Itaú BBA - Fiscal Scenario Deteriorates

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Fiscal Scenario Deteriorates

August 3, 2015

The government significantly reduced its primary surplus targets, and S&P lowered Brazil’s outlook from stable to negative.

The Brazilian Economy in July 2015

The government significantly reduced its primary surplus targets, and S&P lowered Brazil’s outlook from stable to negative. Brazilian assets depreciated during the month. A project for regularization of funds abroad is in the government's plans. Inflation reached 9.25%, and the Central Bank hiked the interest rate again but indicated that the hiking cycle has ended. The current account deficit receded in the first half of 2015. Business and consumer confidence remained low, and the unemployment rate is still rising. Investigations of the “Lava Jato” operation continue and have now reached the electricity sector.

The government makes a significant reduction in its primary surplus targets

The government announced a reduction in its primary surplus target to 0.15% of GDP this year (from 1.1%) and 0.7% in 2016 (from 2.0%). The reduction demonstrates the impact of the decline in economic activity on tax revenue and the difficulties involved in implementing the fiscal adjustment. The Ministry of Planning also announced that any shortcomings in the estimate of extraordinary revenues (BRL 26.4 billion) may be deducted from the fiscal target for 2015, which means that the primary surplus could reach -0.3% of GDP.

S&P lowered the outlook for Brazil's debt from stable to negative

Brazil's rating was maintained at a level above investment grade. The agency said that the revision was caused by "material changes" in the scenario since last March, when the country's outlook had been defined as "stable". Explaining its decision, S&P argued that the fiscal targets for the short term (2015 and 2016) are insufficient but that an improvement is expected in later years.

Brazilian assets depreciate substantially

The country risk measured by the 5-year CDS increased by 33 bps and ended the month at 293. The exchange rate closed the month at 3.39 reais per dollar, a depreciation of 9.4%.The Ibovespa also fell during the month: 4.2% in reais and 12.4% in dollars.

Fund regularization project in government's plans

The Brazilian government has been discussing with congress the adoption of measures to regularize undeclared funds held by Brazilians abroad. Taxes would be paid on these funds upon regularization, which would contribute to the ongoing fiscal adjustment effort andto the compensation necessary for the ICMS tax reform.

IPCA-15 reaches 9.25% in 12 months

Inflation measured by the IPCA-15 reached 0.59% in July, slightly below our forecast and the median of market expectations. With this result, the year-over-year rate reached 9.25%, the highest level since December 2003. The largest upward contributions in the month came from housing, food and beverages, personal expenses, and health and personal care.

Copom raises interest rates again and indicates that this is the last hike 

The Monetary Policy Committee of the Brazilian Central Bank (Copom) hiked the Selic rate again by 0.50 pp, to 14.25%. The decision was unanimous and came as no surprise, giventhe latest communications from members of the Copom. The unexpected aspect was in the statement accompanying the decision, clearly signaling the Copom's intent to end the hiking cycle and maintain the Selic rate at 14.25% for a prolonged period. The Copom allowed for some flexibility when it affirmed that the maintenance of the Selic rate is "necessary" for the convergence of inflation towards the target. But the economic situation remains volatile, and what is "necessary" may not be enough (if, for example, the exchange rate continues to depreciate, making it harder to hit the inflation target).

Current account deficit recedes in the first half of 2015

The current account deficit totaled USD 2.5 billion in June, slightly above our forecast (USD 2.3 billion) and the market consensus (USD 2.1 billion). The deficit was also lower than in the same month last year (USD 5.1 billion). As for financing, despite the fact that direct investment in the country was better than expected in June, both direct investment and portfolio flows continued to recede when measured year over year.

Business confidence posted a slight increase in July, and consumer confidence continues to decline

According to FGV's business survey, the indicator of business confidence increased1.5% in July. Despite the improvement in the month, the indicator remains near its record low, suggesting that industrial activity will remain weak ahead. On the consumer side, FGV's indicator posted a drop of 2.3% in the month and reached a new historical low. Plans to purchase durable goods decreased by 3.4% and stand at the lowest level since October 2005.

Unemployment rate goes up again in June 

According to IBGE, the unemployment rate reached 6.9% in June, in line with market expectations and slightly below our forecast (7.1%). Seasonally adjusted, the rate increased from 6.3% in May to 6.4% in June. The real wage bill remains weak and stands 4.1% below the level posted in the same month last year.

Lava Jatoinvestigations continue

The Lava Jato investigations have entered a new phase, with arrests, indictments and collaboration agreements. The investigations, which began in the Oil sector, have now reached the Electricity sector.

What’s Next?

The voting of fiscal adjustment measures, to be resumed after the congressional recess, will remain the focus of attention.The progress of the Lava Jato investigations is also important, especially due to its political repercussions. The election of a new attorney general will begin on August 5. A protest march is expected on August 16.



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