Deep Recession and Risk of Solvency of the Public Debt

BRAZIL ECONOMICS - Forecast 22 Feb 2016 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Brazil is suffering its worst recession in the past 35 years. GDP in 2015 fell by about 4%, and will probably contract by 4.2% in 2016. Investments next year will also fall 10%, along with further contraction of household consumption, by around 3%. The average unemployment rate in 2016 should be 12%, while the year end jobless rate should reach 13%. Industrial production will also drop again, by around 6%.

The behavior of the external accounts is the only positive factor of the current crisis. The trade surpluses have been growing strongly, and should reach US$ 40 billion in 2016, with the current account deficit falling to US$ 15 billion, or 1% of GDP. In 2017 the current accounts will reach equilibrium. A decline of similar magnitude in the total capital inflows (FDI plus portfolio) will keep the balance of payments near zero.

The behavior of the risk perceptions (CDS quotations) and exchange rate is not connected to the balance of payments, but instead to the terrible fiscal picture. We project two more years of primary deficits, of 2% in both 2016 and 2017. Together with the recession, this will push the public debt to 78% of GDP in 2016 and almost 90% in 2017. Given the government’s political weakness, it will be very hard to reverse this situation.

For 2016 we project inflation of 8.5%, which should decline to 7% in 2017, still above the upper limit of the target interval. We also project the SELIC rate will remain constant at 14.25% a year.

We reiterate that the government is politically feeble and unable to win congressional approval of a reform agenda that could reverse the fiscal picture, leading to the perspective that putting the debt/GDP ratio back on a downward path will only be possible in the more distant future. There also is no outlook for renewed growth anytime soon. The worsening economy, with explosive growth of the debt and unemployment heading towards 13% or higher, will tend to worsen the political scenario, generating a vicious circle and aggravating uncertainty.

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