Brazil: Risk Assessment

Country Rating1

Rating: A4

Business Climate Rating1

Rating: A4

Risk Assessment2

Sharp slowdown in growth

Growth will be weak in 2014. Domestic consumption, the longstanding driving force behind economic growth, is likely to disappoint. The creation of jobs has started slowing down. The supply of credit, the critical fuel for consumption, will fall as the banks become more circumspect and because of high household debt levels (debt servicing accounts for 21% of income), in the face of higher interest rates. Investment is likely to stall with the delaying of several major projects (concessions), with the elections scheduled for October 2014 inducing increased uncertainty among decision-makers. Construction should continue to benefit from public financing of social housing and the completion of sports venues. Exports will feel the positive impact of any recovery in the United States (11% of exports) and a revival in the Eurozone (16%), but suffer from the recession in Argentina (8%) and the slowing of Chinese growth (17%). Oil exports will increase as production gets going from new oilfields. With raw material prices (50% of export sales and including iron, soya, cereals, coffee and sugar) stabilising, there is less chance of any significant growth in earnings. The depreciation of the real in 2013 will only help the price competitiveness of exports of manufactured goods, in sectors such as automotive, avionics, iron and steel, paper pulp, orange juice and meat products.

Will budgetary and monetary policies be tightened in 2015?

Given the deterioration in public sector accounts and the reservations among investors, a tightening in budgetary policy is likely for 2015 and will happen after the October 2014 elections. The people’s favourite remains President Dilma Rousseff of the Partido dos Trabalhadores, even though she lost ground following surveys in April-May, increasing the likelihood of a second round of voting. The government does however have to take into account the promises made at the time of the demonstrations in mid-2013 (investments in healthcare, public transport and education). Current expenditure, the main element of the budget, with wages and social benefits indexed against inflation, continues to rise. On top of this, following the drought which has led to increased use of expensive thermal power stations as opposed to hydroelectric plant, and the delaying of the announced rise in electricity prices in 2015, the government will have to support the energy sector (subsidies should amount to approximately 0.3% of GDP in 2014). Budgetary policy is therefore likely to be moderately expansive in 2014, with the primary surplus probably below the government’s target of 1.9% of GDP. This primary balance surplus will however help keep the public debt (mainly denominated in reals and thus with a low external percentage) stable (at 67% of GDP for gross public debt, but 34% net). Unlike the budgetary policy, monetary policy has been used in the counter inflationary pressures (policy interest rate increased to 11% in April, a rise of 3.75 points in 1 year). The Central Bank has also acted on the currency markets to ease the depreciation of the real, which contributed to the firming up of the Brazilian currency between February and May 2014, when it rose 8% against the dollar. The structural causes behind inflationary pressures will however restrict the effectiveness of this policy; inflation remains close to 6.5%, the upper limit of the target set by the Central Bank (2.5% - 6.5%). Whilst in the short term the Central Bank needs to pause in its cycle of interest rate rises, these inflationary pressures mean that a further tightening of monetary policy in 2015 is likely.

Solid external accounts, slight upturn in exports

The depreciation of the real in 2013 helped close the current account deficit, which will hold steady at 3.6 % of GDP in 2014. The trade surplus, in decline since 2008 and to the point of almost disappearing in 2013 (0.1% of GDP), has been restored to health with the gradual upturn in manufacturing exports, despite the low level of exports to Argentina, currently in recession. The deficit regarding services and income (tourism, dividends, interest) will remain. The current account deficit will be covered at 40% by direct foreign investments and the rest by foreign investments in Brazilian debt. The level of external debt stands at 33% of GDP. The proportion of public debtors (15%) has been sharply reduced in favour of the private sector. Servicing the debt, as well as the current deficit, is easily covered by foreign exchange reserves, currently at one and half years of imports.

Growth potential undermined by structural failings

Brazil has abundant resources and diversified industry, but these are hindered by a lack of appropriate infrastructures and qualified labour, excessive state interventionism and bureaucracy. These factors weigh heavily on the supply, with companies’ costs increasing faster than productivity, forcing them to raise prices and undermining their competitiveness. Protectionist and fiscal measures have been adopted with the aim of relieving these pressures. The level of fiscal pressure however remains high (public expenditure accounts for 37.2% of GDP, a very high percentage for South America). The slowdown in consumption has increased the pressure on those industries and businesses that are dependent on it: electrical household goods, electronics, automobile, etc. The 2013 real depreciation also impacted on companies with increased levels of foreign currency debt.

Strengths

  • World’s 6th largest economy
  • Growing workforce
  • Varied mineral and agricultural resources
  • Cutting edge manufacturing industry: aeronautics. chemicals, pharmaceuticals, oil engineering
  • Resistance to external shocks: primary budget surplus, net external creditor position, considerable reserves
  • Maintenance of key macroeconomic balances

Weaknesses

  • Lack of skilled labour / deficient educational
  • Infrastructure shortcomings (transport, energy)
  • Inadequate investment (18% of GDP)
  • High production costs (wages, energy, logistics, credit)
  • High and inefficient public spending
  • High public debt and debt servicing costs
  • Corruption thriving on inequalities

1Country and Business Climate Ratings courtesy of Coface (10/2014)
2Risk Assessment and methodology courtesy of Coface (10/2014).

Glossary