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BRAZIL

Walking a fiscal and political tightrope

B3

SENSITIVE RISK

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

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GDP USD 1840bn (World ranking 9, World Bank 2019)
Population 211 mn (World ranking 6, World Bank 2019)
Form of state Presidential republic
Head of state Jair Bolsonaro (President)
Next elections 2022, presidential and legislative
  • Important role on an international and regional scale
  • Diversified economy
  • Growing middle class
  • Robust foreign direct investment inflows, high level of foreign exchange reserves and low external debt
  • Support for IFIs likely if needed
  • Vulnerable to global commodity prices
  • High production costs
  • High taxation and red tape ("Brazil cost")
  • Large fiscal deficits and increasing public debt
  • Political and social tensions on the back of corruption and high income inequality
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Effective fiscal response in 2020, but 2021-2022 outlook at risk despite the ramping up of vaccinations

Brazil had a fragile pre-pandemic fiscal outlook, although the pro-business reforms pipeline was encouraging. However, the pandemic shock halted the already sluggish growth and reform momentum. Brazil's fiscal response was extremely ambitious and effective, but it put public finances on an even more unsustainable path.

Brazil’s economy contracted less than that of peers in 2020 (-4.4% vs. -6.8% on average in Latin America). Indeed, ~USD110 in emergency monthly government payments were sent to around 67 million Brazilians (almost a third of the population) and were extended (albeit reduced by half in September) until the end of 2020. Those transfers were so effective that they actually reduced the poverty rate in Brazil. Brazil spent 8.6% of GDP in discretionary measures and, in total, more than what the pension reform voted in 2019 was aiming to save across 10 years (~USD200bn).

The mismanagement of Brazil’s second wave of the pandemic will alter the Q1 2021 economic performance. In fact, one in three Covid-19-related deaths now occur in Brazil, and states undertake different decentralized responses in absence of a nationally mandated lockdown. In addition, the slow start of the vaccination rollout (although it will pick up pace), inflation pressures and political and social risk put the recovery at risk, and should create some stress on the currency, raising borrowing costs for companies and leading to double digit insolvency growth. We expect +2.8% GDP growth in 2021 and +2.3% in 2022.
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Strong buffers delay the risk of full-blown currency or fiscal crisis, but pressure mounts and should peak in 2022

There is a low risk of an immediate external financing crisis in Brazil as it holds around USD350bn in FX reserves (17% of GDP) and the current account deficit is contained. Such FX reserves cover more than five times its external financing needs for 2021 (current account deficit + short-term external debt + long-term external debt maturing). In addition, despite reaching close to 100% of GDP, public debt remains held domestically and is in large part denominated in the local currency, which significantly reduces exchange rate risk.

However, in the short-term and in a context of market nervousness, with several equity bubbles and fear of higher US rates, any policy misstep will trigger severe selloffs. In fact, while every single measure of fair value for the Brazilian real (BRL) shows that it is very much undervalued, it has continued depreciating in 2021 after losing -6% against the USD in 2020. We expect depreciation pressures to continue, adding to recent inflationary pressures: this should cause damage on input prices for already fragile companies and trigger insolvencies; it will also push borrowing costs up as soon as this year as markets demand a higher risk premium.  
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Inflationary pressures are pushing for early normalization of monetary policy

With inflation running at 5.2% in February, the 3.75% central bank target was exceeded and expectations of future inflation rose, prompting the central bank to hike the policy interest rate even more than expected in March (by 75bps to 2.75%). The central bank’s stance remains accommodative as estimates for the neutral interest rate in Brazil hover around 5-6% (and the rate was at more than 14% in 2015, not so long ago!). We expect at least an additional 75bps rate cut at the next central bank meeting, but probably more in the second half of this year to tame inflation pressures and reassure markets anticipating a US interest rate hike. This shows the solidity of the monetary policy framework reinforced by the recently voted central bank independence law. Yet this also shows monetary stimulus will progressively be withdrawn as soon as this year, in contrast to most economies in the world. This also explains why the Brazilian recovery should remain fragile this year.

Good policy orientation, but interventionism and political risk in general are blurring pro-business signals

The orientation of the economically liberal government and center-right leaning momentum in Congress has allowed the implementation of several pro-business “quick win” policies since Bolsonaro’s inauguration, in addition to a flagship pension reform. While Congress and the finance minister have reaffirmed their will to vote fiscal and administrative reforms in 2021, the prospects of the 2022 presidential and legislative election mean ambitious reforms will be more difficult to pass. Our baseline scenario is that the economic team will be able to pass a limited fiscal reform to anchor market expectations and buy Brazil some time, but certainly not reverse the course of unsustainable debt accumulation.

Moreover, former president Lula running in 2022 (not a certainty yet, but the likelihood is high) also makes it less likely for Bolsonaro to adopt stark austerity measures as Bolsonaro’s populist roots will be exacerbated: we expect the president will want to pull the rug out from under Lula and his left-leaning ideology by continuing to spend and abandon fiscal rigor. Bolsonaro’s interventionism is already back under the spotlight. During a recent congressional vote on an emergency bill to contain public expenditure through freezing salaries and delaying promotions in the civil service, Bolsonaro managed to have the police exempted from the measure. The same happened when truck drivers threatened a national strike over fuel prices; Bolsonaro dismissed the CEO of state oil company Petrobras. This was followed by an announcement that he also intended to intervene in the setting of electricity prices.

Upside risks do exist: the acceleration of vaccination could lead the country to lift restrictions in April 2021 and could boost business and consumer confidence.  The urgency of the post-crisis situation could also lead to political consensus on key reforms (tax reform, business environment…), which could restore confidence and create opportunities. - April 2021

Trade structure by destination/origin

(% of total)

Exports Rank Imports
China 21%
1
18% China
United States 13%
2
17% United States
Argentina 7%
3
7% Germany
Germany 4%
4
6% Argentina
Japan 3%
5
3% France

Trade structure by product

(% of total)

Exports Rank Imports
Oil seeds and oleaginous fruits 11%
1
8% Petroleum, petroleum products and related materials
Metalliferous ores and metal scrap 10%
2
7% Electrical machinery, apparatus and appliances, n.e.s.
Meat and meat preparations 8%
3
7% Road vehicles
Petroleum, petroleum products and related materials 6%
4
6% Other industrial machinery and parts
Road vehicles 6%
5
6% Organic chemicals
The payment behavior of domestic companies is acceptable, though standard payment terms are very varied and DSO remains high.

  • Low

  • Medium

  • Sensitive

  • High

  • Payments

  • Court proceedings

  • Insolvency proceedings

  • Payments

  • Court proceedings

  • Insolvency proceedings

Given the length and cost of legal actions in Brazil, chances of obtaining enforceable judgments in a timely manner are low and it is preferable to consider amicable arrangements and specialist debt collection methods as a means to avoid domestic courts.

When it comes to insolvent debtors, use of the company rescue mechanisms is increasing; in practice, however, the chances of recovering debt remain extremely low.

Download the entire collection complexity PDF:

Collection complexity Brazil 843 KB

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Euler Hermes Economic Research
research@eulerhermes.com

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