For anyone who might have missed it, Brazil is in trouble.
The country is "at the center of a triple unwind of EM credit, China’s leverage, and US monetary easing" (to quote Morgan Stanley [11]) and as Goldman recently pointed out, faces a stagflationary nightmare [11].
Last quarter, Brazil suffered through the worst growth-inflation mix in over ten years. As Goldman put it, "since 1Q2004 there has not been a single quarter in which we had simultaneously higher inflation and lower growth than during 2Q2015."
[12]
And then there's the twin deficit problem. Here's Goldman again:
Over the last 11.5 years, we cannot identify a month with a strictly-worse fiscal-CA deficit outcome than that of May-15 (lower left quadrant is empty). In fact, at 7.9% of GDP the fiscal deficit is now the widest it has ever been since Jan-04, and there were only a few months (5 out of 137 months in the sample) were the current account deficit was marginally wider than currently.
Meanwhile, as we mentioned on Monday, Dilma Rousseff is now the most unpopular democratically elected president [13] since a military dictatorship ended in 1985, with an approval rating of just 8%. In a recent poll, 71% said they disapprove of the way Rousseff is doing her job... and two-thirds would like to see her impeached. Here’s Bloomberg summing up the situation [14]:
To be sure, the president faces a host of challenges this month, not least of which is a nationwide protest planned for Aug. 16.
The country’s audit court also must decide whether the government broke the fiscal law by doctoring budget results last year. A ruling against the government could provide the legal foundation to start impeachment hearings, opposition lawmakers say. Her administration says previous presidents used the same practices.
Investors are concerned that the political instability will push Brazil into a deeper recession and make it increasingly vulnerable to a sovereign-credit downgrade. The real has depreciated 8.1 percent in the last month, the biggest decline among 16 major currencies tracked by Bloomberg.
[15]
Given all of this, just about the last thing Brazil needed was for China to officially enter the global currency wars, which is of course exactly what happened overnight. Our response:
Biggest immediate loser from China's devaluation: Brazil
— zerohedge (@zerohedge) August 11, 2015 [16]
And the response from Brazil's trade ministry (via Reuters [17]):
Brazil's Trade Minister Armando Monteiro on Tuesday said China's decision to devalue the yuan could hurt the country's manufacturing exports.
So what lies ahead for Brazil given all of the above? Well, further BRL weakness - or at least according to Goldman. Here's more:
We are moving our BRL forecasts to show further downside – we expect $/BRL to reach 4.00 in 12 months (relative to 3.55 previously). A weaker BRL is part of a necessary adjustment to address the macro imbalances in Brazil; and the combination of a weak and increasingly back-loaded path of fiscal adjustment and a central bank that appears to be done with tightening policy for now suggests that the exchange rate is likely to bear more of the overall burden of absorbing the impact of the commodity price downdraft, restoring competitiveness and correcting the current account deficit.
Brazil stands at a crossroads – both roads involve currency depreciation. The combination of significant macro challenges (economic contraction, elevated inflation and large fiscal and current account deficits) and a deteriorating political and institutional backdrop means that Brazil stands at a pivotal crossroads. One road involves the risk of a further deterioration in the political backdrop morphing into a full-fledged governability and institutional crisis (potentially including the departure of key policymakers) and a further deterioration in investor (and rating agency) confidence, with an associated additional hit to an already contracting economy. The other road involves a potential stabilisation in the political picture, which in turn would provide the authorities with room to undertake necessary short- and medium-term fiscal consolidation measures, coupled with monetary easing further down the line. In either case, we think the BRL is likely to depreciate further because it is hard for us to see a route back to a more balanced set of macro outcomes in Brazil that do not involve currency weakness. Along the first road, the depreciation is likely to be sharper and disruptive, with scope for overshooting and an eventual rebound; the alternative scenario would likely involve a grinding, more controlled move, potentially encouraged by policymakers.
Macro imbalances in Brazil are large, the worst in almost a decade...We have developed a simple scoring algorithm to assess the scale of internal (inflation relative to target) and external imbalances (current accounts relative to sustainable levels) and, as Exhibit 1 shows, in Brazil these imbalances are at their widest combined level in a decade. The fiscal deficit at -8.1% of GDP is also at its widest in more than 20 years, with the combined twin deficits now tracking at a disquieting 12.5% of GDP.
[18]
Of course as we said late last month, the simple fact is that whether it's China, runaway stagflation, or simple politician greed and corruption, Brazil has passed the recession phase and its economy is in absolute free fall and against a backdrop of an escalating currency war (which the country's most important trading partner has just officially entered), unattainable fiscal targets, and protracted weakness in commodity prices, the path to stabilization and rebalancing is anything but clear, but what does seem virtually certain is that Brazil has a date with junk status in the not-so-distant future.
And on cue, just moments ago:
- BRAZIL CUT TO Baa3 FROM Baa2 BY MOODY'S; OUTLOOK TO STABLE
So that's one step up from junk for Moody's and one step from junk for S&P - it shouldn't be long now, because no matter what Moody's says, there isn't anything "stable" about this situation.
[19]
We suppose the only lingering questions are whether Rousseff will be impeached and whether economic decay, a dangerously unstable political situation, and problems of a more, shall we say, "putrid [20]" nature, will conspire to make Rio a veritable ghost town for next summer's Olympic games.
Then again, this young lady doesn't seem particularly concerned...
