Itaú BBA - Central Bank signals sharper interest rate cuts ahead

Brazil Review

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Central Bank signals sharper interest rate cuts ahead

abril 3, 2017

The monetary authority indicates the possibility of a “moderate” acceleration in the pace of monetary easing.

The Brazilian economy in March 2017

The Central bank indicated that the ongoing scenario and more widespread disinflation increase the chance of a “moderate” acceleration in the pace of monetary easing. The Social Security reform’s rapporteur signaled that some items in the government’s original proposal may undergo changes. The government announced BRL 42 billion in spending cuts to achieve its 2017 fiscal target. The National Monetary Committee cut the Long Term Interest Rate (TJLP) to 7% from 7.5%, but announced reforms that will see the TJLP float in line with market-based rates from 2018 onwards. Gross Domestic Product fell again in the fourth quarter of 2016, but there are signs of a recovery this year.

BCB signals faster pace of rate cuts

The Central Bank’s first quarter Inflation Report (IR) indicates that the ongoing scenario and a backdrop of more widespread disinflation have increased the chance of a “moderate” acceleration in the pace of monetary easing. 2017 inflation forecasts are below target in all four scenarios the Bank presented. Forecasts for 2018, which are increasingly gaining importance in Copom discussions, are on or slightly under target in the scenarios incorporating market interest rate expectations. In our view, this is one of the report’s key messages: an easing cycle that brings interest rates into line with the market scenario (specifically, 9.0% at the end of 2017 and 8.5% at the end of 2018 at the time the IR was published) is not inconsistent with achieving the inflation target. As such, we continue to expect a one percentage point cut in the Selic benchmark rate at the upcoming Copom meeting in April.

Social Security reform rapporteur moots changes to original bill

Arthur Maia, rapporteur for the Social Security reform currently being debated by Congress, has signaled that some items in the government’s original reform proposal may undergo changes. Some of the most debated issues are rural workers’ pensions, transitional rules, non-cumulative pension rules, social welfare benefits for the elderly and disabled (BPC) and special pensions. An important albeit undefined issue is whether state and municipal government employees will be excluded from the Social Security reform. Their exclusion would have no impact on the federal government’s accounts, but it would undermine one of the reform’s main points, which is to create a universal regime that encompasses all Brazilians. One possibility currently being evaluated would be to include an amendment in the reform bill creating a 6-month grace period for state and municipal governments to implement the reforms in their own social security regimes. The rapporteur is expected to release his report sometime in April, with the Lower House taking its first vote on the bill before the end of the first semester.

Government announces BRL 42 billion in spending cuts

The government’s need to find BRL 58 billion to achieve its primary result target in 2017 (a BRL 139 billion deficit) led to an announcement of BRL 42 billion in spending cuts.  Apart from cutting spending, the government added BRL 10 billion in revenues from four hydroelectric plant actions, BRL 5 billion from rolling back payroll tax breaks in various sectors of the economy and BRL 1 billion it expects to raise by ending the IOF tax exemption for credit cooperatives. The decision to roll back payroll tax breaks will not affect more labor-intensive areas of the economy (public transport, civil construction and communications) and a provisional measure will be sent to Congress, though it will respect the 90-day period before it has an effect on revenues. On the other hand, the IOF increase can be implemented by decree and will impact revenuesimmediately. According to the announcement, the spending cuts may be reduced by up to BRL 8.7 billion over the coming months if the government obtains favorable court rulings on extraordinary revenues.

National Monetary Council cuts TJLP to 7%, but announces reforms to reduce subsidized credit

The National Monetary Committee decided to reduce the Long Term Interest Rate (Taxa de Juros de Longo Prazo - TJLP) to 7.0% from 7.5%, and the new rate will apply throughout the second quarter of 2017. The decision to cut the TJLP, the benchmark rate for BNDES loans over the coming quarter, was accompanied by an announcement that the way the rate is calculated is set to change; in the future, it will be pegged on a monthly basis on the yields paid by five-year government NTN-B bonds. The TJLP will continue to exist in its current form for the outstanding stock of loans and for new loans issued up to the end of 2017. The new rate will be called the “TLP” and will be valid for new loans starting on January 1, 2018. The TLP will start out at the same rate as the TJLP and will gradually converge to NTN-B market rates on a linear basis over a five-year period.

Federal Police reveal operation to investigate illegal meat sales

The Federal Police revealed an operation to combat illicit meat sales as part of efforts to dismantle a criminal organization involving federal agriculture inspectors and agribusiness executives. The announcement grabbed the media spotlight in Brazil and abroad, with several countries that are major consumers of Brazilian meat temporarily closing their borders to Brazilian protein imports. However, most of these countries suspended these embargoes within a few days, which abated the crisis.

GDP retreats 3.6% in 2016, but there are signs of a recovery this year

Gross Domestic Product fell again in the fourth quarter of 2016: down -0.9% vis-à-vis the previous quarter with a widespread drop in domestic demand. On the supply side, industry and services retreated, while agriculture grew 1.0% over the quarter. GDP shrank 3.6% in 2016. More recent indicators suggest a moderate recovery in activity. Overall, confidence indicators rose in March, particularly consumer confidence (4.3%) and industrial confidence (3.3%). Industrial output remained practically stable in January in the monthly comparison, however coincident industrial indicators already released for February (vehicle production, heavy vehicle traffic on roads, paper cardboard dispatches, etc.) indicate the economy grew during the month. Service sector (PMS) and retail (PMC) surveys posted negative results, but the outcome may have been affected by methodological changes in the series.

Unemployment remains high

In February, the national unemployment rate rose to 13.2%. Based on our seasonal adjustment, unemployment rose to 13.1% from 13.0%. Formal job creation figures have improved in recent months but remain in negative territory, suggesting that unemployment will continue to rise as we move forward.

Inflation consolidates its downward trend 

In March, IPCA-15 inflation was 0.15%, in line with expectations. According to the IBGE, this was the lowest March figure since 2009. The 12-month rate therefore fell to 4.73%, after hitting 5.02% in February. The breakdown of inflation remains benign, with various components retreating, including service prices.

Fiscal deficit remains high

The consolidated public sector registered a primary deficit of BRL 23.5 billion in February. The rolling 12-month primary deficit remains high (2.3% of GDP) as does the nominal deficit (8.5% of GDP). As a result, gross public debt rose 0.6 p.p. to 70.6% of GDP. These figures underline the need for reforms to control the rising trend in public expenditure.

The current account deficit remains stable

The current account deficit totaled USD 935 million in February. This means the rolling 12-month deficit shrank to USD 22.8 billion or 1.2% of GDP. Direct investment in Brazil totaled USD 5.3 billion in February, again exceeding expectations and still financing the current account deficit with ease.

Asset prices deteriorate in March

In March, the Ibovespa lost 4.6% in dollars and 2.5% in BRL while country risk, measured by the 5-year sovereign CDS, increased 2 bps to end of the month at 226 bps. The exchange rate depreciated to 3.17 BRL per dollar.

Upcoming events

The Social Security reform rapporteur is set to publish his report to the Lower House’s Special Committee in April. The Superior Electoral Court (TSE) will begin hearing the case involving the Dilma-Temer presidential ticket on Tuesday of this week. The Central Bank’s Monetary Policy Committee will meet on April 11 and 12 to decide the Selic rate of interest.


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