BRAZIL MEMO: MANAGING EXPECTATIONS

CARLOS GERALDO LANGONI

October 26th, 2020

• The rapprochement between political leaders and the Administration contributed to an improved Brazil risk-perception. The speaker of the House of Representatives has advocated cuts in current expenditures.

• The possible vote in favor of Central Bank autonomy is expected to have a positive impact in the formation of expectations. Such as redressing the fiscal architecture, particularly with the anticipation of payments to the Treasury of loans made to the National Bank of Social and Economic Development.

• The Getulio Vargas Foundation October survey projects a V-shaped format rebound. Inflation is estimated at 4.7% for the next 12 months, which is a pre-condition for the Central Bank to maintain a monetary easing policy.

Brazil’s risk perception has improved despite the high level of global uncertainty fueled by the second wave of Covid-19 that sweeps Europe.

Script:

The rapprochement between the government and political leaders contributed to the improvement in risk perception. The threat posed by the possible extension of the emergency welfare program created last March 20th has apparently been ruled out.

In addition, the speaker of the House has been advocating cuts in current spending in order to enable a new social welfare program.

Actually, cutting the perks of civil servants, such as putting an end to the automatic salary bonus, and putting a cap on pensions are orthodox measures.

On the other hand, the economic team has once again backed the spending cap as the main fiscal anchor.

The Administration is focused on advancing regulatory modernization in the gas market, the Bankruptcy Law, in addition to the liberalization of the railway and cabotage sectors.

Formalizing Central Bank autonomy would have an enormous positive impact on the formation of expectations.

Furthermore, redressing the fiscal architecture is being reinforced with plans to anticipate payments to the Treasury of loans made to the National Bank of Social and Economic Development.

This measure is essential to address the concentration of public debt maturities during the first 4 months of next year, which has been causing stress in the markets.

There is also room for maneuver to accelerate some privatizations such as the state savings bank subsidiaries, federal oil contracts, as well as the Post Office and the electric energy state company (Eletrobrás).

It is interesting to bear in mind that, in the context of structural reforms, the tax litigation issue will have to be addressed.

The stock of corporate debt - reflecting the slow bureaucracy of lawsuits - contaminates investment decisions, being one of the weakest points of Brazil's poor position in the World Bank's “Doing Business” publication.

Avoiding litigation is expected to generate extraordinary revenue gains, in addition to leveraging the private sector.

Recovery:

The October Getulio Vargas Foundation’s industrial survey projects a strong performance that points to a V-shaped format recovery.

In fact, according to this leading indicator, the industry has already exceeded pre-Covid-19 levels. Capacity utilization has already reached 80%, confirming that the pace of expansion in the fourth quarter is expected to mitigate the recession dip to the -4% range during the current year.

The challenge is to transform the economic rebound into a new stage of growth. No simple task: the uncertainty regarding vaccines and the fragility of the labor market interrupted the positive sequence of the October Consumer Confidence Index.

In this sense, the favorable behavior of the Getulio Vargas Foundation’s inflation expectation index for the same period plays a critical role.

A stable inflation during the next 12 months, projected at 4.7%, is a precondition for the Central Bank to maintain the monetary policy’s expansionist bias with a moderate and gradual adjustment in the base rate.

In summary, despite global uncertainties, Brazil is apparently managing expectations better.

The economic and political agendas converged, focusing on regulatory modernization and macroeconomic stability.

The V-shaped format of the industrial recovery is great news that may anticipate a reencounter with sustained growth as of next year.