Recession is over, but the future is fraught with risks

After two consecutive years of recession, real GDP grew by +1% q/q in Q1 2017, the first positive rate since Q4-2014. Yet, on a year on year basis, GDP fell by -0.4% for the 12th consecutive quarter. From the supply side, growth was driven by the agriculture sector (+13.4% q/q) due to a bumper soy harvest. Industrial output expanded by +0.9% q/q, but services struggled to pick up (+0%). Euler Hermes expects GDP growth of +0.6% in 2017 and +1.9% in 2018, far below the pre-crisis pace of +4.5%. Risks loom as more political uncertainties could hit confidence.

Only one year after he took the office after Dilma Rousseff’s Impeachment, President Michel Temer is now also being stained by a political scandal. A local newspaper claimed a secret recording allegedly proved Temer was involved in bribery. Temer’s popularity has sunk below 10%.

Inflation has eased back into the target range of +4.5% +/-2pp as consumer prices moderated to +3.6% y/y in May, down from +9.3% y/y a year before and a peak of +10.7% y/y in late 2015. Hence, monetary authorities have adopted a pro-growth policy stance. The key rate has been cut by 300 bps since October 2016 to 10.25% in June. Moreover, downward pressures on the currency have faded away. 

Still, the BRL remains very sensitive to political developments. It depreciated by -9% against the USD the day after the Temer scandal broke. Although the disinflation process should continue over the next months, allowing for further rate cuts, short-term risks should be closely monitored such as (i) the impact on prices of the approval of fiscal consolidation measures, (ii) the uncertain external environment and its impact on the currency and (iii) food prices shocks stemming to a large extent from tougher weather conditions.

The high fiscal deficit (-9% in 2016) risks weighing further on the public debt-to-GDP ratio already rising quickly while activity struggles to pick up. Indeed, the recession dragged down government tax revenues and pushed up borrowing costs. At the height of recession, 10-year bond yields reached 7% against the 2013-2015 average of 4.5%.

Poor business environment

Brazil ranks 123^rd out of 190 countries in the World Bank 2017 Doing Business Survey, below the Latin American average. Except for protecting investors (32^nd), enforcing contracts (37^th) and getting electricity (47^th), the business environment is poor.

The control of corruption, ease of starting a business or the simplicity and efficiency of the tax system are among the main shortcomings. If enacted, the future bankruptcy law could enhance the business climate.

After two consecutive years of marked increases (+25% in 2016 and 2015), the surge in corporate insolvencies should moderate to +13% in 2017 and +7% in 2018 as Brazil gradually exits from recession.