BRAZIL

While Brazil’s reform momentum was positive (key pension reform approved in 2019, other pro-business reforms on the table) and its economic growth finally accelerating, the Covid-19 crisis is a game changer. As recently as end-March 2020, we downgraded Brazil’s risk rating from B2 to B3: this reflects the deterioration of the country risk picture from “medium” to “sensitive”.  Yet there is no 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.

In addition to lower commodity prices, we should point out two main negatives for Brazil’s economic outlook in 2020: (i) the stronger blow of domestic lockdowns (albeit less stringent than in Argentina, Peru or, say, Spain and France), which will lead to a deep contraction in GDP in Q2. (ii) The medium-term hit to confidence and higher political uncertainty for companies due to the disastrous management of the pandemic in Brazil (two ministers of health have left since the beginning of the pandemic; figures for the number of deaths are now suspected to be manipulated by the government). At end 2020, we can expect higher unemployment and a spike in company insolvencies. GDP could only come back to its pre-crisis level in 2022.

There are three main risks ahead.

Political and social risk in the short to medium term: Tensions between local and central authorities and Bolsonaro’s increased criticism of Congress will reduce the political leeway for reform after the crisis. Crisis mismanagement will hamper confidence as it proves that Bolsonaro’s interventionist past has come back to haunt him. Adding the corruption allegations in Bolsonaro’s entourage and a new accusation of abuse of power, impeachment at the exit of the crisis is no longer a fantasy. Moreover, growing income inequality, the rise of disinformation, lack of trust in democratic institutions and hyper-partisanship put Brazil among the riskiest countries of our Social Risk Index.

Risk of second lockdown in the short-term if both international and domestic pressure ramp up. Indeed, the first wave is not over yet, the curve is all but flattened, but the country is reopening. It appears Bolsonaro will do everything to maintain his stance and reopen the country before the predicted peak of the epidemic in July, in spite of a continued increase in the number of deaths.

Fiscal risk: Public debt could cross the 100% GDP threshold in 2020 (as per IMF criteria, closer to 90% as per the national methodology). Although the debt is in local currency and most of it is held domestically, it can still present a risk of higher interest rates at the exit of the crisis.

Due to these risks, although the exchange rate with the USD has recovered from previous lows, we believe there is downside risk on the Brazilian currency in the medium-term.  

It is hard to find a silver lining. A faster than expected recovery in developed countries in a low-rates environment could increase risk appetite, which would benefit Brazil and its financing conditions, and attract more investment, especially as the Brazilian government auctions dozens of state-owned assets. The urgency of the situation post crisis leads to political consensus on key reforms (tax reform, business environment…), which could restore confidence and create opportunities. But it is not very likely at this stage.