Brazil Economic Outlook - My Mood for Today

And yet to look at Brazil’s economy, blue skies beckon. Inflation is falling. Interest rates have never been so low. Following this month’s victory on pension reform, expected to save around $196 billion over the next decade, the government is pushing the most ambitious overhaul of the bureaucracy since the return to constitutional democracy 31 years ago. Investors are eyeing opportunities in one of the world’s most attractive energy frontiers, notwithstanding last week’s unimpressive auctions for drilling rights. A huge infrastructure remake stands to reap Brazil $65 billion over three decades, Eurasia Group’s Christopher Garman recently wrote clients.

So which Brazil is real? Both, it would appear. Unsettling as it may be, the chasm between Brazil’s toxic politics and its potentially transformative economic agenda has become a familiar anomaly. Odder still, investors are learning that the same schism thrives within the government itself. “Banks and companies are saying, ‘forget Bolsonaro. Look at the markets’,” said former finance minister Mailson da Nobrega, a partner at the consultancy Tendencias. “It’s as if this were the new normal.” 

Yet the disconnect between reformers and dogmatists is hardly auspicious. Brazilian politics is umbilically connected to economic expectations and decisions. The only way the country can remake the profligate state, raise productivity, draw investment and lock in its modernizing agenda is to mute the internal dissonance and align political muscle behind structural change. That mission takes conviction and focus, both in short supply in a ruling claque thriving on cacophony and polarizing disruption. 

A lot of Brazil’s forward march is actually inertia. The vital policy shifts now gaining traction were set in motion more than three years ago, when Bolsonaro was still a choleric culture warrior on the conservative fringe. The impeachment of Workers’ Party leader Dilma Rousseff in 2016 ended more than a decade of economic magical thinking that produced Brazil’s worst recession. Vice President Michel Temer took over and, despite his dismal approval ratings, drafted reforms that set Brazil on a new path. 

One was the government spending cap, which put federal authorities on notice to live within their means or face legal consequences. Another was a sweeping pension reform, which — with some repackaging by Bolsonaro’s economic czar Paulo Guedes — finally cleared Congress and was signed into law Nov. 12. 

Temer also unleashed state oil giant Petrobras to compete in the open market and rescinded protectionist local content rules. That paved the way for the next round of drilling tenders, which by 2030 could put Brazil among the world’s top five oil producers, Eurasia Group said. 

Yet Brazil is not fated to succeed. The virtuous reform cycle that has emerged on Bolsonaro’s watch relies on good fortune and a fragile pact among unlikely partners. With Bolsonaro roiling diplomacy, attacking rainforest science and railing against a brand of communism that went out with the Cold War, the task of retooling the overextended bureaucracy and fixing the economy has fallen to Guedes and his technocrats. A surprisingly proactive legislature, led by the capable and institution-abiding congressional president Rodrigo Maia, has done the rest. 

But this felicitous workaround has an expiration date. With local elections slated for late next year, the broad legislative consensus that rewrote the pension system is likely to dissolve over the more divisive plans now before Congress to slim down the state, overhaul an irrational tax code and stanch fiscal incontinence. 

Brazil has 5,570 municipalities, each one loath to relinquish its slice of the federal tax pie. And don’t expect lawmakers, all of whom have hometown constituencies, to fall in line behind Guedes’s proposal to abolish small townships that subsist only on transfers of federal revenues — an existential threat to one in every five Brazilian mayors. Who knows what will befall unpopular reforms once Maia’s mandate as house speaker ends in early 2021? 

It’s paradoxical that the hard right-wing agenda that propelled Bolsonaro into office — anti-abortion, home-schooling, banning (leftist) ideology from the classroom and the anti-crime bill — has gotten nowhere in Congress. Instead, what’s propped up Bolsonaro’s ratings are an incipient economic upturn and falling crime rates. Both are wins for long-term reforms and policy measures for which Bolsonarismo has paid little mind and dispensed even less political capital. 

The return of an obstreperous leftwing adds another layer of complexity. Although Lula has pledged to amp up dissent, his long game is to revive the political left, not to sabotage salutary and necessary economic restructuring. Whether reformism can coexist with partisan fury as election season looms is an open question. On the ideological proving grounds, Bolsonaro and his inner circle wage permanent battle. “Every week we have a new outrage that is no longer a surprise but is shocking, nonetheless,” said Octavio Amorim Neto, of the Getulio Vargas Foundation. “That’s a sign that we can plunge into crisis from one moment to the next.” 

For us, on the private side, have Bolsonaro as a pier for propaganda is a disaster. A few companies and institutions in the globe, wants to have a “partner” with no commitment with deforestation and a heavy user of doubtful speeches and data when approached by the press. 

Perhaps the combatants have taken notice. Bolsonaro recently visited Beijing, dropping the red-bashing that fueled his campaign. A few weeks ago, Bolsonaro’s youngest son Carlos, the most vociferous of the clan, deleted all his social media accounts — maybe none too soon. If Brazil’s recent history is any guide, political luck also runs out.

Brazil Economic Growth

Growth is seen gaining steam next year, on the back of recovering confidence and accommodative monetary policy. In addition, household spending should receive a boost from a government measure to allow workers to tap into an unemployment benefit fund. Risks to the outlook linger, however, particularly from subdued external demand and stalling reforms. FocusEconomics analysts project growth of 2.1% in 2020, which is up 0.1 percentage points from last month’s estimate. In 2021, growth is seen at 2.5%.

COPOM slashes key interest rate to a new record low in December

At its 10–11 December meeting, the Central Bank of Brazil’s Monetary Policy Committee (COPOM) unanimously voted to cut the benchmark SELIC interest rate from 5.00% to a new historical low of 4.50%. The move was widely expected by FocusEconomics panelists and represented the Bank’s fourth consecutive cut as part of its efforts to support the economic recovery.

COPOM’s latest move came as inflation remains below the Bank’s 4.25% target for the end of 2019. Moreover, COPOM views the economic recovery to be gaining traction, albeit gradually, with lingering risks to the outlook stemming from stalled reforms and a deterioration in the external environment. Moreover, the Bank was guided by accommodative monetary policy stances in advanced economies, which gives emerging markets’ central banks more policy scope. Regarding the inflation outlook, the Bank sees the risks as balanced, with lagged effects from the Bank’s prior easing likely to exert upward pressure, whereas the sluggish economic recovery could cap inflationary pressures. COPOM expects inflation to come in around 3.6% at the end of 2020 and 3.8% for the end of 2021, based on market expectations.

Looking ahead, COPOM sees additional room to maneuver given the below-target inflation expectations, but emphasized exercising caution would be necessary at the current stage of the economic cycle. The Bank currently projects another 50 basis points in easing in the year ahead but noted that any move will continue to depend on the evolution of economic activity, the balance of risks and inflation. That said, in our latest LatinFocus Publication, panelists were relatively split on the scenario for 2020, with a small majority seeing the rate on hold next year.

Commenting on their monetary policy outlook, Cassiana Fernandez and Vinicius Moreira, economists at JPMorgan, noted: “COPOM kept the door open for further easing […] The Central Bank’s models continued showing inflation significantly below target, suggesting room for additional easing next year. In this sense, after becoming more cautious about the confidence in our monetary policy expectations following the recent strong economic growth numbers, today’s statement makes us feel more comfortable about our call for a 25bp cut in February.”

The next monetary policy meeting is scheduled for 4–5 February 2020. FocusEconomics panelists forecast the SELIC rate to end 2020 at 4.61% and to end 2021 at 6.14%.

Industrial output growth gathers momentum in October

Industrial production increased 0.8% month-on-month in seasonally-adjusted terms in October, accelerating to a five-month high from September’s 0.3% increase. Moreover, the result came in above market expectations of 0.7% growth.

November’s solid outturn was largely driven by stronger output of intermediate goods and nondurable goods, whereas production of capital goods continued to decline and consumer goods output growth moderated. Among sectors, industrial output grew in 14 of the 26 sectors surveyed, with the main positive contribution coming from food products, and pharma-chemicals and pharmaceuticals. In contrast, mining and quarrying output contracted in the month as did production of coke, petroleum products and biofuels.

On an annual basis, industrial production grew 1.0% in October, matching September’s revised reading (previously reported: +1.2% year-on-year). The analysts surveyed by FocusEconomics for this month’s LatinFocus Consensus Forecast see industrial production rising 2.4% in 2020, which is up 0.1 percentage points from last month's estimate. In 2021, industrial output is expected to grow 2.8%.

Solid domestic demand underpins strong GDP outturn in Q3

The economy continued to strengthen in the third quarter, with GDP growing at the quickest clip since Q1 2018. Seasonally-adjusted GDP increased 0.6% quarter-on-quarter in Q3, a notch above Q2’s revised 0.5% expansion (previously reported: +0.4% quarter-on-quarter) and exceeding market expectations of 0.4% growth. On an annual basis, GDP growth clocked in at 1.2% in Q3, up from Q2’s revised 1.1% expansion (previously reported: +1.0% year-on-year).

Robust consumer spending, which hit an over one-year high in the third quarter (Q3: +0.8% quarter-on-quarter; Q2: +0.2% qoq), spearheaded the acceleration. Meanwhile, fixed investment expanded at a healthy rate of 2.0%, albeit softening from Q2’s 3.0% rebound, and was supported by the recovery in industrial activity during the quarter and more accommodative monetary conditions. On the other hand, government consumption fell 0.4% in Q3, following Q2’s 0.3% contraction amid tight public finances.

With regards to the external sector, waning demand from Brazil’s key trading partners, particularly Argentina and China, in tandem with ongoing difficulties for mining giant Vale after a dam collapsed earlier this year, weighed on foreign shipments. Exports of goods and services declined 2.8% in Q3, worsening from the 2.0% contraction in Q2. Conversely, growth in imports of goods and services notably accelerated in the third quarter (Q3: +2.9% qoq; Q2: +0.7% qoq). As a result, net trade dragged on growth in Q3.

Turning to next year, the economy should continue to gain momentum, supported by robust domestic demand. Brisk household spending, lower borrowing costs and a continued recovery in industrial activity will boost growth. Moreover, the external sector should rebound due to an improving global trade backdrop. That said, a depressed Argentine economy will likely limit external demand, while recent government proposals to curb public spending suggests government consumption will continue to drag on growth.

Commenting on the outlook, Gustavo Rangel, chief economist for Latin America at ING, noted: “The yet-to-be-seen impact of the monetary stimulus, which affects consumption after a significant time-lag, should be the critical driver behind the acceleration in economic activity over the coming quarters. As seen in the 3Q GDP report, renewed evidence of the steady recovery in the construction sector, a key credit-sensitive and labour-intensive sector, bodes especially well for a faster recovery. External demand, along with the persistent fiscal contraction, should remain important headwinds […] Given that prospects for a recovery in Argentina remain remote, this should contribute to weigh down industrial exports throughout 2020, especially in the auto sector.”  

LatinFocus Consensus Forecast panelists see growth at 2.1% in 2020, which is up 0.1 percentage points from last month’s estimate. For 2021, the panel sees the economy growing 2.5%.

Real plunges to new record low in November

The Brazilian real ended 27 November at a record low against the U.S. dollar, before recovering mildly in the following days. On 29 November, the real ended the day at 4.24 per USD, a 5.6% depreciation from the same day in October. The currency has weakened notably in the second half of the year, and was down 9.1% year-on-year and 8.4% year-to-date.

A slew of interest rate cuts has undermined the real, which is also being weighed on by a worsening trade balance and generally subdued demand for emerging market assets. To stem the slide in the currency, the Central Bank intervened in the foreign exchange market for the first time in three months on 26 November.

Looking ahead, the real is seen remaining week in the coming months, before gaining some ground half-way through 2020 as growth picks up. Commenting on the currency’s outlook, Gustavo Rangel, chief economist for Latin America at ING, noted: “Overall, Brazil’s fundamentals should display a more substantial improvement throughout 2020, as the effect of the aggressive monetary easing seen in recent months and the improved fiscal outlook, resulting from fiscal reforms, should result in faster economic activity. But the inability to execute a fiscal stimulus package suggests that this recovery could be slower than past recoveries, with its pace heavily dependent on the private sector’s “animal spirits”. This suggests that the consolidation of a stronger BRL trajectory is more likely towards the latter part of 2020.” 

Our panel sees the real ending 2020 at 4.01 per USD and 2021 at 4.00 per USD. 

This is my last report of the year. May 2020 be much better than 2019 and may the force be with ALL OF US !  

Let’s ROCK !

Emerson de Pieri | Board Member