The economic landscape in Brazil is improving, but independent financial analysis company Eleven Financial says the emerging markets powerhouse is still a long way from making the recovery sustainable.
All commentary and opinion is that of Eleven Financial and any views expressed are not those of Thomson Reuters.
We never imagined that Brazil’s recovery would follow a linear path, free from frustration or setbacks.
But the list of achievements so far this year has been impressive as the country attempts to recover from the deepest recession in a century.
Now there are signs that the tide may be turning.
Our own forecast suggests that economic activity should have expanded 1.5 percent in 2017 from a year earlier, which would be the fastest pace in three years.
Encouragingly, this upturn in growth is unlikely to stoke inflation as firms are still grappling with idle capacity while employment gains are being concentrated on off-the-books jobs.
Many problems remain for Brazil, not least political uncertainty as President Michel Temer continues to face difficulties pushing through a pension reform seen as key to shoring up fiscal health.
Also, it is now increasingly clear that the burden of reforms will fall to the winner of next year’s presidential election.
Inflation is a good starting point for measuring Brazil’s recent progress as the rate has reversed its downward trajectory. In November, Brazil’s inflation rate accelerated to a five-month high of 2.77 percent, albeit helped by an increase in power costs.
The increase should be taken positively by the Brazilian Central Bank.
Lower real interest rates, inflation on target and GDP above expectations are the pillars that support the basis of a strong economic recovery.
In fact, the resumption of economic growth will be responsible for bringing inflation back to the target in a shorter period than the market expects. We expect that inflation will end the year at 3.6 percent.
The reasons for this include the closing of the productivity gap and real interest rates at expansionary levels, which will have an upward effect on prices.
Selic rate outlook
As Brazil cuts interest rates toward all-time lows, firms have found it easier to cut debt and fund expansion plans.
Even so, the central bank continues to feel it has room to cut its benchmark Selic rate. In order to support a nascent economic recovery, it has already cut the rate by 675 basis points since October 2016.
When the Brazilian Central Bank made a 75 bps cut in the Selic rate, to 7.5 percent, the communiqué accompanying the decision pointed out that the favorable price dynamics and idle capacity still allowed for subsequent cuts in the interest rate.
The committee also highlighted the potential risk factors for inflation dynamics.
Food and drink prices may pull inflation down, but frustrations regarding the reforms proposed by Congress may change the risk perception on the Brazilian market.
A possible non-approval of pension reforms could have damaging consequences on the interest and exchange market, which would generate inflationary pressures.
Thus, the situation must be monitored with great caution by the central bank.
For the December meeting, we estimate a rate cut of 50 bps. As a result, the interest rate is expected to close 2017 at 7 percent.
Political uncertainty in 2018 prevents us from making longer term projections for the Selic rate.
Scenarios arising from the accusations against the President, potential frustrations in the reforms and the forthcoming elections generate many instabilities in relation to future interest rate options.
Our fixed income and economy team maintains an exchange rate projection of R$ 3.35/US$ by the end of 2017.
This is despite an October sell off in which the currency suffered its worst month in nearly a year.
Even when the Brazilian Real was doing well against the US dollar, we pointed to an artificial and unsustainable appreciation of the currency. This relates to the interest differential, terms of trade, commodities, reserve balance and capital flow.
The combination of national and international dynamics creates a natural pressure that has materialized in recent movements of the Real versus Dollar relationship.
Brazil’s debt burden
Brazil lost its investment-grade credit rating in 2015 after missing its goals for years.
Temer, who replaced impeached President Dilma Rousseff in 2016, pledged to set realistic targets and meet them to regain credibility with investors.
But Brazil’s central government primary budget deficit widened more than expected in September, to a figure of R$22.725 billion ($6.9 billion), up from R$9.56 billion in August.
The government is continuing with its efforts to cut spending, which fell 1.91 percent in real terms. It is worth noting reductions of 71.2 percent in subsidies, and of 8.6 percent in unemployment insurance.
Another factor that should benefit the result in the short term is the auction of four hydroelectric plants currently operated by Cemig, generating revenues of R$12.13 billion to the federal government, above the R$11 billion expected by the Ministry of Finance.
Also at the end of September, the Brazilian Development Bank announced the return of R$33 billion to the National Treasury.
Finally, in early October, the Senate approved another Refis, the federal government’s tax debt installment payment program. According to the Ministry of Finance, the estimated collection of the program is R$ 3.8 billion.
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Although these measures guarantee some stability in the short term, the long-term impact is negligible. This is because they do not tackle the core fiscal problem, which is the rigidity of compulsory spending.
In recent months, the government has treated only the symptoms of this disease, leaving aside proposals to tackle the cause of the problem: the social security deficit.
In addition to pension reform, a broad fiscal adjustment requires a review of the entire government spending structure to take into account subsidies, the extension of the payroll of civil servants and the financing and exemptions directed to interest groups.
All this boils down to a structural abolition of the culture of privileges that has been established in the Brazilian public machine. The road to long-term productivity begins by tackling such inefficiencies.