Itaú BBA - Congress prepares to vote on fiscal reforms

Brazil Scenario Review

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Congress prepares to vote on fiscal reforms

octubre 3, 2016

If approved, the measures will cause federal expenditure to decline as a percentage of GDP in the coming years.

The Brazilian economy in September 2016

The new government´s fiscal reform agenda moves forward, as Congress prepares to vote on the constitutional amendment that creates a ceiling for public expenditure. The municipal elections’ first round vote highlights a growth in municipalities run by the center-right PSDB party and a downfall of the PT´s local base. Amid forecasts of declining inflation, the Central Bank has set the stage to begin an easing cycle. August economic activity data came on the weak side, but confidence indexes kept improving, which suggests that the recovery will continue towards year-end and 2017. The unemployment rate, however, continues to rise as the labor market lags economic activity. The BRL has been relatively stable in recent weeks, while the CB continued its interventions in the currency market.

Spending cap proposal gains traction in Congress

The news flow regarding the spending cap proposal has been, overall, favorable. Most parties of the government’s allied base have declared support for the measure, which limits federal expenditure growth to the previous year’s inflation rate. Press articles report that the measure is expected to undergo only marginal changes in Congress. The Lower House is expected to vote on the matter in October. If approved, the cap will cause federal expenditure to decline as a percentage of GDP in the coming years, reversing a continuous upward trend observed since the 90s.

PMDB and PSDB lead municipal election results in 2016

The 2016 municipal elections' first round vote took place on Sunday in 5,568 cities across the country. Results show that the PMDB, president Temer´s party, retains control of the largest number of cities, 1027. Among the largest parties, PSDB presented a 15% growth in number of municipalities  won relative to the 2012 elections, and the PT party underwent the significant downfall, winning in 256 cities vs. 630 in 2012 (a 59% drop). 55 cities will undergo a second round vote in the runoff between the top two ranked candidates. Out of the 26 state capitals, 18 will go to runoffs. Among the two largest cities (São Paulo and Rio de Janeiro), only Rio de Janeiro will go to runoffs, between evangelical church-linked Marcelo Crivella (PRB) and left-winger Marcelo Freixo (PSOL). In São Paulo, João Dória (PSDB) was elected with the greater majority of votes (53.3%). Dória is the first candidate to win in first round in São Paulo since 1992.

Activity data came out weak in August…

Indicators related to industrial production, such as paper cardboard sales, traffic of heavy vehicles on toll roads, auto production, all declined in August. We thus forecast industrial production to decline 2.0% seasonally adjusted, interrupting a rising trend ongoing since March.

... but confidence continues to improve

The majority of business confidence indicators and consumer confidence continued to rise in September, indicating that the drop of economic activity in August will be temporary. The main drag to the economy in recent years was the investment decline. The rise in business confidence indicates that investment will post positive growth in the coming quarters, as the economy slowly comes out of the recession. The unemployment rate, however, is expected to continue rising (now at 11.8%) because the recent recession has not yet has its complete impact on the job market.

Central Bank inflation report sets the stage for an easing cycle

The Copom is carefully setting the stage for an easing cycle, and this communication drive saw another important step with the release of the September edition of the Quarterly Inflation Report (QIR). In two of the four scenarios that the COPOM presented, inflation forecasts for 2017 are at the 4.5% target, and in three of the four scenarios for 2018 inflation is at or below target (and is above target by just 10bps in the other one). Faced with this set of forecasts an inflation forecast targeting central bank is bound to ease the policy stance. Our call remains that the Copom cuts its base rate by 75bps this year, staring with 25bps in the October policy meeting.

Inflation falls as the food price shock fades away

The September consumer price inflation preview (IPCA-15) came at 0.23%, well below expectations (0.33%), as the shock in food prices fades away, and inflation in services, industrial goods, and regulated prices continue to decelerate. The 12-month inflation reading currently sits at 8.8%, while we expect deceleration to 7.2% by year-end and 4.8% in 2017.

Current account adjustment slows...

The current account deficit was narrower than expected in August (at USD 579 million). Nevertheless, the external adjustment continues to lose steam due to stabilization in economic activity and, to a lesser extent, to a stronger currency. For the coming years, we maintain our expectation of wider deficits than in 2016, but remaining at historically-low levels.

... while the Central Bank continues to intervene in the currency market

The Central Bank (CB) continued its currency-market interventions, offering reverse swaps. However, the CB reduced the volume of daily currency-market interventions to USD 250 million (from USD 500 million) due to a scenario of less global liquidity, as the U.S. Fed prepares for its next rate hike.

Relatively steady asset prices in September

The Ibovespa rose 0.8% in BRL and 0.5% in USD, while country risk, as measured by the five-year sovereign CDS, rose 13 bps and ended the month at 273 bps. The BRL remained relatively stable compared with August, ending the month at 3.25 BRL to the dollar.

Upcoming events

The focus will remain on the fiscal reforms under debate in Congress, particularly the constitutional amendment setting a cap on public-spending growth. The Special Committee rapporteur, Darcísio Perondi (PMDB-RS), is expected to submit his report on October 4 and the Lower House Special Commission is expected to vote on the measure on October 6 or 7. Once voted by the Committee, the measure is then voted in 2 rounds in the Lower House floor, also expected to occur in October. The government may also send a social security reform bill to Congress. On monetary policy, the focus will be the October COPOM meeting, in which the BCB is expected to begin a cycle of rate cuts.



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