Brazil improving, but Olympian feat required to reclaim investment grade

By:
Jeremy Weltman
Published on:

A cyclical recovery is under way yet huge fiscal problems remain, and whether progress is sustained depends on structural reforms, risk experts caution.

Rio Olympics finish line-R-600

On track: but Brazil needs to up its game to win back its investment grade

One of the worst-20 performers in Euromoney’s country risk survey for the past five years, Brazil’s investor appeal has become tarnished by its economic and political woes.

Falling precipitously from 37th in the global risk rankings to 59th, the nation reverted from a promising prospect, outshining Mexico, to one that justifiably lost its investment grade:

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Reeling from poor governance and the commodity crunch, the economy contracted severely, heading into a downturn in 2014 with GDP posting a real-terms decline of 3.8% last year, and a further 3% to 4% drop pencilled in for 2016.

Political problems continue, with more corruption investigations pending, tensions are rising with unemployment sky-high, and crucially there is a lack of faith in the new government’s ability to execute structural reforms.

Scores for all of Brazil’s economic indicators have fallen sharply since this time last year, with the economic-GNP outlook and government finances indicators sliding below half of the 10 points available.

Political factors, such as government stability and institutional risk, are similarly marked down, along with all four structural indicators.

Positively, the current account is improving, and FX reserves have stabilized. Business confidence is returning, with industrial production growing, and inflation now falling.

New administration

Confidence in the new Temer administration is building with the pursuit of a more orthodox economic policy line and an ally, Rodrigo Maia, installed as parliamentary speaker.

Yet the fiscal deficit is large and deteriorating, with sovereign liabilities continuing to rise.

Five-year CDS spreads have tightened, but are still around 250 basis points, worse than for Russia, South Africa and Turkey.

Research from BBVA economists taking part in Euromoney’s survey predict a 10% of GDP fiscal deficit for 2016/17, with public debt rising to 78% of GDP in 2018, and 88% by 2020, from 52% at the end of 2013.

The new administration plans to keep public spending unchanged in real terms for the next 20 years, but it is not clear whether the government will obtain parliamentary approval.

"Even if it does, its implementation will require a social security reform and/or a reduction in the degree of rigidity of expenditure, which are not straightforward," claims the BBVA research team.

"[Besides], an approval of the expenditure ceiling would not guarantee the debt stabilization in the short and medium terms. That would require further measures such as tax hikes."

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Marijke Zewuster,
ABN Amro

Marijke Zewuster, head of emerging markets at ABN Amro, expects the recession to bottom out, with a gradual recovery taking place in 2017 and investment picking up when the Senate concludes the impeachment process against former president Dilma Rousseff.

However, improving the fiscal situation and implementing structural reforms are crucial, she believes, adding: "The main domestic downside risks to this scenario are the annulment of the impeachment, further developments in the Lava Jato corruption probe – such as allegations against people close to president [Michel] Temer – and political polarization in general."

Brazil is finally recovering. Its country risk score is stabilizing. However, it’s a long road back for a borrower with enormous problems to address when the feel-good factor of the Games fades.

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