Itaú BBA - Further downgrades

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Further downgrades

March 1, 2016

Brazil’s credit rating was again downgraded by the rating agencies

The Brazilian economy in February 2016

Brazil’s credit rating was again downgraded by the rating agencies and is now two notches below investment grade. Public finances continued to deteriorate. Operation Car Wash reached its 23rd phase, during which the marketing strategist behind the 2014 presidential campaign was arrested. Concerns grew about the transmission of the Zika virus.  The economy remained in recession, as retail sales fell and the labor market weakened.  Inflation indices remained high, but service and regulated prices signaled a deceleration ahead.  The adjustment to external accounts has accelerated as the current account deficit shrank faster.  The senate has approved a law that reduces Petrobras’ mandatory involvement in pre-salt oil exploration, but the bill has yet to receive congressional approval.  

Brazil downgraded by ratings agencies

Brazil has once again been downgraded by both Standard and Poor’s and Moody’s. S&P cut Brazil’s rating one notch, from BB+ to BB with a negative outlook.  Moody’s downgraded Brazil by two notches, to Ba2, also with a negative outlook.  According to both agencies, Brazil is now two steps down from investment grade.

Public accounts continue to deteriorate, despite better January results

In January, the primary consolidated result registered a surplus of BRL 27.9 billion, well above the consensus figure of BRL 18.4 billion. However, this positive surprise was mainly the result of temporary factors, such as a change in the method used to book interest rate equalization expenditures. The cumulative 12-month primary deficit stood at 1.8% of GDP, slightly lower than the previous month (1.9% of GDP).  The nominal deficit continues to trend upward, rising from 10.3% to 10.8% of GDP, alongside gross debt, which climbed from 66.2% to 67.0% of GDP. 

Operation Car Wash reaches its 23rd phase, and the marketing strategist behind the 2014 presidential campaign is arrested

Investigators continue to look at possible illegalities in relationships between the government (current and former) and private companies hired by state-run corporations.  The police have arrested the head marketing strategist and his wife as investigations focus on 2014 campaign finances. 

Concerns over the Zika virus escalate

The number of microcephaly cases continues to rise, along with public alarm over the disease, which could be linked to the Zika virus transmitted by the Aedes Aegypti mosquito.  

Retail sales contracted significantly in 2015

Retail sales slumped in December based on either the core (-2.7%) or broad (-0.9%) measure, which includes vehicles and building materials.  This sharp drop came after a surprisingly positive November as people brought forward their Christmas shopping.  The figures reflect a wider weakness, as six of the eight core retail sales segments stumbled. Core retail sales fell 4.3% in 2015, or 8.6% based on the broader measure.

The labor market continues to weaken

According to CAGED figures, 100 thousand formal jobs were eliminated in January, or 90 thousand stripping out seasonal effects.  Unemployment, measured using the Monthly Employment Survey (Pesquisa Mensal de Emprego - PME), fell back during the month (from 8.1% to 7.8% using seasonally-adjusted figures), but this was driven by a reduction in the participation rate, which hit its lowest level since 2002. Wages continue to fall.

IPCA-15 was 10.8% for the 12 months through February, but services have slowed down

The IPCA-15 rose 1.42% in February, ahead of market expectations.  This means a 12-month rate of 10.84%, 0.10 percentage points higher than January. January inflation came under greater pressure from food, transport and education.  However, service inflation is starting to show signs of losing steam.  

Government announces green flag for electricity

The Ministry of Mines and Energy announced there will be no extra charges for electricity in April, having shut down its thermal power plants.   Additional charges were avoided because of greater-than-expected rainfall recently.  Under the tariff flag system, the flag will now change from yellow to green.  The ministry pointed out that additional charges will be made if thermoelectric plants are brought back online.  Our calculations show that the green flag will have the effect of reducing the April IPCA by 0.11 pp.

Current account deficit continues to retreat

January saw a current account deficit of USD 4.8 billion, which was below our expectations and the market consensus.  This means the rolling 12-month deficit has again shrunk (to USD 52 billion, or 2.9% of GDP).   The biggest surprise came in the Service sector, which recorded a significant drop in international travel expenditure.  Elsewhere, direct investment in Brazil totaled USD 5.5 billion, bringing the 12-month total to USD 75 billion (4.3% of GDP).  January figures confirm the external account adjustment that has been continuing since last year. 

Senate approves pre-salt bill

The senate has approved a bill exempting Petrobras from acting as sole operator with a minimum 30% stake in pre-salt oil exploration areas.  The bill is now up for vote in the lower house. 

Markets improve in February

Assets prices were largely better. The BRL gained 1.6%, closing the month at BRL/USD 3.98, the CDS-measured 5-year country risk fell 13 bps to 460 bps and the Ibovespa gained 5.9% in BRL and 7.6% on a dollar basis. 

What’s Next?

The focus is now on the March 2 Copom meeting.  We expect the benchmark Selic rate to remain steady, at 14.25%, in line with recent remarks from committee members. The IBGE publishes fourth-quarter GDP for 2015 on March 3, which we expect to slide 1.8% against the third quarter.  In political news, Brazil’s Supreme Court is expected to rule on the impeachment process, the PMDB will elect a new chairman, and anti-government protests are set to continue (scheduled for March 13).



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