The Political Crisis and the Worsening of the Economic Scenario

BRAZIL ECONOMICS - Forecast 19 Jun 2017 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

From a purely economic standpoint and a strictly short-term scenario, the current crisis is not as severe as many of the previous ones, but in the political realm the story is very different. Governability has eroded, making it virtually impossible to win approval of a reasonable version of the pension reform, increasing the risks regarding fiscal variables, GDP growth, the behavior of the unemployment rate, the pressures on the exchange rate and the intensity of the monetary easing cycle. Despite these weaknesses, we assume that Temer will remain in office until the end of his term, and that the government will not abuse the “fiscal benevolence” to remain in power, with maintenance of the economic team. We also assume that (despite the high probability) the government will not become more fragile politically. In other words, the risks are of a worse scenario than that we are painting.

We are reducing the projection for GDP growth in 2017 to 0.2% and to 2.0% in 2018 (the previous projections were 0.5% and 2.5%, respectively). Although the latest data indicate that modest economic growth is on tap, the GDP gap should remain strongly negative, leading to a steep decline of inflation, allowing the cycle of cutting the SELIC rate to continue, taking it to 8.5% at the end of 2017, where it will stay until the end of 2018. These projections are predicated on a change in the behavior of the exchange rate, which will gradually weaken due to the growth of risks, until reaching R$3.50/US$ at the end of 2017, and an average level of R$3.28/US$ this year and R$3.54/US$ in 2018.

The slightly weaker exchange rate and global growth will help to boost Brazilian exports, although imports will remain depressed because of the modest growth of gross fixed capital formation. With this, the trade surplus should reach US$ 65 billion in 2017, before falling to US$ 50 billion in 2018, with the current account remaining near equilibrium in 2017, and its deficit rising to US$ 15 billion in 2018.

Finally, we assume that with the help of non-recurring revenues, the government will manage to offset the decline of recurring revenues and deliver the promised primary deficits of R$ 139 billion and R$ 129 billion in 2017 and 2018, respectively.

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