Brazil

Cyclical decline in insolvencies, but corporates are not home and dry yet

We expect a -6% decrease in company insolvencies in 2019 in Brazil.

The cyclical recovery and lower cost pressures should benefit companies in 2019

On the cost side: the temporary spike is behind us. First, (i) wage pressures should remain limited; nominal wages are barely growing. There is indeed still slack in the economy, with unemployment at 11.6%. Second, (ii) the input price shock in 2018 with the combined effect of higher oil prices and the truckers’ strike is now fading. We do not see oil prices soaring (USD69/bbl on average for Brent in 2019) and we expect the producer price index to continue on its decelerating trend (+7.9% y/y in January down from +13.9% in October) while inflation stays muted (+3.8% in December). Finally (iii) financing cost are decreasing as lending rates are at a four-year low for corporates. The 10-year sovereign rate is at a historical low (8.7% against highs of 12.5% last year), helping to push down corporate borrowing costs. The policy interest rate is also at a record low (6.5%) and the central bank is not expected to tighten its monetary policy this year.

On the revenues and activity side: we see a gradual acceleration. In 2019, real GDP growth should accelerate from +1.3% in 2018 to +2.3% in 2019. In addition, credit growth for non-financial corporations is back to positive territory after contracting for close to 3 years.

Yet fundamentals are not so rosy for corporates, despite the post-election confidence boost

Doubts remain on the sustainability of such decline in insolvencies, as risks remain. The sector risk picture has improved since Q4 2017, as Euler Hermes has recorded 8 sector risk upgrades and 0 downgrade. Yet Brazil’s industry risk remains relatively high: 11 out of 18 Brazilian sectors are still rated sensitive risk compared to ~4 out of 18 sector in country on average in the world. And no sector is rated “”low risk” compared to ~2 out 18 of sectors in Latin American countries on average.

Lastly, the economy has still not fully recovered from its worst recession in history. Besides, the level of company capacity utilization, at 74.3 in January, was still 7 points below its long-term average.

In conclusion, while companies should start reaping the sows of the cyclical economic recovery, it will take much needed reforms to improve the business environment and overhaul the social security system to durably restore confidence; this would help put insolvencies back in a sustainable decreasing trend. Yet we continue to believe that the reform outlook is challenging, given governability issues and potential instability of the new president’s policy platform. Watered-down reforms or political gridlock would end Bolsonaro’s honeymoon and could trigger market volatility; it could lead to an increase in Brazil’s risk premium, hence rising corporate borrowing costs.

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.