Successes and Conflicts in Executing the Adjustment: What’s Next?
Executive Summary
Four months have passed since the start of President Rousseff’s second term, and the greatest hope is on Joaquim Levy’s capacity to reverse the unfavorable inherited situation. The fiscal adjustment is under way, and initial hopes were that its execution, along with a weaker exchange rate to boost exports, would lead to economic recovery. But in recent weeks, the real has been appreciating. The cause is a combination of the high real interest rate in Brazil and a fall in risk premiums, basically derived from the removal of the “tail risk” that had been caused by the “non-publication” of Petrobras’ balance sheet.
Since the recession has been deepening, it would be desirable for the real to remain weak, but the Central Bank’s attempt to regain its credibility, by signaling further monetary tightening, tends to accentuate the strengthening of the real. Unless the authorities believe the appreciation is welcome to control inflation, the Central Bank will have to reduce the stock of currency swaps, which so far has not occurred. In the meantime, all the confidence indicators point to a more pronounced deceleration, meaning GDP in 2015 should shrink closer to 1.5% than to 1%.
Even if the primary surplus target of 2% of GDP set for 2016 as part of the fiscal adjustment is achieved, the debt/GDP ratio will only start to decline: a) with acceleration of potential GDP growth; and/or b) with a lower real interest rate, which requires reforms. The government is facing political difficulties in completing the first part of the fiscal adjustment, so there is not even any guarantee that the fiscal surplus target of 1.2% of GDP will be met, and the only hope for resumed growth is a program of infrastructure concessions, about which no details have yet been announced.
Even with the alleviation from publication of Petrobras’ balance sheet, Brazil’s CDS quotations remain above the level compatible with the current risk classification by S&P. Brazil needs reforms to promote growth and/or reduce the interest rate. In the absence of either of these movements, it will need even higher primary surpluses. But this will accentuate the recession, and the Central Bank’s lack of credibility complicates matters, since it will have to keep the real interest rate high to recover this credibility.
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