Brazil: Recent developments are mostly negative – BBH

Research Team at BBH, suggests that the recent developments in Brazil, both economic and political, are worth discussing as corruption is in the headlines again even as the economy remains in deep recession while the external developments are not friendly to Brazil and EM in general, and so we think further underperformance is likely for Brazil assets.

Key Quotes

“Political Outlook

Political risk has been rising.  Last month, President Temer’s top congressional liaison was implicated in an influence peddling scandal.  Government Secretary Lima resigned after former Culture Minister Calero claimed that he was pressured into authorizing a construction project that Lima had financial interest in.  Lima’s exit could potentially harm the government’s efforts to get bills passed by congress.”

“Economic Outlook

The economy remains mired in recession.  From the latest weekly central bank survey, GDP is forecast to contract -3.4% this year before recovering modestly to grow around 0.8% in 2017.  GDP contracted -2.9% y/y in Q3.  This was slightly better than expected, but it was still the tenth straight quarterly contraction.  The slower than expected pace of monetary easing (see below) means that the recovery will most likely be delayed and perhaps shallower as a result.  Some microeconomic stimulus measures will reportedly be unveiled soon.

Price pressures are still easing, with IPCA inflation rising 7.64% y/y in mid-November.  Full November data will be released Friday, and is expected to rise 7.09% y/y.  If so, this would be the lowest rate since January 2015, and suggests that the central bank will continue easing.  COPOM cut rates 25 bp to 13.75% last week, as expected.  However, it offered hints that the cuts could be accelerated.  COPOM next meets January 11, and we see some potential for a 50 bp cut then.  However, much will depend on the exchange rate and external developments. 

Fiscal policy has been tightened, but recession continues to hurt revenues.  October data was boosted by the one-off impact from the tax amnesty program.  As such, we believe that the November and December data will revert to the worsening trend.  Consensus forecasts see the budget deficit coming in around -9% of GDP in both 2016 and 2017, up from -8.2% in 2015.”

“Investment Outlook

The real has generally outperformed this year after a poor 2015.  In 2015, BRL lost -33% vs. USD.  This was ahead of only the worst performer ARS (-35%).  So far this year, BRL is up 15% YTD and is lagging only the best performer RUB (+16%).  Our EM FX model shows the real to have WEAK fundamentals, so this year’s outperformance can be viewed as unwarranted.

Despite the recent bounce, USD/BRL has not yet surpassed the minimal 38% retracement target from this year’s drop near 3.51.  The 50% and 62% objectives come in near 3.64 and 3.76, respectively.  The central bank should continue to adjust its FX swaps program as needed to help manage the currency.

Our own sovereign ratings model shows Brazil to be correctly rated by all three agencies at BB/Ba2/BB.  Fitch retained its negative outlook on Brazil last month, and both S&P and Moody’s also have negative outlooks from earlier this year.  For now, we do not think further downgrades are warranted.”