six months ago were celebrating Brazil's seemingly unstoppable emergence as an economic power now privately admit they have few good options to meaningfully kick-start activity in the wake of news on Tuesday that the economy grew just 2.7 percent last year.
"There are no miracle solutions," one economic official said on Wednesday, on condition of anonymity. "It's going to be another difficult year."
Persistent inflation -- which at the end of 2011 was at a seven-year high of 6.5 percent, due to residual price pressures from Brazil's economic boom -- means that any tax incentives and other stimulus measures for struggling industries will be relatively limited in scope, the economic official and other officials say.
Other dramatic measures, such as draconian capital controls that would cause Brazil's currency to weaken sharply, are also off the table for now, the officials said. They cited Rousseff's concerns that a crisis could still break out over Europe's debt woes or Iran's nuclear program, which would leave Brazil exposed to a sudden reversal in risk appetite among investors.
Such considerations go to the heart of Brazil's core problem, which is instantly apparent to anyone who gets off a plane here.
Whether it's paying $40 for a pizza, $50,000 for a locally built Toyota sedan, or some of the world's highest rates for electricity, both manufacturers and consumers are struggling with what has become known as "the Brazil cost" -- the product of high taxes, tight labor markets and woeful infrastructure.
Many of those problems are the product of Brazil's success, as economic growth exceeded 5 percent for all but one year from 2007 to 2010, peaking at 7.5 percent that final year. Capital rushed into the country, the currency strengthened, and unemployment fell to all-time lows, pushing up costs everywhere.
Worried that the bottlenecks were piling up, business leaders have been clamoring for years for ambitious reforms such as a sweeping change to the tax code, a crusade to cut red tape, or other steps to unlock a new era of higher growth.
Yet Rousseff, a trained economist who spent her career in the public sector, opted instead for a more incremental approach -- at first because she and her Cabinet ministers believed, in a nutshell, that Brazil was doing just fine.
In a brief interview just prior to her election in 2010, Rousseff gently chastised a Reuters reporter for asking if major reforms were necessary, responding that it was "possible" for Brazil to keep growing at a 7 percent pace without them.
Fernando Pimentel, a long-time Rousseff confidant who is now her trade and industry minister, said around that same time that Brazil was "in a stage of tremendous growth." That meant that her government would be able to "turn on the automatic pilot" in some areas of economic policy, he said.
No one is making such declarations now.
PROBLEMS IN CONGRESS
The gross domestic product data released on Tuesday showed that Brazil barely escaped a mild recession in the second half of 2011. "Brazil's economy took a beating in Dilma's first year," O Globo newspaper's front page blared on Wednesday.
While Brazil's growth last year was still good by the standards of Europe or the United States, it paled in comparison to most of the South American nation's peers. Emerging market nations as a whole grew 6.2 percent last year, according to projections made in January by the International Monetary Fund.
Rousseff and Finance Minister Guido Mantega have blamed Brazil's slowdown on what they describe as predatory actions by rich countries. They say decisions such as last week's move by the European Central Bank to issue low-cost loans have caused cheap money to come rushing into Brazil, where interest rates are much higher than in the developed world.
That cheap money is the main reason for Brazil's high costs, Rousseff has said, calling the trend a "currency war."
There is little doubt that heavy foreign inflows are partly responsible for Brazil's woes. Yet, again, other emerging markets do not seem to be as adversely affected. Brazil likely finished in last place among members of the BRICS group of emerging markets, which also includes Russia, India, China and South Africa.
Some of Rousseff's advisers say that she does now see the need for more ambitious reforms. But they say her relationship with Congress, which has deteriorated since she took office in January 2011, effectively makes contentious changes impossible.
A long list of comparatively simple legislation has been stuck in Congress since last year, including bills related to the mining and forestry sectors. The main reason? Many legislators are angry at Rousseff for cutting their discretionary funds in order to keep inflation under control, and are dragging their feet on legislation in protest.
"Congress became accustomed to doing very little when the economy was good for all those years," a Rousseff aide said last week. "She's made the decision to avoid them whenever possible."
The upshot is that Rousseff is likely to continue relying on relatively minor policy moves that require little political will. One example was Rousseff's decision last month to end or overhaul a trade deal with Mexico in the auto sector, where Brazilian-made cars have struggled with foreign competition.
Aggressive rate-cutting by Brazil's central bank in coming months should also help. The bank is expected to cut rates by at least half a percentage point on Wednesday.
Indeed, the news is certainly not all bad. Tuesday's GDP data showed that consumer spending recovered somewhat in the last quarter of 2011. Unemployment remains near historic lows, and many Brazilians still seem oblivious to the slowdown, cheered by growth that has pulled an estimated 25 million people from poverty in the last decade.
Still, the IMF said in January it expects Brazil's economy to grow just 3 percent this year -- which would again put it well below the 3.6 percent average in Latin America, and the 5.4 percent growth the Fund expects for emerging and developing nations as a whole.
Mantega repeated on Tuesday, after last year's disappointing GDP data was published, that he still expects Brazil to grow 4.5 percent in 2012. However, that's the same pace of growth that he was forecasting for 2011 -- until September of last year.
(Editing by Todd Benson and Andrea Evans)