Brazil: recovery consolidating, fiscal policy continues to be the main risk for the economy - Rabobank

Analysts from Rabobank, look for the USD/BRL to be at 3.30 for end-2018, with the depreciation led by less fancy global liquidity conditions and if the winner of the October presidential elections is a pro-reform candidate. 

Key Quotes: 

“Past the worst recession in decades, the (gradual) recovery is consolidating and spreading across the sectors. Inflation and interest rates have fallen to historical lows. Balance of payments remains solid (yet with some cyclical help).”

“Fiscal policy continues to be the Achilles heels of the Brazilian economy. Despite a cyclical improvement in the budget performance (as faster activity gears up tax collection and discretionary spending remains under lid), the “time bomb” of mandatory expenses has not been dismantled. Quite the opposite, as the pension reform was pushed back to (at least) after the election. Without a comprehensive overhauling of constitutional spending rules – especially via deep changes in Brazil’s overly generous social security system – government debt will not stabilize (even in the long run) and the economy will be (at some point) dragged back into recession, with inflation, interest rate and FX expected to jump through the roof in time.”

“The urgent necessity to finish off the set of budgetary reforms started in the current administration (even better if those are complemented with other macro and micro adjustments) make this year’s general election a critical one for the Brazilian economy.”

“The election outlook still looks very uncertain, and the execution of key reforms is far from a done deal for any electoral scenario. The results will (definitely) matter.”

“We assume positive developments ahead, with the next government keeping (and delivering on) the commitment to pass reforms and keep a sound economic policy. Taking this key element for granted (at least for now), we see inflation and rates taking longer than expected to normalize to a new, lower equilibrium (given the huge
economic slacks), a cyclical GDP acceleration taking a bit longer than expected to materialize (as uncertainties fade), as well as a long, painful but well succeeded fiscal consolidation process. With no domestic stress expected, we look for a BRL repricing ahead, but only reflecting the less fancy global liquidity conditions.”

“The BRL has posted a nearly zero year-to-date gain in late March (standing just above 3.30/USD), lagging slightly peer-currencies (commodity FX up 1%). We look for FX rate at 3.30 for end-2018, with the depreciation led mostly by less fancy global liquidity conditions, in spite of our expectation of pro-reform outcome in October elections. Overall, financial markets have had a constructive stance towards Brazilian assets and the maintenance of such conditions depend on the approval of fiscal reforms. While a reversal in global conditions may lead to repricing, it shall not rock the boat.”