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Brazil – A hint of optimism

Tom06.08

Following Jair Bolsonaro’s 2018 presidential victory, social and pro-business reforms were enacted. Amongst other initiatives, lowering borrowing costs, back then, to its lowest on record and the well-needed pension reform, set to reduce the government’s expenditure by $250bn over the next decade, stirred investor optimism. Fresh investor optimism on Brazil’s political and economic prospects was however short-lived, as the COVID-19 outbreak in the Hubei province, China struck, renewing political uncertainty and fears of a deterioration in economic conditions.

The economic repercussions brought about by country-wide closures to reduce contagion, augmented pressure on governments to intervene. Although strained from a fiscal perspective, Bolsonaro’s government stepped-in to soften the economic blow. While cutting its benchmark interest rate by a total of 200 bps, Bolsonaro’s pro-business government introduced a multi-billion support package, bringing forward social assistance payments and deferrals in tax collections – a sizeable emergency policy response.

Albeit softening the impact, the unprecedented COVID-19 posed, as the number of infected cases mounted, the likelihood of a v-shaped economic recovery diminished, making Bolsonaro’s challenge way tougher than initially expected.

Due to rising external challenges, including China’s significant slowdown – a key trading partner and consumer of Brazil’s manufacturing industry, lower commodity prices, and tightening external financing conditions, the economic outlook deteriorated. Contrasting pre-pandemic estimates, signalling economic growth and gradual recovery from the 2016 recession, social distancing and lockdown measures instated to mitigate the spread led to a sharp contraction in domestic economic activity and higher unemployment rates.

Albeit an economic recovery remains far from certain, this being mostly dependent on contagion figures and the prospects of re-instating normality, for the fifth week in a row, a central bank survey, based on some hundred economists estimated an improvement in Gross Domestic Product (GDP) figures to a 5.7 per cent contraction, in contrast to the 6.5 per cent contraction reported in July. While the said levels comfortably represent the steepest annual downturn on record, the most recent figure is the most optimistic outlook since May.

Also, for the sixth consecutive week, the Central Bank of Brazil latest survey showed 2020 current account deficit projections narrowing to $6.2 billion from a projected $8.3 billion. Meanwhile, inflationary expectations fell slightly to 1.6 per cent from the 1.7 per cent projected earlier, with the former figure being well below Brazil’s Central Bank goal of 4 per cent.

Economic data, which have in recent times been battered over Brazil’s weak outlook, also showed improvement.

Notably, in July’s reading Brazil’s Services Purchasing Managers Index (PMI) – a leading contributor to Brazil’s GDP, increased to 42.5 from 35.9 in June, pointing to the fourth consecutive contraction in the service sectors. Meanwhile, Brazil’s Manufacturing PMI rose to 58.2 from 51.6 in June, leading to the second successive expansion in factory activity as businesses resumed operations following lockdowns imposed to reduce contagion.

In a bid to alleviate the economic environment, and thus try to increase spending throughout the economy, yesterday, as widely anticipated, the Central Bank of Brazil decided to once again slash its benchmark interest rate, better known as the Selic rate, by a further 25 bps to a new all-time low of 2 per cent.

Now, more than ever, Brazil’s vast and diverse economy, a high income per capita relative to its peers, and capacity to absorb external shocks play a vital role to the future of Brazil’s economy. Should the spread of COVID-19 pandemic, be contained and improvement in both outlook and economic data, persist, a quicker than expected recovery, may indeed be plausible.

Once again, we reiterate that as long as uncertainties remain, a bottom-up approach is imperative to determine whether corporates have sufficient liquidity, to weather these turbulent times, particularly should the COVID-19 pandemic prolong.

Disclaimer: This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information, visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.