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Brazil's Disastrous Debt Dynamics Could "Create Contagion" For Emerging Markets, Barclays Warns
Last week, we got the latest round of abysmal economic data out of Brazil. To summarize: GDP is in “free fall mode” (to quote Barclays), inflation hit double digits for the first time in over a decade, and unemployment soared to 7.9% in August, up sharply from just 4.3% a year earlier.
Put simply: it’s a full on economic meltdown.
The situation is made immeasurably worse by the country’s seemingly intractable political quagmire. The standoff between President Dilma Rousseff (who has been accused of cooking the fiscal books) and House Speaker Eduardo Cunha (who has been implicated in a kickback scheme tied to Petrobras) has led to a veritable stalemate that’s made it exceedingly difficult for Rousseff and her embattled finance minister Joaquim Levy to push through badly needed austerity measures.
Rousseff scored a victory on the austerity front on Wednesday when lawmakers approved her veto of a bill that would have raised retirement payments alongside the minimum wage, but this is an uphill battle and while incremental wins may be enough to give the beleaguered BRL some temporary respite, the medium- to long-term outlook is abysmal.
As Brazil continues to muddle through what has become a stagflationary nightmare, Barclays is out with a fresh look at the country’s debt dynamics and unsurprisingly, the picture isn’t pretty.
The road ahead depends on fiscal policy, Barclays begins, and that, given the current dynamic, is not a good thing. “Even if politics were uncomplicated and policy unconstrained, Brazil would still face enormous challenges adjusting to far less supportive local and global conditions,” the bank notes, referencing the now familiar laundry list of EM problems including slumping commodity prices, lackluster demand from China, the yuan deval (bye, bye trade competitiveness), and the incipient threat of a Fed hike and thus an even stronger USD.
“Investors are also grappling with the prospect of a prolonged, unsustainable fiscal policy framework,” Barclays adds.
And here’s Antonio Pascual doing his best Alberto Ramos impression by rattling off a comically long list of problems:
“Brazil is confronting a toxic combination of a primary budget deficit, high public debt (relative to EM countries), very high real interest rates (the Selic stands at 14.25%), sluggish trend growth, a negative commodity price shock and potential contingent liabilities for the sovereign, which together spell trouble for public debt dynamics.”
Yes they sure do “spell trouble for debt dynamics” and if the prospect of further imperiling the economy wasn’t enough to tie Copom’s hands, the relationship between public debt and rates leaves the central bank virtually paralyzed:
The combination of high debt/GDP and high interest rates means that Brazil suffers from ‘fiscal dominance’, a situation where monetary policy is driven by sovereign solvency concerns. Given the sensitivity of public debt to high interest rates in Brazil, the central bank is unlikely to tighten policy despite high inflation.
And even as Brazil doesn’t necessarily have an “original sin” problem (at least when it comes to public debt), the outlook is still rather dire:
How much time does Brazil have before markets push sovereign yields higher, accelerating the unsustainable debt dynamics? There are some important risk mitigants. Brazil’s debt is predominantly payable in local currency, and what is payable in foreign currency is covered many times over by its international reserves. The problem is that, by our estimates, public debt in Q4 2015 will be more than 71% of GDP with average funding costs at more than 12%, with no prospects for a turn-around towards a sustainable primary surplus or stronger growth prospects.
Going forward, “the prospects of success are bleak”:
The challenges of fiscal consolidation in Brazil are only beginning, and without policy changes, prospects of success are bleak.
In a stressed scenario, in which there is a lack of full Congress support and an unsuccessful asset sales program, we see the fiscal adjustment for 2016 amounting to only 1.0% of GDP.
This scenario is consistent with increased market pressure for the remainder of 2015 and 2016 (Figure 9). Market stress could increase, for example, due to a potential impeachment of the President, a loss of confidence in the fiscal outlook, and/or a significant increase in contingent liabilities. Our projection assumes that the primary balance worsens relative to our base case, reaching -2.3% of GDP in 2016. The deficit falls gradually thereafter but a deficit persists until 2019 (-0.5 percent).
The recession lasts for longer than in the base case, but inflation rises further because further BRL depreciation pushes actual inflation and inflation expectations higher. Inflation rises to 9% in 2015 and remains high (but gradually falls) thereafter. Interest rates rise 2pp more than in the base case in 2015 and 2016, as higher risk premia push up the cost of debt.
The end result, Barclays warns is that "in the stress scenario, debt/GDP rises to over 100% of GDP by 2020 and does not stabilise." And while the bank admits that "there are various negative developments compounding this scenario, including higher average interest rates and weaker growth," Barclays cautions that it "does not view [the] assumptions as unrealistic" given that for instance, the projection only assumes interest rates rising 200bp relative to the base case which "is half the increase in the cost of debt seen during the global financial crisis of 2008, and considerably less than the pressure seen in 2002 when the Selic rate rose by 800bp in less than six months."
What happens if the cost of debt rises in line with what we witnessed in 2008, you ask? This:
The chart depicts 40 paths for debt/GDP associated with increasingly higher interest rates in steps of 10bp, starting from the baseline path for debt/GDP to the last path corresponding to the baseline scenario for interest rates plus a 400bp shock. The shock is applied to the interest rate in the transition years, not to the steady state interest rate (set at 8%). The key takeaway is that as the cost of debt rises in the baseline scenario, public debt/GDP increases rapidly and stabilizes later relative to the base case. In the extreme case of a +400bp increase in the average cost of debt, the public debt/GDP ratio peaks at a whopping 114% in 2021.
So what's the takeaway besides the fact that Brazil is, for lack of a better word, screwed (because we already knew that)? Well remember, Brazil is representative of the problems facing EM as a whole. Slumping commodity prices, currency carnage, FX pass through inflation, sensitivity to decelerating Chinese demand and to Beijing’s yuan deval, Brazil has it all - they even have a seemingly intractable political crisis, and as we never tire of pointing out, idiosyncratic political risk factors have become an important part of the EM calculus (see Turkey and Malaysia for instance). In short, the country is a proxy for EM as a whole. With that in mind we close with what Barclays says are the wider implications of Brazil's deteriorating fiscal picture and challenging debt dynamics:
"The prospect of such deterioration is likely to lead to a further sell-off in Brazilian assets and could create contagion – especially to vulnerable EMs – given Brazil’s systemic importance."
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Moar bailouts please!
"Thursday, just hours after giant insurer UnitedHealthcare said it’s losing money selling ObamaCare plans and will likely exit the health exchanges next year, the Obama administration quietly promised to bail out insurers for their losses — using your money."
"On Thursday, the administration tried to calm insurers, sending them a written memo full of promises. Obama’s Department of Health and Human Services vowed to go to Congress for full funding to reimburse insurers for their losses.
At issue is the Affordable Care Act’s so-called “risk corridor” program."
Toldja so.
http://nypost.com/2015/11/20/a-new-taxpayer-bailout-to-cover-up-obamacar...
Brazil will do what it always does, default on her debts.
Precisely.
Oh, oh, oh! Do not start this round of Musical Chairs without me too! Let it be to the Samba!
I don't think Brazil will default this time, since all our debt are in local currency.
However, I expect hyperinflation ahead.
it would be nice to know how much of that (oh, my gosh!) $9-11 trillion in USD carry-trade made its way there
"likely to lead to a further sell-off in Brazilian assets and could create contagion – especially to vulnerable EMs"
This is perhaps deliberate as strong EM's are not so useful at the moment.
God damn it, they are at it again! Fucking around with our money; the dollar amounts that are extracted from my paychecks with greater regularity than fiber for a year! I hope that no one publicly pronounces the ACH/Obamacare near me this upcoming week; I'm going to let them have it.
nmewn
At issue is the Affordable Care Act’s so-called “risk corridor” program."
Toldja so.
The only reason the major insurers signed up in the first place was because of the "Risk Corridors". No one could predict what the actual costs would be from signing up a bunch of previously uninsured with pre-existing conditions. The original Obamacare included this reimbursement. After it got started the terms were changed. Obama signed the bill limiting the funds available HHS for the reimbursements. It ended up being about 13% of amount necessary for 2014. So first Obama screwed those who had existing plans, then screwed the insurers which believed the promises. It turns out that many of those with medical problems signed up, got treatments, then quit paying premiums. Entirely as many had predicted as they can always just sign up again if necessary. That is one of the reasons, beyond general incompetence, that the nonprofit plans are rolling over into bankruptcy. No reserves in first place and unreimbursed costs.
Brazil is a victim of Obama's war on oil to attack Russia and Putin. Brazil produces about 3 million barrels a day and lower oil prices cost Brazil $240 million a day or about $88 billion a year. The slowdown in China is not helping either.
Until oil prices recover, Brazil's economy will be stressed.
Good points. Brazil is interesting. The govt is deeply corrupt, run by a person accused of murder. At the same time, the Brazilians are catching on and getting angry. Will be interesting to see if they can have a positive impact on the system.
Good points. USA is interesting. The govt is deeply corrupt, run by persons accused of repetitive drone murder, to say nothing of the hundreds of thousands killed in "Little 'Ghani" and "Little 'Raqi". At the same time, the USA-ians are catching on and getting angry. Will be interesting to see if they can have a positive impact on the system.
Yea, that can-kicking shoe fits just fine!
Unfortunately, I think people in the USA are more apathetic than Brazilians. That's the point.
Unfortunately, I think people in the USA are more pathetic than Brazilians. That's the point.
You're welcome.
Cute and even a little funny, but not necessarily true. I like Brazilians a lot, but they have their problems like everyone else.
Agreed. Note also that the gal in the second jpg seems to be suffering from Bra Zilla.
This is a very common affliction in Brazil, and from which there is only one cure: a speedy removal of the stress lines. ;-)
Barclays warns.
yeah those maggots are just the salt of the earth. when they aren't helping little old ladies cross the street they are stealing their pension checks.
This is what we wrote in 2013:
To offset the slack in growth (+2.7% in 2011 and only +0.9% in 2012), state banks were used by the government to lend more than non-state financial companies for the first time ever.
President Dilma Roussef expanded credit faster. This lending has been spear-headed by Banco do Brasil SA, Caixa Economica Federal and Brazil's development bank to the tune of 560 billion USD in 2012 (+27% according to Bloomberg), more than triple the 8% increase to 1.2 trillion reals (roughly 600 billion US equivalent) by commercial banks Itau Unibanco Holdings SA and Banco Bradesco SA. Private lenders were stung by rising delinquencies in 2012 FYI.
Of course this "classic" populist policy of enticing a "boom" in housing thanks to "cheap credit" to get re-elected will end up as it always does, in an epic bust.
"Dilma Roussef expanded credit faster."
This seems to be a characteristic of the Chosenites. But it seems to be working fine in America.
It only works when you're the world's reserve currency and have the military to back it
What does the future look for Brazil, Ms. Rousseff?
http://www.horrorsociety.com/wp-content/uploads/2015/10/Elsa-Lanchester.gif
The first picture is from Bride of Frankenstein.
Don't you think that the U.S. is doing this through the Fed in order to destablize the BRICS?Of course they are.It's their last ditch effort to keep confidence in the rererve currency.It's no different from military war,they are doing this to others as well.That's the American way.
They should blame the weather. Works for the U.S.
Could some of Brazil's problems be due to the country having implemented a vigorous policy of affirmative action over the last few decades? Are there various Eric Holders in key positions?
Could you please pick that wad of snot off your upper lip, go wash your hands, and get ready for your lunch? Mommie has prepared some Hot Pockets with Stupid Sauce for you. (Not that you are running out of Stupid....)
[And pick up your hands when you walk! Your knuckles are dragging on the ground again, and you are going to slip on your drool on the stairs like you did this morning!]
The truth is racist and should be banned, just like freedom of speech. You should go on a hunger strike until ZH bans free speech on its website
What do you mean? It worked fine for Detroit and South Africa.
ever been to Brasil? they don't give a shit about "affirmative action" ...that's the USA pandering to the coons since the Mexicans arrived
Lula began an active AA program and it's been continued by Roussof.
Yes. Whilst many people in Brazil have private views of non-whites, these are kept private and most people go along with political correctness in public. And the law is fairly clear, it's not a good idea to describe him/her as "preto/a" (black). Oh no. The only correct word is "negro/a" and they mustn't be blamed for anything because it's not their fault.
Get it? Welcome to Affirmative Action.
Even though the blacks are responsible for the overwhelming majority of crime (murders, assaults, drugs, kidnappings, robbery, car thefts, highway robbery, 'sweeping' the Copacabana Beach on Sundays, blowing up ATMs etc) it's not their fault. It's white-man's fault.
The key takeaway is that as the cost of debt rises in the baseline scenario, public debt/GDP increases rapidly and stabilizes later relative to the base case. In the extreme case of a +400bp increase in the average cost of debt, the public debt/GDP ratio peaks at a whopping 114% in 2021.
And the same chart for the USSA in 2021 at +400bps? or for an apples to apples comp... 12%?
Jesus H Christ! How difficult can it be (for Russia and China) to set up their version of BIS?
This is child's play, and a bunch of tech companies are already letting you wire money via the Internet, for far less than what the banks charge. With a few clicks, I can send money from the US to a bank account in country XYZ for a $5 fee and decent exchange rates.
Methinks that the Rottenchild's fifth column is putting sand in the gears in China, Russia and other BRICS, or else it'd be done already.
And unless/until they do separate from the USD (Usury System of Debt), they are all screwed. BRICS, decouple or die a Usurious Death!
The entire world of finance is assuming less than 1929 ** Dunning-Kruger. My spreadsheets say no government can pay back the bonds.
https://thinkpatriot.wordpress.com/2015/10/27/ignoring-the-absolutely-in...
https://thinkpatriot.wordpress.com/2015/07/28/lebowski-enlightenment-3/
https://thinkpatriot.wordpress.com/2015/10/24/lebowski-enlightenment-9/
Brazil could be the brick that breaks BRIC !