Brazil

Grim growth outlook, mixed reform prospects

B3

SENSITIVE RISK

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

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GDP USD2055.506bn (World ranking 8, World Bank 2017)
Population 209.29mn (World ranking 5, World Bank 2017)
Form of state Federal Republic
Head of government Jair Bolsonaro (President, far-right) since January 2019
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

Reality check incoming?

2018 GDP growth came in at a disappointing +1.1%, the same as in 2017, after a year of financial volatility and a strike that had non-negligible effects on economic activity and confidence. The recovery is exceptionally torpid given that the economy contracted -3.5% in both 2015 and 2016; GDP hence remains below its peak of 2014. Yet 2018 showed an acceleration in private consumption (+1.9% after +1.3% in 2017) and a rebound in investment (+4.1% after -2.6% in 2017), which were matched by soaring imports (+7.6%) negatively contributing to growth. Exports did not keep up (+3.4%) due to an uneven harvest, despite goods exports to China rising again by a third. The outlook for consumption in 2019 is only mildly positive as unemployment is falling slowly. Investment may continue to recover with the return of confidence, supported by privatizations in H2 and a still accommodative monetary policy stance this year. We see growth of just around +2% in 2019, and +2.5% in 2020, lower than the 2000s average of +3.5%.

The expected reality check for 2019 has started to materialize. Retail sales stalled in February, confidence fell to pre-Bolsonaro election levels as his approval ratings dropped, and the unemployment rate is back above 12%. As for companies, although industrial production rebounded in February (+0.7% m/m), it contracted in y/y terms for the sixth straight month, and business confidence weakened. Political confusion (corruption allegations in Bolsonaro’s entourage, firing of a minister, disagreements with the House Speaker) and the first difficulties in the pension reform legislative process have also caused the Brazilian real (BRL) to follow a depreciating trend since the end of January, erasing almost all the gains made in the first month. The stock market rally is moderating after breaking the 100,000 points threshold (now around 96,000). As a result, we still forecast a sluggish recovery (+2% GDP growth this year) and painful and lingering pension negotiations which could raise borrowing costs again.

Yet Brazil enjoys pockets of resilience: (i) it has built a large stock of foreign exchange reserves (around USD380bn) covering 20 months of imports (ii) it has rebalanced its current account (now only at a small deficit) and (iii) has a low external-debt-to GDP ratio, and most debt denominated in local currency. A balance of payments crisis (similar to Argentina and Turkey) is hence unlikely in the case of 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 although modest acceleration. 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.  

Poor business environment, but policy quick fixes will help

Brazil ranks 109th out of 190 countries in the World Bank 2019 Doing Business Survey, below the Latin American average. Any company doing business in Brazil is well aware of the so-called "Brazil cost". Except for protecting investors (48th), enforcing contracts (48th) and getting electricity (40th), 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. Indeed, companies need close to 2000 hours to prepare their taxes, against less than 400 in Argentina, and 200 in Colombia and Mexico.  

President Bolsonaro's business environment reforms (decreasing the number of days needed to create a company in Brazil from 79.5 days down to the regional average of 30 days) could also lead to the creation of 90 000 additional companies in 2019 compared to 2018. Easing of regulation in some sectors and potential amendments to the tax system should help as well. 

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

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

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Contact

Contact Euler Hermes

Economic Research Team

research@eulerhermes.com

Contact Georges Dib

Economist for Latin America, Spain and Portugal

georges.dib@eulerhermes.com 

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