Itaú BBA - Social Security Reform vote is postponed to 2018

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Social Security Reform vote is postponed to 2018

January 2, 2018

The government intends to have the main floor of the House vote on the pension reform proposal on February 19.

The Brazilian economy in December 2017

According to Lower House Speaker Rodrigo Maia (DEM-Rio de Janeiro), the government intends to have the social security reform proposal voted on February 19. The original plan was to hold the vote in late 2017, but lack of support caused the delay to early 2018. The Central Bank’s Monetary Policy Committee (Copom) cut the benchmark Selic interest rate by 50bps to 7.0% p.a., the lowest on record. The National Monetary Council (CMN) reduced long-term interest rate TJLP to 6.75% from 7.00%. The unemployment rate dropped to 12.0% in November. Tax revenues in November reached 121.1 billion reais, showing strong real annual growth (9.5%).

Pension reform vote is delayed to 2018

According to Lower House Speaker Rodrigo Maia (DEM-Rio de Janeiro), the government intends to have the social security reform proposal voted on February 19, the week following Carnival festivities. Official discussions on the matter are planned to start on February 5. Without the reform, the government is less likely to comply with the constitutional spending cap after 2019, jeopardizing the gradual return to primary budget surpluses that would be compatible with public debt stabilization. Maintaining the currently-unsustainable path of public debt increases uncertainties about the consistency of the economic recovery and historically-low interest rates.

Central Bank lowers the Selic rate to 7.0% p.a.

The Copom delivered the widely expected outcome, a 50bps rate cut, taking the Selic to 7.0%, an unprecedented low. The committee signaled, quite clearly, that unless the economy surprises in a major way it will cut the Selic by 25bps, to 6.75% in its next policy meeting, in February. For now we stick with the view that the Copom will reduce the Selic to 6.5%, in two 25-bp moves, in February and March, rather than in a single 50bp-move. But we reckon that absence of progress on the fiscal adjustment and reform agenda would make the second 25bp-cut less likely, and hence increase the likelihood that the cycle ends with the Selic at 6.75%. The minutes of the December meeting signaled that the committee may be somewhat uncomfortable with the pace of convergence of inflation towards the target (from below) and stressed the importance of progress on the reforms and adjustments front in order to limit inflation risks and consolidate the environment for lower interest rates. Finally, forecasts presented in the Central Bank’s 4Q17 Inflation Report are consistent with our call that the cycle will end in 1Q18.

CMN lowers the TJLP to 6.75%

The National Monetary Council (CMN) reduced long-term interest rate TJLP to 6.75% from 7.00% in a decision that will be valid for 1Q18. Importantly, the TJLP will exist as long as there are outstanding loans granted at this rate, and the CMN will continue to set its value on a quarterly  basis. According to the bill approved by Congress, the new long-term interest rate TLP (formed by a fixed rate plus the change in consumer price index IPCA), which will replace the TJLP, will apply only to new contracts starting on January 1, 2018.

Activity indicators weaker in October 

Retail sales fell 0.9% in seasonally-adjusted terms in October and disappointed expectations. Weakness was widespread among components, and contradicted other coincident indicators for the month. We expect retail sales to resume an upward trend in the coming months, driven by lower interest rates, lower debt levels among households and gradual improvement in the labor market. Industrial production expanded 0.2% in October, sustaining a gradual rebound.

Unemployment declines again in November

According to the national household survey (PNAD Contínua - IBGE), Brazil’s nation-wide unemployment rate fell to 12.0% in the quarter ended in November from 12.2% in the quarter ended in October. Using our seasonal adjustment, unemployment slid 0.1 p.p. to 12.5%. Informal jobs are still the major driver of the decline in unemployment. By the end of 2018, we forecast that the unemployment rate will be at 11.8%, with a higher contribution from formal jobs. Finally, the real wage bill increased 4.5% in the annual comparison, benefited by the increase in real wages.

Inflation remains at low levels and shows a favorable composition

According to census bureau IBGE, the mid-month consumer price index IPCA-15 climbed 0.35% in December, in line with expectations. The index ended the year up by 2.94%, down substantially from 6.58% in 2016. Our preliminary forecast for the headline IPCA in December is around 0.30%. For the full year, we expect the IPCA to rise 2.80%, down from 6.29% last year. For 2018, we expect inflation to reach 3.8%.

Federal tax revenues continue to pick up

Tax revenues in November topped expectations, at 121.1 billion reais, rising sharply by 9.5% year-over-year in real terms. The recovery in revenues was widespread among components, with gains in consumer-dependent revenues (PIS/COFINS, IPI) and wage-related revenues (IRPF and social security taxes).

Small primary budget deficit in November 

The consolidated public sector posted a small primary deficit of 0.9 billion reais in November, performing better than our forecast (-5.3 billion) and market consensus (-6.0 billion). The consolidated primary deficit accumulated over 12 months reached 2.3% of GDP. The central government’s result, as published by the National Treasury, was a surplus of 1.3 billion reais (our estimate: -3.8 billion; Central Bank methodology: -0.4 billion). The surprise was caused by lower discretionary expenses, which were not yet affected by the 25 billion reais freed up since September. Hence, this line of spending is expected to accelerate sharply in December and the primary budget result will probably be a very large deficit. In November, regional governments and state-owned companies posted a deficit of 0.8 billion and a surplus of 0.2 billion reais, respectively (while we anticipated zero and a surplus of 0.2 billion). With positive surprises in terms of recurring and extraordinary revenues, mandatory expenses below the budget, and better results from regional governments and state-owned enterprises, the primary result for 2017 will be at least 15 billion reais (0.25% of GDP) better than the target of 162 billion reais (-2.5% of GDP) set for the consolidated public sector.

Current account has a deficit of $2.4 billion in November

The current account had a deficit of $2.4 billion in November, which was wider than expectations. Equipment rentals and other services were behind the surprise. The current account deficit is set to end 2017 at a low level, supported by the good performance of the trade balance, but the service and income deficit expanded during the year. For the next years, we maintain our expectation of a gradual increase in the current account deficit, in line with the rebound in economic activity, but not to the point of compromising Brazil’s external sustainability.

Financial assets

In December, the Ibovespa rose 4.6% in dollars and 6.2% in local currency. Country risk measured by the five-year CDS decreased and ended the month at 163 bps. The exchange rate depreciated to BRL 3.31 per dollar.

What’s next

The focus will be again on news related to the 2018 presidential election, as the trial of former President Luiz Inácio Lula da Silva in the 4th Region’s Federal Regional Court  (TRF4) is scheduled for January 24. Headlines on the pension reform will also be important, as the vote is set to take place in February.

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