Brazil is facing many external and domestic headwinds, but strong external position will prevent it from following Turkey’s fate, according to analysts at ABN AMRO.
Key Quotes
“Monetary policy normalisation in the US, fears of rising protectionism and (geo)political tensions have caused significant turbulence in emerging markets in recent months. And the flight to less risky assets also led to a strong depreciation of the Brazilian real.”
“We are only two months away from the final outcome of the presidential elections, which remains highly unpredictable. Still, we believe that Brazil is less vulnerable than Turkey to a rise in risk aversion caused by either domestic or global headwinds. While Turkey’s economy is highly dependent on volatile foreign portfolio inflows to finance an extensive current account deficit, Brazil has a small current account deficit and rather strong foreign direct investment inflows. Inflation is also much lower and real interest rates higher.”
“While the overall external position is Brazil’s biggest asset, the fiscal situation is definitely its weakest spot. The fiscal deficit has been running above 5% of GDP since 2015 and even if the reform process goes full speed ahead after the elections, the deficit will remain elevated in the coming years.”
“Lower interest rates are favourable for the government debt situation, it will be difficult to maintain real interest rates at current low levels without a strong improvement of the fiscal situation.”
“The central bank will remain on hold for the rest of the year and resume a tightening cycle at some point in 2019.”
“Last week, USD/BRL broke above 4.0 and is challenging the high set in September 2015 (just below 4.25), when there was a crisis in Brazil (2014-2016). The weakness in the real is understandable and largely due to external factors but it is not justified by Brazil’s current fundamentals. Indeed, the situation in 2014-2016 was far worse. We think that once the elections are behind us and there is clarity about who will be the new president, currency markets will calm down.”
“According to the latest data, the central bank has not recently increased the outstanding FX swaps but we think it will step this up if the real is under pressure in isolation. It is likely that the central bank would like to avoid a break in USD/BRL of above 4.25, because this could trigger more investor selling of the BRL.”
“In short, the real is currently under pressure but the central bank will counterbalance this move by increasing FX swaps and, ultimately, by raising interest rates. Later in the year (after the elections) we expect a recovery of the real thanks to decreased political uncertainty and a less negative external environment. We therefore maintain our forecast for the BRL/USD of 3.70 end-2018 and 3.20 end-2019.”
“The second quarter GDP figures will be published on 31 August. Given the monthly economic activity indicator figures, we expect growth to be around the same level as in Q1, namely 1.2% yoy. In the second half of the year we expect only a minor acceleration of economic growth.”
“Next year, some of that uncertainty will at least have faded, and we expect the economy to accelerate. But with a tight fiscal policy and a monetary policy that is becoming less accommodative, economic growth of 1.5% in 2018 and 2.5% in 2019 will remain below potential, and not strong enough to make up for the 7% decline in GDP in 2015/16.”
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