ECONOMY TO STRONGLY DECELERATE IN 2023

In 2023, the economy is set to cool down substantially, driven mainly by base effects and the lagged impact of aggressive monetary policy tightening, which should be felt more sorely (policy rate stands on hold at 13.75% per year since August 2022, up from a minimum of 2% up to March 2021). In addition, the slow easing of interest rates expected from H2 2023 onwards could be jeopardized in case of fiscal slippage. Moreover, household consumption (61% of GDP), albeit remaining the main driver of growth, will decelerate in 2023, also owing to families’ high indebtedness levels and durably historically high consumer price inflation (above the 4.75% upper range of the central bank´s target). This should prevail over the higher social transfers and the natural minimum wage increase. Meanwhile, gross fixed investments are expected to contract slightly as global credit conditions are tightening, the growth outlook has clouded, and assuming some caution on the part of companies amid the start of a new government. Durably historically elevated commodity prices (accounting for 60% of foreign sales), the bright 2022/2023 crop outlook, and relatively higher growth in China in 2023 (the leading export destination), along with the easing of COVID-19 lockdowns will allow exports to grow, even as the global economy loses traction.

FISCAL DEFICIT TO WIDEN, WHILE THE EXTERNAL SHORTFALL WILL BE REDUCED

Brazil will keep an excellent external position in 2023, with the current account deficit expected to narrow somewhat. The trade balance surplus should increase (2.2% of GDP in 2021) since the deceleration in import growth (reflecting weaker domestic activity) should exceed that to be registered by exports. In addition, the primary income deficit (3.6% of GDP) should be curtailed by the drop in repatriated foreign investment income. Meanwhile, the services deficit (1.6% of GDP) will likely remain broadly stable as expected lower average freight cost could be compensated by higher foreign travel. On the financing side, foreign direct investment (2.8% of GDP) will continue to cover the external shortfall comfortably. FDI recovered the 2019 pre-pandemic level in 2022 but should marginally weaken in 2023, reflecting higher financing costs and a weaker activity outlook. Meanwhile, foreign currency reserves will remain robust (ensuring an import coverage of 13 months as of December 2022). Finally, total gross external debt (including intercompany loans and domestic fixed-income securities held by non-residents) stood at 36% of GDP in November 2022, with its public share representing 5% of GDP.

Regarding the fiscal accounts, the budgetary deficit is set to climb in 2023, owing to a current rise in public expenditure and higher interest payments. In December 2022, Lula´s then-transition government was able to obtain approval for a constitution amendment (PEC) in Congress to expand the spending cap (which limits the rise in public expenditure to inflation) by 1.4% of GDP for the year 2023, the third in a row. These extra resources will be used to cover higher expenses with the social welfare program Bolsa Família, gas subsidies, Popular Pharmacy, and a natural increase in the minimum wage of roughly 3%, among others. The amendment also excluded the outlay of an additional 0.2% of GDP in windfall revenue on public investment from the spending cap. Finally, the PEC also establishes that a new fiscal anchor to replace the spending cap rule must be presented by August 2023. As a result of the agreed changes, the 2023 primary deficit estimate was increased to 2.3% of GDP against the 0.6% initially forecast. Overall, the already elevated gross public debt (95% domestically owed) is set to increase further in 2023.

BRAZIL TURNS BACK LEFT

Luiz Inácio Lula da Silva, from the leftist Labor Party (PT) and already twice president (2003-2010), retook office in January 2023 after defeating by a tight margin (50.3% vs. 49.7% of the valid votes) the then incumbent leader Jair Bolsonaro, from the right-wing Liberal party, in the October 2022 presidential elections runoff. Nonetheless, as suggested by his tight margin of victory, he will face a polarised political environment. Moreover, Lula must build a coalition with centrist parties to pass constitutional amendments. This is because, in the Lower House, the left-leaning members will hold 27% of the benches, while centrists and right-wing members will have 24% and 49% of the seats, respectively. The framework is no better for the ruling government in the Senate, with the leftists holding 16% of the seats, the centrists 40%, and right-wing members 44%. During his term, Lula is expected to favor a more active role for the state in the economy, including raising the participation of state banks, halting new privatizations (shifting emphasis to public-private partnerships), reversing the state-owned oil company Petrobras´ divestment policy towards more investments to increase domestic energy autonomy, while also changing the fuel price policy (instead of following international prices). He also intends to prioritize tax reform, aiming to simplify taxes, reduce consumption, and raise income and wealth. In foreign policy, relations with neighboring countries (many of which have also leaned left in recent years) could be strengthened, including with Venezuela, where ties have been severed since 2019. Lastly, the new government is also poised to sign the Mercosur trade agreement with the European Union, which has been stalled due to environmental concerns by the EU member states. However, to move forward with this topic, the new Brazilian government will likely have to make progress in combating deforestation, which was one of its campaign promises.