The Fiscal Adjustment, End of the Recession and Easing of Inflation

BRAZIL ECONOMICS - Forecast 05 Jul 2016 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Although the progress of the fiscal adjustment is subject to uncertainties, both because the necessary measures are unpopular and because it is not possible to ignore the political effects of the Lava-Jato investigation, we assume that the government will manage to obtain congressional approval of the necessary measures, starting with the constitutional amendment (PEC) capping expenditure growth, complemented by a reform of the social security system that raises the minimum age for retirement.

The decline of risks will contribute to reduce exchange rate volatility, which should fluctuate around R$3.20/US$. This, allied with the Central Bank’s firm commitment to the inflation target (which will be reached by the end of 2017), should assure a decline of inflation expectations, allowing the start of a monetary easing cycle. At the end of 2017, the SELIC rate will be 10.75%, after reaching 13.25% at the end of 2016. Inflation should fall to 7.5% at the end of 2016, and drop further to 4.7% the following year.

GDP will contract by 3.5% in 2016, but will remain relatively stable in the second half of the year, before starting to recover timidly in 2017, when growth should be around 1%. The drop in 2016 will be led by household consumption and gross fixed capital formation. The rising confidence levels and falling interest rates will enable investment growth in 2017.

Assuming that commodity prices remain stable and that world exports increase by around 3% a year, the current account deficit will start to grow in 2017 after a period of intense decline. The reason behind this movement will be the behavior of the real exchange rate combined with the increase of domestic absorption in relation to GDP. In 2016, the current account deficit will be US$ 18 billion, with a trade balance of US$ 42 billion. Then in 2017, imports will grow in relation to exports, reducing the trade balance to US$ 20 billion, causing the current account deficit to climb again, reaching US$ 30 billion. During this entire period, we expect the balance of payments to remain near zero, as has been the case in recent years, with a constant level of international reserves.

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