BRAZIL MEMO: EXPECTATIONS

CARLOS GERALDO LANGONI

November 16th, 2020

• As the 2nd pandemic wave sweeps Europe, an abatement on the pace of recovery in Europe is expected.

• In Brazil, the focus on privatizations such as the Post Office and the electric energy company (Eletrobras) is key to adjusting the debt stock. The end of the production sharing agreements in the oil and gas sectors can generate around US$ 100 billion, which are enough to positively impact the fiscal risk.

• Continuous growth over long periods of time hinges on the successful transition from household consumption into private investment. Signs of economic recovery are consolidating, but they still depend on the reassessment of Brazil country risk.

Uncertainty engulfs the global economy. According to the OECD, the 2nd wave of the pandemic is expected to lessen the pace of recovery in Europe, while the United Kingdom and France suffer more adverse consequences.

Excepting Russia, the expansion of BRICS countries is expected to run their course without major hindrance.

Scenario:

In terms of global risk aversion, the short-term prospect of effective vaccines introduced a downward bias benefiting stock markets.

In addition, it is expected that Biden's economic policy, by reversing the protectionist wave, will restore the role of international trade as a leverage for world GDP growth.

In the case of Brazil, the focus on privatizations – the Post Office, the largest state-owned producer of electric energy (Eletrobras) and the state-owned Pre-Salt Oil company (PPSA) - is key to adjusting the debt stock. Privatizing these companies can mitigate overshooting caused by the compensatory policies used to dampen the economic and social effects of the pandemic.

The first estimates suggest that the oil and gas contracts, which were signed by the Union and are managed by PPSA, may be worth around US$ 100 billion, enough to positively impact fiscal risk, the main threat to the low interest strategy.

Until now, market expectations reveal a relatively stable inflation measured by the consumer price index (IPCA), as summarized in the Central Bank Focus Bulletin. However, those projections already point to a moderate increase in the base rate (SELIC) to a new level of 2.75% in 2021.

There is an implicit uncertainty regarding the depth and political feasibility of reconstructing the consistency of fiscal architecture.

Economic Activity:

Domestically, the 5th consecutive increase in September retail sales confirms a recovery trend, with sales above the pre-pandemic level observed last February.

Some financing-intensive sectors such as durable goods and construction hover in the double-digit range, indicating the sustainability of the recovery.

In contrast, services remain in negative territory, despite advancing in September. The disproportionate impact of social distancing on the activities of this sector explains its weaker performance when compared with trade and industry.

The high unemployment rate in Brazil (13.4%) is well above the average observed incountries with pandemic-related mortality rate (9.6%), according to Getulio Vargas Foundation estimates.

A continuous growth process is a precondition for mitigating the fragility of the labor market and, concomitantly, relieving political pressure for new social protection programs. It should be borne in mind that about 38 million informal workers will lose their emergency monthly stipend as of January.

The viability of this new expansion cycle hinges on the successful transition from family consumption into private investment, which would become the main source of economic vitality.

Tax reform, alongside regulatory updating (for example, the end of production-sharing contracts in the oil and gas sectors), is the trigger for this structural change that, in turn, depends on the improvement of the Brazil rating, which is currently under threat of being downgraded.

In a nutshell, global expectations are positively biased, fueled by the new crop of vaccines and the likely dismantling of barriers to international trade.

Signs of domestic activity resumption are consolidating but still depend critically on the reassessment of Brazil risk.