The hole in Brazil's economy keeps getting bigger. This was not the base case scenario of any of the economists I speak with regularly here at FORBES, but the mood is shifting. Brazil is in the quick sand now, and there are very little branches around to pull these guys out.
This Wednesday, the government -- basically being led now by Finance Minister Joaquim Levy -- announced big revisions to its primary surplus targets for 2015-17. Less money is flowing into the government's coffers. Jobless claims are on the rise. Unemployment is nearly 7%. Even if Levy's lower target was expected and had been widely discussed as a possibility, the sizes of the cuts were caught people off guard. For this, the iShares
The target change raises concerns about Brazil’s short-term fiscal standing and ability, in a politically turbulent environment where vice president Michel Temer is no longer supportive of president Dilma Rousseff, to implement the needed policy changes to avoid a credit downgrade to junk this year.
The government’s new stance on the primary target clearly shows that the fiscal side has underperformed. This combination of factors bodes poorly for debt dynamics, says Nomura Securities analyst Joao Pedro Ribeiro in New York. The government sees gross debt (currently at 62.5% of GDP) rising to 66.4% by the end of next year and remaining mostly stable (66.3%) in 2017. A drop is expected only by 2018, when the government estimates debt to be around 65.6%.
This is the highest it's been since the days when the International Monetary Fund was telling Brazil what to do and Dilma's predecessor, Luiz Inacio Lula da Silva, swept into power by talking trash about the
Moody’s was in Brazil recently and is was expected to downgrade the sovereign credit rating to Baa3, joining Standard & Poor’s in putting Brazil one notch above speculative grade. That would make Brazilian debt more expensive for government borrowers. Ribeiro said he expects a Moody’s downgrade is imminent.
"We do not go as far as saying that Wednesday's events reflect an unwinding of the Levy-led policy agenda -- and we see reasons for why more modest fiscal targets make sense -- but we recognize that the cuts paint a worse picture for debt dynamics and add elements that increase the likelihood of investment grade loss in the next two years," Ribeiro says.
The Central Bank Has Spoken
Inflation of nearly 9% trumps a deteriorating job market. Interest rates will crack 14% next week for sure.
Central Bank policy director Luiz Awazu Pereira da Silva said in Rio on Friday that the recent political corruption scandal was adding insult to injury in Brazil.
"The adjustment process is taking a toll on short-term growth. We are carefully observing these developments that derive from our policy stance but have also been compounded by the effect of non-economic events," he said without singling out the fact that Dilma's allies are jumping ship like pirates in the Caribbean.
Silva reminded the market that inflation was in the Bank's cross-hairs and nothing more. “Monetary policy’s best contribution for Brazil’s growth prospect is to help, by bringing inflation to our target and anchoring it there. Monetary policy is-- and should continue to remain -- vigilant to ensure the convergence of inflation to the 4.5% target by the end of 2016.”
The monetary policy committee of Brazil's Central Bank will decide on rates next week. The futures market is pricing in a 25 basis points hike to 14% instead of a 50 bips hike a month ago. Growth data continued to surprise on the downside, specially the retail sales and the monthly GDP proxy, together with the failing job market.
More importantly, inflation keeps rising even though expectations are for it to decrease late next year. The concerns over how far the monetary policy already went in its losing battle against inflation in detriment to growth means the Bank will likely slow the pace of tightening, but not pause or reverse course anytime soon.
The primary fiscal surplus target shift for this year makes things harder too. It was reduced to only 0.15% of GDP, from 1.1%, and for 2016 it is now at 0.7% of GDP, from 2.0% previously. To put this change into context, Bank Director Tony Volpon said in London recently that inflation has been above target for the past five years because fiscal policy was looser than expected, namely in Dilma's first year when a less independent Central Bank was busy helping then FinMin Guido Mantega fight the currency wars.
In order to put inflation back to the midpoint of the target next year, aside from the monetary policy tightening, the Copom also expects that fiscal policy likely reaching its primary surplus targets and the labor market adjustment should decrease the inflation inertia, wrote Bruno Rovai, an analyst with Barclays in New York.
Changes in Brazilian fiscal policy only increases the difficulty of anchoring inflation expectations to 4.5%, Rovai says. Thanks to the change in the fiscal targets, Brazil is now at greater risk of losing its coveted and hard won investment grade rating. The currency is reacting accordingly, with the Brazilian real depreciating 5% during the past four weeks.
