Brazil: Risk Assessment
Country Risk Rating
Business Climate Rating
- Varied and rich mineral resources and agricultural harvests
- Well diversified industry
- Improving institutional transparency following recent corruption scandals
- Strong internal reserves position (import coverage of roughly 30 months)
- Very sensitive fiscal position
- Bottlenecks in infrastructure
- Low investment level
- High cost of production (wages, energy, logistics, credit)
- Shortages of qualified labor; inadequate education system
Activity is Gradually Recovering
After two years of sharp recession, the economy rebounded in 2017, with GDP growing by 0.6% year-on-year during the first three quarters of the year. On the supply side, agriculture climbed by 14.5% year-on-year, driven by the favorable weather conditions that contributed to a record harvest. Industrial and services activities improved as well: industry rose by 0.4% year-on-year in the third quarter of 2017, while services grew by 1%. On the demand side, the rebound has been mainly driven by household consumption. The improvement is explained by more benign macro fundamentals, such as declining unemployment, low inflation level, and a strong easing monetary cycle since October 2016. On the other hand, investments have weakened as a result of political turmoil: gross fixed investments shrunk by 3.6% in the first nine months of 2017 year-on-year.
Activity is set to gain strength this year, driven by a stronger recovery of household consumption and by exports. A repressed consumption, a stronger job market and a faster pass-through from lower policy rate to the final interest rates will contribute to this movement. In addition, foreign trade should continue to benefit from a still solid global activity (particularly the recovery in Argentina). Despite the generally more positive perspective, investments are likely to remain undermined by upcoming presidential elections (October 2018).
Comfortable Trade Surplus Diverges from a Bleeding Fiscal Account
Brazil’s current account has improved significantly in recent years. This shift has been mainly led by a record trade surplus. Weakened local demand versus the relatively higher global growth played a decisive role. The current account deficit is expected to marginally widen in 2018 as economic rebound gains traction. Nevertheless, the current account deficit will remain easily covered by direct investments received by the country (coverage of approximately eight times).
The fiscal aspect remains the Achilles’s heel of the Brazilian economy. Gross public debt has increased significantly over recent years, leading the country to successive downgrades by rating agencies. The economic team of President Michel Temer took office in May 2016 and has since pursued a tightened fiscal policy. Improvements were achieved, such as the approval in Congress of a spending cap that limits the growth of government expenses by the previous year’s inflation. A social security reform, which is a key to containing fiscal bleeding, was also sent to the Lower House in December 2016. However, the proposal – which requires 60% support in two rounds of voting in the Lower House and in the Senate – was delayed by new political scandals that came into light and threatened President Temer’s government, who managed to weather two complaints imposed by the Attorney General, but not without consequences. The now-weakened government, with less political support in Congress, is running out of time to pass a softer version of the social security reform, which nonetheless might be unsuccessful due to the proximity of the legislative elections in October 2018.
Presidential Elections of October 2018 Will Be Closely Watched
Former Vice President Michel Temer (center-right PMDB party) became President in August 2016, after President Dilma Rousseff (leftist Labor Party) was impeached by the Congress. The case was triggered by the accusation that her government was hiding the size of the public deficit (breaking the Fiscal Responsibility Law). Her dismissal, however, gradually became more likely with the “Operation Car Wash” investigation approaching the heart of her party. This investigation, initiated in March 2014 and carried out by the Federal Police of Brazil, has revealed widespread corruption scandals within several of the country’s political parties, and impacted President Temer in May 2017. The new turmoil was triggered by the content of the plea bargain of the chairman of Brazil’s largest meat processing group. President Temer was able to survive two charges brought against him by the Attorney General, thanks to a mobilization that included the ostensive use of the state apparatus.
The presidential and legislative elections in October 2018 will be held in a challenging political environment. The population is both tired of the current government (only 5% considers the PMDB government good or very good) and angered by the widespread corruption. This scenario might create an opportunity for outsiders, but because the presidential candidates are not yet concretely confirmed, it is too early to try and predict the winner. However, former president Luiz Inácio Lula da Silva (Labor Party) and the extreme-right populist Jair Bolsonaro were doing well in the polls in late 2017. “Lula” is currently the frontrunner, but might not be able to run after being found guilty on corruption and money-laundering charges in July 2017. If his sentence is maintained on appeal, he will be prevented of running for elections.