Brazil: Optimism partially regained – HSBC

Analysts at HSBC, explain that against the expectations of many, the Temer administration not only avoided a Supreme Court investigation, but also continued to pass reforms; it passed a broad labour reform that removes onerous employer requirements and allows outsourcing, implemented a new market-based long-term credit interest rate for loans from state banks, and put on the docket tax reform in addition to social security reform.

Key Quotes

“After providing what looked like incriminating tapes on President Temer, former JBS president Joesley Batista inadvertently handed over self-incriminating tapes that also involved the attorney general's office. The upshot is that President Temer is strengthened, which increases the probability that the remaining reforms will be passed. The recent political uncertainty has taken its toll but the economy has continued to recover. The increased certainty has led us to raise our 2018 real GDP growth forecast from to 2.4% to 2.9%, but not to restore it to the previous forecast of 3.5%.”

“Brazilian inflation continues to fall below our optimistic forecasts. August saw another large drop to 2.46% y-o-y, and the decline in non-tradables inflation to 3.18% y-o-y from 3.58% in July has led us to reduce our forecast for 2017 slightly to 2.6% (from 2.7%). We keep our lower than consensus 2.9% forecast for 2018. The slowdown in inflation has also caused us to cut our forecast for the SELIC rate slightly. We expect the COPOM to taper cuts to bring the SELIC rate to 7.25% (previously 7.50%) at end-2017, but maintain our 7.0% forecast for end-2018.”

“Brazil’s poor fiscal performance has markets, rating agencies, and the Brazilian government on alert. Although the market has given Brazil the benefit of the doubt, continued fiscal deterioration could create more market volatility going into the 2018 election year. To that end, the Temer administration announced revised primary budget targets as tax revenues have not recovered. The central government primary balance deficit target is now, subject to congressional approval, BRL159.5bn, as achieved in 2016, for both for 2017 and 2018. This is up from a deficit target of BRL139bn for 2017 and BRL129bn for 2018. For the public sector as a whole, the primary deficit target is now BRL163bn for 2017, up from BRL143bn, and BRL161bn for 2018, up from BRL131bn. There were reports that the central government target could increase to BRL170bn, but the market breathed a sigh of relief when the economic team announced the expected targets combined with a number of strong fiscal initiatives on 15 August. A larger primary deficit target could have signalled politically motivated fiscal expansion going into the 2018 election year, a potential concern for investors and rating agencies.”