Brazil: What You Need Is Not What You Get

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Which of the following would be the least favorable development for a major economy in recession?
1. The president is suspended.
2. Public debt on the rise.
3. High inflation.
4. Falling external demand.
Brazil has been in the economic doldrums for quite some time.
Its economy, battered by both inflation and recession, will shrink by -3.5% this year, after a -3.8% fall in 2015. Add to that falling domestic demand and prolonged low commodity prices, tight financing conditions and financial volatility. And on top of it all a +22% surge in insolvencies, means the country suffers the worst deterioration in bankruptcies worldwide.
But when the country’s Senate voted to suspend and impeach President Dilma Rousseff after months of political turmoil, it felt as if some of the world’s most complex problems were dumped in a heap in Brazil’s front yard.
Definitely not what one would hope for in the run-up to the Rio Olympics.
So where is Brazil heading now?


Our latest Economic Insight report on Brazil attempts to investigate this question.
Five crucial downside risks plague the Brazilian economy.
• Painful adjustment: falling domestic demand and low for longer commodity prices. Domestic demand is deteriorating sharply. Retail sales fell by -7.5% y/y in February 2016. Consumer confidence is at record low levels.
The external sector did not fare better. Amid falling commodity prices (notably agriculture) and Chinese slowdown (China accounts for 18% of exports and is the leading trade partner), nominal exports fell by -15% in 2015. However, given very weak domestic demand, imports have plummeted even more: -25% in 2015.
• Tight financing conditions and financial volatility. National credit outstanding for non-financial corporations has slowed to a modest +3.3% y/y in March, while banking interest rates have increased strongly and stand now above 20% on average for corporations. The tightening of US monetary policy combined with the Petrobras scandal and the deterioration of economic indicators in Brazil led to strong downward pressures on the currency and increased financial volatility.
Moreover, the deteriorating credit profile of Brazil had an impact on ratings. The first agency to downgrade Brazil was S&P in September 2015. It was soon followed by Fitch (December 2015). This is a structural change as a borrower falling into ‘speculative’ grade might need 6 to 8 years to rebuild its Investment grade status. Euler Hermes downgraded its country risk rating for Brazil to C3 in Q1 2016.
• Political and fiscal uncertainty. A clear majority of the Brazilian Senate voted on May 12 to suspend Dilma Rousseff. The 55 to 22 vote, means that Rousseff faces an impeachment trial at the senate, a process that might drag for up to 180 days. Vice-President Michel Temer assumes the presidency while the trial takes place, and a new government will be installed. If Rousseff is not able to return to her role as head of state Temer will hold office until the next elections are held in 2018.
The bottom line for any government should be to revamp the country’s fiscal accounts: they have deteriorated sharply in the last two years (see Figure 5). The fiscal deficit widened to -10.3% of GDP in 2015 from -6.0% in 2014 and -3% in 2013. Public debt is increasing at a strong pace: +9pp from December 2014 to date, standing at 67% in March 2016. Political turmoil could also mean increased financial volatility including an increased cost of financing for Brazil on the international market.
• Where could all this lead to? Down the slippery slope that ends with bankruptcies. A direct and particularly risky result of all of the above is a hike in business insolvencies. These could surge by +22% this year after soaring by +25% in 2015.
Any good news to report on?
Net exports contributed positively to growth in 2015. But the moderate growth in exports (+6%), was coupled with a collapse in imports: -14%.
Foreign direct investment is another spot of sunshine in the gloom. Overall, net FDI inflows (inflows-outflows) stood at USD62bn in 2015, enough to cover the entire current account deficit which could narrow by -2.5% of GDP in 2016.
Moreover, FX reserves are at a comfortable level, covering more than 15 months of imports. External debt is moderate, amounting to about 15% of GDP or 113% of exports of goods and services in 2015. External vulnerability seems under control.
As for internal shocks: brace yourselves.
Ludovic Subran
Chief Economist
Euler Hermes
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