Brazil: Risk Assessment

Country Rating¹

Rating: A3

Business Climate Rating¹

Rating: A4

Risk Assessment²

Further slowdown in 2012

In 2012, economic activity is expected to decelerate again. The lack of growth in Europe and the economic slowdown in China, Brazil's two major trading partners, will affect exports. Domestic consumption, buoyed by a very accommodative economic policy, will continue to play the role of growth engine.

Household consumption and public administrations will be the main source of growth. At the start of each year, the minimum wage and pensions received by a quarter of the population benefit from at least the inflation indexing for the year N-1. This time around, the minimum wage was increased by 14%. Falling unemployment, less than 6%, has also contributed to rising incomes. Moreover, the government puts a lot of pressure on state banks so that they pass on the cut in the key rate now fixed at 8.5%. This rate could be lowered to 8 or 7.5% by the end of the year, i.e. a real rate of 2%. Banks are reluctant because household lending as well as non-performing loans have grown significantly in recent years. However, household lending still has room for improvement given the reduced share of mortgages in outstanding debt, comprised primarily of short-term consumer loans. Lastly, fiscal policy also favors households. Taxes on purchases of home appliances, housing and certain types of vehicles have been lowered. Several social programs targeting the poorest are continuing.

Lack of industrial competitiveness

This dynamic consumption will be of particular benefit to services, but, once again, insufficient for industry. For several years, the market share of local companies on the domestic market has shrunk in favor of imports due to a lack of industrial competitiveness, resulting in deindustrialization and the increasing weight of primary products (oil, soya, etc.) in the economy. The authorities see it as the lagged effects of restrictive monetary policy in the 2000s, which promoted the appreciation of the Brazilian real. In fact, the real effective exchange rate has appreciated by only 5% in 5 years. It seems, also, to be the consequence of a lack of productivity due to insufficient skilled labor, together with high wages, lack of infrastructure, red tape and high and complex taxes.

This context does not encourage manufacturers to invest. Tax exemptions for companies investing in port and rail facilities, as well as soft loans from the Brazilian Development Bank (BNDES) for automotive industry equipment purchases will not help. Moreover, the recent depreciation in the real (30% over one year to June 2012, 15% over the first 6 months of the year) increases the cost of foreign borrowing, which large companies use to finance their investments and overcome the weakness of domestic savings. On the other hand, public investment should be more resilient with Growth Acceleration Plan no. 2 (2012-2017) intended to finance the energy sector, housing construction, transport infrastructure and water supplies for the 2014 football World Cup and 2016 Olympic Games.

Industry support measures

Several protectionist measures, aimed at promoting Brazilian industry, have been adopted. Given the increase in car imports, the government decided to increase by 30% a tax on vehicle sales with a local content below 65%. Moreover, Brazil has challenged the free trade agreement with Mexico on automobiles and imposed quotas. A minimum local content of 65% is also imposed on oil services and equipment, at the risk of delaying delivery or increasing the cost of equipment required to exploit new deepwater oilfields. In addition, the Brazilian government has adopted tax exemptions for industries that are the most affected by competition from imports, such as the textile industry. The minimum rate of exports in total sales determining access to certain tax exemptions has fallen from 65 to 50%.

Financial situation under control

The budget shows a primary surplus of 2% of GDP, but an overall deficit close to 3%. Current expenditure (wages, pensions) increased greatly because of its indexing, as well as stimulus measures for households and industry (Maior program). Gross public debt remains relatively high (65% of GDP), but stable. Its external portion is only 5% of GDP.

Trade is in surplus (1% of GDP), but given the deficit of services, repatriation of dividends by foreign investors and remittances of many immigrant workers present in Brazil, a current account deficit close to 3% has been posted. The change in the balance is very closely tied to that of prices and demand for commodities, favorable at the moment. For this reason, the authorities want to improve the competitiveness of the manufacturing industry. The current account deficit is financed easily by foreign capital flows. In total, the external situation is comfortable with gross debt representing 12% of GDP and 125% covered by foreign currency reserves, and a net credit position.

Corporate payment behavior, while still above the global average, is likely to worsen with the economic slowdown. Furthermore, the risk may be increased by more expensive and lower availability of credit and the depreciation of the real for companies with foreign currency debt.

Strengths

• Scale and potential of the domestic market
• Abundant mineral and agricultural resources
• Significant manufacturing industry
• Primary budget surplus
• Significant margins for contra-cyclical policies
• Net external creditor
• Considerable currency reserves (11 months of imports)

Weaknesses

• Dependence on raw materials and foreign capital
• Global general government deficit linked to debt service
• Deficient infrastructures (energy, transport)
• Lack of skilled labor
• Shortfall in household savings rate and high cost of credit
• High taxes primarily devoted to operating expenditures
• Corruption and crime flourishing on inequalities