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Political events elevate uncertainties surrounding reforms

June 1, 2017

The latest developments led ratings agencies to change Brazil’s sovereign outlook to negative.

The Brazilian economy in May 2017

Under a plea bargain agreement in the Car Wash investigations, the Federal Supreme Court (STF) released tape recordings of conversations between President Michel Temer and a private-sector businessman, which elevated uncertainties in the political realm and on the continuity of the measures of adjustment currently underway Congress. The latest developments led ratings agencies to change Brazil’s sovereign outlook to negative. The Central Bank cut the benchmark interest rate by 100bps to 10.25% p.a. and signaled a moderate slowdown in the pace of monetary easing in its next meeting. GDP grew 1.0% in 1Q17, led by agriculture. 

Political developments elevate  uncertainties surrounding reforms

Under a plea bargain agreement in the Car Wash investigations, the Federal Supreme Court (STF) released tape recordings of conversations between President Michel Temer and a private-sector businessman, in addition to videos involving other politicians. After the release, protests against the President were held in the main state capitals. These developments contributed to increase political uncertainties and, consequently, elevated uncertainties around the measures of adjustment that are currently underway in Congress, particularly the Social Security reform, which is key to comply with the constitutional spending cap and stabilize public debt. These events generated volatility in local markets. During the month, the BRL depreciated as much as 10%, reaching BRL/USD 3.41, but ended the month at 3.24. The Ibovespa stock market index fell as much as 12%, but, like the exchange rate, recovered to some extent.

Despite heightened uncertainties, some reforms advanced in Congress. The Social Security reform’s baseline text was approved by the Special Committee in the Lower House by a 23-14 vote and is now awaiting a vote in the Lower House floor. Approval will require 308 votes, or 60% of all representatives. The Senate approved the states’ fiscal recovery regime’s baseline text, concluding its process in Congress. The labor reform advanced in the Senate’s Economic Affairs Committee (after approval by the Lower House in the previous month) and is set to be voted by committee members.

Two replacements in Temer’s cabinet  

The head of development bank BNDES, Maria Silvia Bastos, issued a resignation letter to President Michel Temer, who named Paulo Rabello de Castro to replace her. The Minister of Justice was also replaced: Osmar Serraglio left and his post was filled by the former Minister of Transparency Torquato Jardim.

Ratings agencies change Brazil’s outlook to negative 

Amid recent developments that increased political uncertainties and fueled volatility in local markets, S&P and Moody’s changed their outlook for Brazil’s long-term sovereign ratings in foreign currency to negative. Both agencies mentioned risks to the fiscal reform agenda, which is essential to rebalance public accounts and restore economic growth.

Central Bank maintains the pace of rate cuts, but signals a slowdown going forward

The Central Bank’s Monetary Policy Committee (Copom) cut the Selic benchmark interest rate by 100bps to 10.25% p.a., without bias, in a unanimous decision that matched expectations. The committee signaled that a moderate reduction in the pace of monetary easing should be adequate in its next meeting. We expect the Copom to lower the Selic to 9.5% in its July 25-26 meeting, taking it to 8% by year-end. The statement following the decision made it clear that the biggest risk factor is the implementation of the reform agenda, particularly changes to the Social Security and labor legislation, and stressed the economic cost of heightened political uncertainty.

GDP expanded 1.0% in 1Q17, led by agriculture

GDP advanced 1.0% qoq/sa in 1Q17, in line with expectations.The result, which broke a sequence of eight consecutive quarters of contraction, was driven by a strong contribution from agricultural production and a favorable statistical effect from industrial production.Compared to 1Q16, GDP shrank 0.4%. Hence, the rolling 4-quarter GDP figure improved to -2.3% from -3.6%. From the demand standpoint, domestic components displayed weakness. Gross fixed capital formation retreated 1.6%, while household spending slid 0.1%. The quarterly result was positive mainly due to a substantial contribution from inventories and stronger net exports. On the supply side, agriculture climbed 13.4% and the industrial sector expanded 0.9% during the period, while the service sector was stable on the margin after eight consecutive quarters of declines.

Net job creation in April, but unemployment remains on an upward trend 

According to the Labor Ministry’s CAGED registry, 59,900 formal jobs were created in April, topping estimates. The release marks the first net job creation in for the month of April since 2014 (not seasonally adjusted), although the seasonally-adjusted reading registered a destruction of 34,000 posts. The nation-wide unemployment rate reached 13.6% in the quarter ended in April vs. 13.7% in 1Q17. Applying our seasonal adjustment, unemployment was stable at 13.2%.

Inflation continued to recede

The mid-month consumer price index IPCA-15 advanced 0.24% in May, slightly above market forecasts. Year-over-year inflation decelerated to 3.8% from 4.4% in April. According to census bureau IBGE, it was the lowest May reading since 2000. The result was in line with the falling trend of inflation seen in recent months and continues to reflect the widespread slowdown of its components, highlighting the impact of still-weak economic activity.

Public deficit remains high 

The consolidated public sector posted a primary surplus of BRL 13 billion in April, beating expectations. The positive balance for the month was driven by favorable seasonality related to oil royalties and income taxes. However, the rolling 12-month consolidated primary deficit remained at 2.3% of GDP. Approval and implementation of fiscal reforms (particularly the Social Security reform) are vital for a reversal of the upward trend in public debt.

Current account deficit in 1Q17 was the narrowest since 2007

The current account surplus totaled USD 1.2 billion in April, marking a second consecutive monthly gain. The rolling 12-month current account deficit receded to USD 19.9 billion or 1.1% of GDP. Data again confirms the ongoing adjustment in the current account, which has been taking place since last year, due to a weaker exchange rate and slower economic activity. In terms of financing, direct investment in the country has been resilient, but usually-volatile portfolio flows receded again. 

Upcoming events

On Tuesday, June 6, the Supreme Electoral Court (TSE) will resume the trial that is analyzing the request to annul the Dilma Rousseff/Michel Temer presidential ticket. The Senate’s Economic Affairs Committee may vote the labor reform, which could then proceed to the Senate floor in the same month. The Copom will release the minutes of its May meeting on Tuesday, June 6.


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