Brazil: Risk Assessment
Country Risk Rating
Business Climate Rating
- Varied mineral resources and agricultural harvests
- Large population (estimated at 210 million)
- Well-diversified industry
- Strong foreign exchange reserves (import coverage of roughly 25 months)
- Net creditor in foreign currency
- Sensitive fiscal position
- Infrastructure bottlenecks
- Low level of investment (roughly 16% of GDP)
- Relatively closed to foreign trade (exports represents only 13% of GDP)
- High cost of production (wages, energy, logistics, credit) harming competitiveness
- Shortage of qualified labour; inadequate education system
Economic momentum should marginally improve
Activity registered another year of weak growth in 2019, when it was mainly led by household consumption and private investments (albeit still at low levels). Meanwhile government expenditure remained limited by tight fiscal budget and exports felt the headwinds coming from decelerating global activity (notably the recession in Argentina). This year GDP should register a relatively stronger economic momentum. Consumption should be favored by some improvement on the job market, low inflation and by the current expansionary monetary policy (interest rate stands at historical minimum). Meanwhile, private investment is likely to benefit from relatively higher business confidence (following the approval of the social security reform and the expected progress in pro-business reforms) and the lower lending rate. Contrarily, exports should remain at weak levels, as the recession in Argentina is not likely to ease this year and global GDP should continue to decelerate. Finally, mining activity should report some rebound in production, following the normalization of iron ore production, which has been affected by the Brumadinho dam accident in January 2019. The main risks to the economic scenario are related with a possible stronger than anticipated global economic deceleration and a strong escalation of political polarization in the country (as it has been seen recently in other neighboring economies).
Sound external position continues to diverge from fiscal outcome
Current account deficit widened in 2019, mainly driven by a lower trade balance surplus as the general slowdown in global activity took its toll on exports. Meanwhile, the deficit in services (1.9% of GDP) and the primary income imbalance of around 2.7% of GDP remained wide (mainly due to high profits and dividends remittances). In 2020, the current account deficit is expected to further widen, given the decelerating global economy and considering the scenario where the Brazilian economy gains some traction (increasing imports). Despite that, the strong foreign direct investment inflow (of roughly of 4% of GDP) and foreign reserves position will assure an adequate external position. Finally, the country remains a net creditor in foreign currency, with total external debt at roughly 18% of GDP (24% of the total debt is owed by the public sector and 38% by each non-financial and financial sectors).
The fiscal deficit marginally improved in 2019, driven by lower interest payment (because of the decline in policy rate Selic – three quarters of Brazilian debt is indexed to it) and the state owned development bank BNDES reimbursements to the Treasury. Moreover, in October 2019 the congress approved the much needed and long awaited social security reform, which is expected to save BRL 738 billion over ten years (roughly USD 180 billion or 10% of the 2019 GDP estimated value). However, this amount does not include savings of subnational entities, which are still under discussion in the Congress (their total adherence could add estimated BRL 350 billion to the 10-year savings). Finally yet importantly, the government expects to spare an extra BRL 240 billion in the same period thanks to the combat of fraud in social security benefits. Despite the relatively brighter outlook for public balance, the gains are more in the long term. In the short term, as will be the case of this year, the fiscal imbalance will remain high. In order to smoothen the high rigidity of public expenditure (at present, about 95% of public spending is compulsory), policymakers were sent to Congress in November 2019 to propose economic reforms, which aim, among other things, to decentralize the public budget and increase its flexibility.
A first year in office marked by controversies
The far-right President Jair Bolsonaro has completed one year in office in early January 2020, after a year marked by controversies, even with members of his own party (prompting to his exit of the Social Liberal party in late 2019). Although his government was able to get the much-needed social security reform approved, it was more the outcome of a broad political consensus on the matter, than a merit of the ruling government alone. With the latter reform now approved, policymakers will focus on passing other important measures (such as reforming taxes, granting official independence to the central bank and selling public assets). That said, to move forward with the pro-business agenda, the executive will need to assure a cohesive political base (a point to be monitored, given the recurrent needless political noise between the executive and legislative powers). Indeed political risk has recently escalated, which could jeopardize the progress of the executive agenda in the legislative. This deterioration was triggered by the release from prison of the former President Luiz Inácio Lula da Silva (2003/2010) from the left-wing Labour party (PT) in early November 2019 (after 18 months in jail for money laundering and corruption). His release followed the Supreme Court vote that a person can be imprisoned only after all appeals to higher courts have been exhausted. Since this episode, political polarization has gained further momentum.