Asset Prices and the Real Side in Temer’s Fiscal Adjustment
The climate is one of extreme optimism regarding the future of the Brazilian economy. After years of a seemingly endless succession of economic policy blunders, the new government has a competent economic team with a correct diagnosis. Although the recession is not yet over, important signs exist that the end is in sight, and the typical pattern of reactions in the financial market is that asset prices change their behavior well before the turning point in the real side. So, the feeling of anticipation is strong.
Although the currency appreciation and the CDS quotations decline have occurred in other emerging countries as well, this decrease has been greater in Brazil, reflecting the perception of improved execution of economic policy. But do these changes presage a resumption of growth? In our opinion, the Brazilian economy will start recovering in 2017, but only very sluggishly. In economics, no two cycles are equal, and in the current cycle in particular conditions do not exist for rebounds either of consumption or gross fixed capital formation, in contrast to what occurred after the recession in 2008-2009. The most probable scenario is the one painted in the last World Economic Outlook, which is similar to what we showed in our last Quarterly Outlook, of very weak growth in 2017.
Temer has a competent and experienced economic team. But he inherited an unenviable legacy, and even if he succeeds in winning approval of reforms (the key ones require qualified congressional majorities) and tax increases, Brazil will continue producing primary deficits into the next government. The risks are high and will remain even if progress is made on the fiscal reform front. So, although these risks do not prevent an improvement in asset prices, they certainly will retard economic growth.
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