Economic Overview

The hangover

Brazil has not from presently on emerged from a two-year long recession, the worst on record. Optimism about a vigorous rebound in production is taking an increasingly dim view. Investment plunged by -10.3% and has been the worst performing component in 2016. Private and public consumption decreased by -4.3% and -0.6% respectively. Imports contracted -10.4% while exports expanded by +1.6%.

However, the fall in real GDP moderated and confidence and production indicators that hit rock bottom early in 2016 are presently gradually bottoming out. Both private consumption and investment are estimated to become the engines of increase in 2017 and push the economy back into positive territory.

Relax

In what can be seen as a promising turning point, the Central Bank cut its key policy interest rate for the initial time in four years, no longer running counter to the current recessive environment. Banco Central do Brasil lowered its key policy interest rate by 200bps to 12.25% from 2016. The easing cycle is expected to be extended with additional cuts throughout 2017 to fuel increase in the battered economy.

The rapid fall in consumer prices enabled the Central Bank’s move. Headline inflation moderated to +8.8% in 2016 on average, down from a peak of +10.7% y/y recorded in December 2015. Inflation continued its downward trend in February with +4.7%. This brought inflation back into the Central Bank’s 4% +/-1pp target range for the second consecutive month.

The hidden face of debt

Businesses and households have accumulated deficit below other emerging economies, 43.9% and 22.9% in contrast to 36.6% and 105.9% of GDP in Q3 2016, respectively. Meanwhile, public deficit continued the rally initiated two years ago and escalated to 74.2% of GDP, compared to 47.5% of GDP on average for emerging economies.

However, it is crucial to put into context the sustainability of Brazil’s public deficit. Part emerging economies, the country is one of the best at the same time as it comes to reserve adequacy. This allows Brazil to hold the current level of indebtedness. In the case of a negative tail risk event, reserve adequacy covered 231% of the country’s needs in 2016, both on the deficit sustainability and liquidity sides.

The fiscal balance could prompt a deficit of -9.2% of GDP in 2016. Accounting for interest deficit payments, Brazil is expected to have the second major deficit in the region. In order to contain public finances loss making, the lower home recently passed a proposition to limit the real increase of government spending to zero for the next twenty years.