Itaú BBA - Challenges Intensify

Brazil Review

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Challenges Intensify

julio 1, 2015

Key measures for the fiscal adjustment have advanced, but so have rules that increase pension spending.

The Brazilian Economy in June 2015

Key measures for the fiscal adjustment have advanced, but so have rules that increase pension spending. Inflation hit 8.80%, and the central bank indicated that the interest rate hiking cycle has not ended yet. The government’s approval rate fell to its lowest level since 1992. Unemployment continued to rise, reaching 6.7%. In May, the current account deficit was narrower than expected. The long-term interest rate (TJLP) was hiked once again, and the tolerance range around the inflation target in 2017 was reduced. A new stage in the concession program was launched.

Key measures for the fiscal adjustment have advanced...

The Lower House approved a bill reducing payroll tax cuts. The measure is relevant for the fiscal result in 2016. However, a tax hike for some industries and products — transportation, footwear, apparel, communication, call centers, meat, poultry and bread producers — was smaller than the government originally intended. Now the bill moves on to the Senate.

... but so have rules that increase pension spending

President Dilma Rousseff vetoed the alternative to the so-called “pension factor” (or formula 85/95) and sent congress a new provisional measure introducing a progressive rule through which the formula would reach 90/100 by 2022. In other words, women may retire without discounts to their benefits if the sum of their age and years of contribution totals 90; for men, the sum has to be 100. This proposal implies higher spending than under the pension factor.

Furthermore, the Lower House approved a provisional measure renewing until 2019 the rule that adjusts the monthly minimum wage, and it extended this rule to all retirees. If implemented, this measure would increase Social Security spending by about 10 billion reais per year. This proposal also moved on to the Senate.

Year-over-year change in the IPCA-15 hits 8.80%

The mid-month consumer price index IPCA-15 climbed 0.99% in June, topping the highest of market estimates. Hence, the year-over-year change reached 8.80%. The largest upward contributions came from foodstuffs, personal expenses, housing and transportation. The biggest deviations in relation to our call (0.85%) involved food consumed at home and airfares.

The central bank indicated that the interest-rate hiking cycle has not ended yet

The central bank’s Monetary Policy Committee (Copom) once again increased the Selic benchmark interest rate by 50 bps, to 13.75%. In the minutes of the meeting, the Copom restated that the balance of risks for this year is “unfavorable,” and that “efforts in the fight against inflation (...) are not yet sufficient.” In the Quarterly Inflation Report, forecasts in the reference scenario indicate 4.8% inflation by the end of 2016, still above the 4.5% target center. We expect a final 50-bp hike in the Selic rate in July, to 14.25%.

Government’s approval ratings slide again

According to a Datafolha survey carried out on June 17-18, the government’s approval rating fell from 13% in April to 10%, the lowest since September 1992. Participants were also asked about their expectations for the economy: about 77% of them think inflation will rise, while 73% anticipate higher unemployment.

Another hike in the unemployment rate 

According to census bureau IBGE, the unemployment rate reached 6.7% in May, in line with our forecast and somewhat higher than market estimates (6.6%). The seasonally-adjusted unemployment rate rose to 6.3% in May from 6.0% in April. The real wage bill declined 1.8% from the previous month, showing that the 0.3% advance in April was transitory.

Narrower-than-expected current account deficit

The current account deficit stood at USD 3.4 billion in May, much narrower than our estimate (USD 5.0 billion) and market consensus (USD 4.6 billion). The deficit over 12 months fell to USD 95.7 billion (4.4% of GDP). Financing is still comfortable, as direct investment covers 87% of the deficit. However, portfolio flows and direct investment flows over 12 months have cooled down.

CMN increases the TJLP and reduces the tolerance range for the inflation target in 2017 

The National Monetary Council (CMN) increased by 50 bps the Long-Term Interest Rate (TJLP), which is used as a benchmark for most loans granted by the state development bank, BNDES. The hike, the third this year, is part of a set of adjustments proposed by the economic team. We expect the TJLP to reach 7% this year and 8% next year. The Council also decided to keep the inflation target for 2017 at 4.5%, but the tolerance range was reduced to 150 bps from 200 bps.

Government launches a new stage in the concession program

The government’s initiative includes BRL 198.4 billion in investments, with BRL 69 billion in the period between 2015 and 2018, and BRL 129 billion from 2019 onward. There are planned concessions for highways, railroads, ports and airports. By focusing on known bottlenecks in the economy, the program aims to improve future productivity and attract foreign capital.

Risk premium on the rise

The five-year Brazilian CDS increased 24.4 bps and ended the month at 259.9 bps. The exchange rate closed the month at 3.10 reais per dollar, strengthening 2.4%. The Ibovespa benchmark stock index remained relatively stable in local currency (+0.6%), and rose 3.1% in US dollars.

What’s next?

We expect a final 50-bp hike in the Selic rate in July, to 14.25%. Discussions in congress about the fiscal adjustment are still on the radar, particularly the reduction of payroll-tax cuts, changes in pension rules and the increase in the tax applied to net income (CSLL).

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