Itaú BBA - Political uncertainty remains high

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Political uncertainty remains high

July 3, 2017

High political uncertainty contributes to postpone discussions about the pension reform in Congress.

The Brazilian economy in June 2017

The accusations against President Michel Temer have reached the Lower House, which will hold a vote on whether or not to begin investigations. New accusations may follow. These proceedings will likely slow the process of reforms, especially pension reform. Consumer and business confidence retreated in June, a sign that political uncertainty will negatively affect economic activity. Inflation continues to decline, and the Central Bank continues to cur rates. The National Monetary Council (CMN) established inflation targets of 4.25% for 2019, and 4.0% for 2020 (currently at 4.5%).

Accusations against President Temer reach the Lower House

The accusations will be sent to the Lower House, which will require at least 342 votes (two thirds) to authorize the start of procedures against the president. If authorized in the Lower House, accusations will be sent to the Supreme Court (STF). There is the possibility that new accusations will be submitted by the Attorney General. This process will likely slow down discussion of reforms, especially pension reform, which is essential to reestablishing fiscal balance.

Labor reform being discussed in Senate 

After being rejected in the Senate’s Social Affairs Committee, the labor reform text was approved in the Constitution and Justice Committee, with 16 votes for and 9 against. The reform changes labor laws, seeking to make the labor market more flexible. Among the main aspects are the prevalence of individual negotiations between companies and workers over what is stipulated in law, the limitation on the power of labor courts to interpret legislation, and the end of the mandatory payment of union dues. The next step will be to vote in the Senate floor, scheduled to take place over the next two weeks.

CMN sets inflation target of 4.25% for 2019 and 4.00% for 2020

Currently at 4.5%, the inflation target was set by the National Monetary Council (CMN) at 4.25% for 2019 and 4.00% for 2020, retaining the tolerance band of 1.5 p.p. above and below the target. In our view, the decision marks an important step in the process of bringing Brazil’s inflation target in line with international standards, and contributes to an environment of sustained reductions in interest rates. We believe that the decision will have no meaningful implications on current monetary policy, because inflation expectations already take into account the reduction in the target. The CMN also decided to keep the Long Term Interest Rate (TJLP) at 7% a year, in line with expectations. The decision goes into effect in the third quarter of 2017. TJLP is the BNDES benchmark lending rate.

Inflation continues to retreat

Inflation measured by the IPCA-15 was 0.16% in June. The 12-month cumulative rate retreated to 3.5%, compared with 3.8% in the previous month. This was the lowest IPCA for the month of June since 2007. The result is in line with the downward inflation trend observed in recent months, and continues to reflect the slowdown that has been widespread in its components, reinforcing the impact of still-weak activity. The main risk factors for the inflation outlook continue to be tied to the pace of reforms, especially the Social Security Reform, and necessary adjustments in the economy, which could lead to additional impacts on risk premiums and the Brazilian Real.

Confidence indicators declined in June

Confidence indicators published by the FGV showed negative results. For industrial business confidence, there was a 3.0% drop, with negative results in both outlook for the future (-3.8%) and the current situation (-2.2%). Along the same lines, consumer confidence retreated 2.3%. The drop came after an increase of 2.4% in May, and was more influenced by the component of outlook for the future (-3.1%) than the current situation (-0.6%). Confidence indicators for trade and services also retreated (3.3% for both). In our view, the result reflects the more complex political scenario, which may postpone the much-needed reforms aimed at regaining fiscal equilibrium, consequently affecting confidence and asset prices.

Unemployment retreats in May

According to the national household survey (PNAD Contínua - IBGE), the unemployment rate reached 13.3% in May, compared with 13.6% in the quarter ended in April. Using our seasonal adjustment, unemployment declined to 13.0% from 13.1%, remaining approximately stable throughout 2017. The real wage bill posted a 0.5% gain yoy, with an increase in real wages (1.8%) offsetting the 1.3% drop in the labor force.

Fiscal deficit remains high

The consolidated public sector posted a primary deficit of 30.7 billion reais in May, well below expectations. The negative surprise came mostly from 10 billion reais in advance payments of judiciary deposits (so-called “precatórios”) that were made between November and December in the past years. Thus, the consolidated primary deficit accumulated over 12 months increased to 2.5% of GDP from 2.3% in April. We believe that approval and implementation of fiscal reforms are essential to consistently reverse the trend of rising public debt.

Current account deficit remains well behaved

Current accounts posted a surplus of US$2.9 billion in May, the third monthly surplus in a row. The cumulative 12-month current account deficit narrowed to US$18.1 billion, or 1.0% of GDP. The strong surplus in the trade balance has helped keep the current account deficit at low levels. On the financial side, direct investment in the country remains resilient, thereby reducing dependence on more volatile capital flows.

Upcoming events

Focus continues to be on political events, especially the proceedings following accusations against President Michel Temer in the Lower House. Progress on labor reforms in the Senate will also be relevant.


 



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