Itaú BBA - Lower House Approves Spending Cap

Brazil Review

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Lower House Approves Spending Cap

noviembre 1, 2016

The Lower House approved the measure by a wide majority: 366 votes in the first round of voting and 359 in the second.

The Brazilian economy in October 2016

The constitutional amendment instituting a spending cap has been approved by a wide majority in Lower House, and will now be taken up by the Senate. Municipal elections yielded positive results for the PMDB and PSDB parties, but also increased party fragmentation. The central bank began a cycle of interest rate cuts, delivering a 0.25-pp cut to the Selic benchmark rate. Economic activity disappointed in the third quarter, and the labor market remained markedly weak. October IPCA-15 inflation surprised to the downside. The current account deficit continued to narrow, but the primary fiscal deficit is still rising. Repatriated assets yielded BRL 50.9 billion in revenues from taxes and fines for the government.

Lower house approves spending cap, which now moves on to the Senate

The Lower House approved Constitutional Amendment no 241, which sets a cap on public spending growth, by a wide majority (366 votes in the first round of voting and 359 in the second, well above the 308 votes, or three-fifths majority, needed for approval). The bill now moves on to the Senate, where it will be analyzed by the Constitutional Committee before being brought to the Senate floor for two rounds of voting. Based on the Senate’s timetable, the voting should be concluded by around December 13. The second major fiscal reform planned by the government, the Social Security reform, has yet to be submitted to Congress.

Municipal elections benefited the PMDB and PSDB, but also increased party fragmentation. 

Municipal election results mainly favored the PMDB, which continues to run the largest number of cities in  Brazil (1,036, or 19% of all the country’s cities) and the PSDB, which now governs the largest share of the population (48.7 million people). The PT now governs 254 cities, 61% fewer than in 2012. Fragmentation has also increased, with 31 of 35 parties having at least one mayoral candidate elected this year. For the first time, a PRB candidate was elected mayor in a state capital (Rio de Janeiro). Smaller parties, such as the PMN and PHS, won mayoral elections in the cities of Curitiba and Belo Horizonte, respectively.

Central bank starts the cycle of interest rate cuts

At its October meeting, the central bank’s monetary policy committee (Copom) cut interest rates by 0.25 pp, bringing the Selic rate to 14.0%. The minutes released after the meeting statement show that the authorities intend to further trim the Selic rate, in what they describe as a “gradual and moderate” process. The committee expressed its concern about slower-than-expected services disinflation, which suggests a more cautious stance towards monetary policy. While the statement indicates that, for the time being, the Copom would prefer to make cuts of 0.25 pp per meeting, we believe that the data and news are likely to evolve sufficiently to allow for a 0.50-pp cut in November.

Economic activity disappoints in the third quarter…

Data on economic activity came in worse than expected, with some sectors of the economy handing back the growth they had achieved in recent months. Retail sales retreated in August, both in the core measure (‑0.6% month over month) and in the broad measure (-2.0%), which includes vehicles and building materials. The IBGE’s Monthly Service Sector Survey revealed a service sector contraction of 1.6%, and industrial production grew by 0.5% in September, insufficient to offset the 3.5% drop in August. Industrial business confidence fell by 1.8% in October. Despite this, we continue to forecast an economic recovery ahead.

...and the labor market remained weak

In September the job market registered a net loss of 39,000 formal jobs, or -117,000 jobs after a seasonal adjustment. The unemployment rate rose to 11.9% in October from 11.7% in September. The average real wage is 1.7% lower than one year ago, and wages for new hires continue to fall faster than wages previously earned by those recently laid-off.

October IPCA-15 comes in lower than expected

The IPCA-15 rose by 0.19% in October, falling short of market expectations (+0.21%). The last-12-month rate has now fallen to 8.3%, after hitting 8.8% in September. The main downside surprise this month came from industrial prices, which retreated by 0.05% (compared with our forecast of a 0.17% increase). The average of core inflation measures rose by 0.32%, less than we forecasted (+0.41%). However, services inflation rose by 0.46%, slightly higher than our forecast of a 0.44% increase.

The current account continues to adjust…

The current account deficit for September (USD 465 million) was lower than expected, as the income account deficit was smaller. The cumulative 12-month deficit was USD 23.3 billion, or 1.3% of GDP (compared with 4.1% one year ago). Direct investment in Brazil totaled USD 5.2 billion in September, or a cumulative USD 73 billion for the last 12 months.

…but the primary deficit continues to rise.

In September, the consolidated public sector recorded a cumulative 12-month primary deficit of BRL 188.3 billion (3.1% of GDP), with a nominal deficit of BRL 576.8 billion (9.4% of GDP). Federal government tax revenues remain weak, down 8.3% year over year in real terms. Regional governments, which have been reporting better-than-expected figures recently, recorded a primary surplus of BRL 298 million for the month. Public debt rose from 70.2% to 70.7% of GDP.

Repatriation program concluded

The government raised BRL 50.9 billion in taxes and fines via the repatriation of undeclared foreign assets. This is the result of BRL 169.9 billion regularized abroad after the Special Regime for Foreign Exchange and Tax Disclosure, also known as the Repatriation Act, went into effect. Twenty-five thousand individuals and a little over one hundred firms took advantage of the program.

Asset prices continue to rise

The Ibovespa gained 11.2% in BRL and 13.6% in USD, while country risk, as measured by five-year sovereign CDS, fell by 1 pp to end the month at 274 bps. The BRL appreciated 2.1% to BRL 3.18 per U.S. dollar.

Upcoming events

All eyes remain on the fiscal reform agenda, particularly the progress of the spending cap amendment through the Senate and the Social Security reform proposal, which may be submitted to Congress in November. In the monetary policy realm, the highlight will be the Copom’s November 30 meeting, at which we expect the central bank to cut interest rates by 0.50 pp.


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