Itaú BBA - Fiscal Challenge in Brazil

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Fiscal Challenge in Brazil

October 1, 2015

Government announced new fiscal package to achieve a primary surplus target in 2016. Congressional Approval could be challenging.

The Brazilian Economy in September 2015

Standard & Poor's removed Brazil's investment grade status. Afterwards, the government launched a new fiscal package, but congressional approval will be a challenge. The markets registered significant volatility, and the Central Bank resumed intervention. The Copom maintained the Selic rate unchanged at 14.25% and the National Monetary Council raised the TJLP to 7%. Inflation stood at 9.6% in September. The current account deficit continued to decline. Both business and consumer confidence remained low and the unemployment rate rose again.

Brazil Loses Investment Grade Rating by S&P

Standard & Poor's downgraded Brazil's sovereign credit rating from BBB- to BB+ and maintained the negative outlook. The new rating means that the country no longer has the investment grade status that it achieved in 2008. S&P cited the increasing political challenges and argued that the budget proposal sent to Congress is incompatible with the fiscal adjustment signaled earlier. Moody's and Fitch have maintained the country’s investment grade status.

New Fiscal Package Includes the Return of the CPMF Tax, but Congressional Approval Could be Challenging

Following the downgrade by S&P, the government announced a package of fiscal adjustment measures to achieve a primary surplus target of 0.7% of GDP in 2016, after announcing a budget deficit of 0.34% of GDP. The main measure is the return of the CPMF tax (at a 0.20% rate), through which the government expects to raise BRL 32 billion. On the expenditure front, the highlight is the postponement of the adjustment of civil servant salaries from January to August 2016. The government estimates that the proposed measures would result in a BRL 72 billion adjustment (1.2% of GDP), of which BRL 46 billion corresponds to tax increases and BRL 26 billion to spending cuts. The announcement demonstrates an effort to improve the fiscal situation, but it carries an implementation risk. Most of the measures (80% of the fiscal improvement) require congressional approval.

Markets Register Significant Volatility

The BRL depreciated 8.9% in September, to close at 3.97 reais per dollar. There was high volatility throughout the month, with the exchange rate peaking at 4.25 per dollar on September 24. The country risk – measured by the 5-year CDS – increased by 126bps and ended the month at 476. The Ibovespa dropped 3.4% in BRL and 11.3% in USD.

Central Bank Resumes Intervention

The BCB intervened in the market through the offering of net credit lines in USD and foreign exchange swaps. Central Bank Governor Alexandre Tombini stated that "all instruments are within the BCB's range of action, if necessary." The National Treasury also repurchased government bonds in the local market.

Copom: Flat Interest Rate, Exchange Rate Remains a Risk

The Monetary Policy Committee of the Brazilian Central Bank (Copom) maintained the Selic rate unchanged at 14.25%. According to the monetary policy documents (statement, minutes and inflation report), the Copom signaled its intention to maintain the Selic rate unchanged for an extended period. However, there is risk of new interest rate hikes if the exchange-rate depreciation significantly affects inflation expectations. 

TJLP Raised to 7%

The National Monetary Council (CMN) raised the long-term interest rate (TJLP), which is used as a base for most BNDES loans, from 6.5% to 7%. The hike (the fourth this year) is part of a set of economic adjustments proposed by the country’s economic team.

Inflation at 9.6% in September

The IPCA-15 rose 0.39% in September, slightly below our estimate and near median market expectations. The surprise was driven by the price of food consumed at home, which declined slightly more than expected. The year-over-year inflation rate remained at 9.6%.

Current Account Deficit Continues to Decline

The current account deficit receded again, to USD 84.5 billion (4.3% of GDP) over the 12-month period ending in August, compared with USD 103.6 billion at the end of 2014 (4.4 % of GDP). Direct investment in the country also fell in the period, to USD 73.6 billion (3.8% of GDP), compared with USD 96.9 billion (4.1% of GDP) in 2014.

Industry and Consumer Confidence Remain Low

Business confidence in the industry dropped 2.9% in September, according to the FGV Business Survey. The consumer confidence indicator also receded by 5.3%, reaching a record low.

Another Rise in Unemployment

The unemployment rate reached 7.6% in August. According to our seasonal adjustment, the unemployment rate rose from 7.2% in July to 7.4% in August, marking an eighth consecutive increase. The deterioration in the labor market was also reflected in wages, which posted a 5.2% year-over-year decline.

What’s Next?

The Brazilian Audit Court (TCU) may announce its decision in the fiscal accounts trial of President Dilma Rousseff's administration. The performance of financial asset prices, following the significant volatility in September, will also be in the spotlight.


 



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