Economic Recovery alongside High Risks

BRAZIL ECONOMICS - Forecast 04 Dec 2017 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

The most positive point of economic policy execution is the conduction of monetary policy fighting off inflation. The SELIC rate should close 2017 at 7% a year and remain at that level throughout 2018. With this, the ex-ante real interest rate for one year will remain near 3%, below the neutral rate, which will stimulate recovery of economic activity.

The dominant force behind the recovery continues to be household consumption, with gross fixed capital formation making a much smaller contribution. Our projection is that GDP will grow by 1% in 2017, and although we do not discard the possibility of better performance we stick with our projection of 2% growth in 2018. The reason rests with the factors that are restraining recovery of gross fixed capital formation: a) the high levels of idle capacity and indebtedness of firms, a legacy of the recently-ended recession; and b) the risks from the fiscal-political binomial, namely the doubts about whether the current government will manage to win approval of important measures for the fiscal adjustment and uncertainties over the outcome of next year’s elections.

We assume that the international scenario will continue to be favorable, marked by strong demand for emerging markets’ assets, favoring stability of the exchange rate and steady growth of global trade. Still, Brazil’s trade surpluses will decline and its current account deficits will increase due to the growth of imports.

The main risk comes from the reflections of the political crisis on execution of the fiscal adjustment. Besides the difficulties in meeting the primary deficit target in 2018 and the spending cap ahead, the current government will have a hard time winning congressional approval of a pension reform that can lead to a downward path of the debt/GDP ratio in the future. The reflections of these factors will be smaller if the current version is approved – even though watered down – and the election of a strongly reformist president in 2018 appears likely.

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