It’s not that we want to pick on Brazil, it’s just that simply put, it’s one of the most important emerging markets in the world, which means that when depressed demand from China, plunging commodity prices, a shock devaluation from the PBoC, and the generally lackluster pace of global trade conspire to trigger an emerging market meltdown, Brazil is very likely to end up at the center of it all and sure enough, that’s exactly what’s happened.
Late last week, we noted that Brazil officially entered a recession [16] in Q2, a quarter which also ushered in the worst stagflation in a decade and saw unemployment rise to five-year highs. Then on Monday, the government officially threw in the towel [17] on running a primary surplus (striking a major blow to market confidence in the process) and then yesterday, we got a look at industrial production in July which missed wildly [18], coming in at -1.5% m/m versus consensus of -0.01%. Meanwhile, exports cratered 24%.
We could go on. And bear in mind that the budget issue is complicated by the fact that Rousseff’s political woes are making budget cuts next to impossible to pass. As Italo Lombardi, senior LatAm economist at StanChart told Bloomberg [19] earlier this week, the admission that the country would likely miss its primary surplus target underscores the trouble "Finance Minister Joaquim Levy faces in winning congressional approval for austerity measures and pushes Brazil’s credit rating closer to junk status." "Politics are making Levy’s life very difficult," Lombardi added.
So difficult in fact, that he may now resign and that, according to at least one trader, would be the worst scenario possible. Here’s Bloomberg with more [20]:
Brazil’s real declined for a fifth straight day and fell to a new 12-year low as speculation grew that Finance Minister Joaquim Levy is closer to leaving his post amid budget turmoil.
A gauge of the rout’s momentum rose to a five-month high as a Valor Pro newswire columnist, citing unidentified people at presidential palace, reported that Levy canceled a trip to the Group of 20 meeting in Turkey and planned to talk with President Dilma Rousseff later Thursday. In a setback for Brazil, the Treasury scrapped an auction of local fixed-rated government bonds for the first time in 19 months as yields at a six-year high made borrowing expensive.
“Seeing Levy leave would be worse than Rousseff stepping down or even her impeachment,” Guilherme Esquelbek, a currency trader at Correparti Corretora de Cambio, said from Curitiba, Brazil. “His departure is the worst scenario we can have right now.”
Meanwhile, Copom is stuck between a rock and a hard place - that is, they can’t hike to support the currency because the economy is in such terrible shape. Here’s Goldman on Wednesday’s MPC decision to hold Selic at 14.25%:
One could argue that given the drifting currency (approximately 20% since June) it would even demand additional rate hikes if the monetary authority's objective is still to, with reasonable confidence, drive inflation to the 4.50% target by end-2016. However, given the rapidly deteriorating real activity picture and heightened political/institutional noise and uncertainty, near-term rate hikes are unlikely.
[21]
And in the wake of last week's GDP data and Monday's confirmation of the budget blues, Barclays is out with a bit of decisively negative commentary both on the outlook for the economy and for the fiscal situation. Here's more:
We now forecast a 3.2% fall of real GDP in Brazil in 2015, to be followed by a 1.5% contraction the next year. The downside surprise in Q2 and the deeper recession in the second half of this year also imply a negative contribution to next year’s growth. Household consumption should continue contributing negatively to headline growth, together with fixed asset investment.
[22]
The disappointment with fiscal execution, coupled with the lack of capacity of the government to negotiate structural changes in how expenditures grow, leads us to expect a fiscal primary deficit for this year and next of 0.3% and 0.5% of GDP, respectively. For 2015, the fiscal measures approved in Congress were reduced meaningfully from the original proposal and are contributing with only 0.53% of GDP to the fiscal balance. Even including those, we forecast total real fiscal revenues to fall 3.2%, as the growth slowdown is having the biggest negative contribution on this year’s result.
[23]
And the inevitable result (as we’ve been saying for months):
The implication is a downgrade in less than one year. We believe the rating agencies will take off the investment grade rating in H1 16, starting likely in April by S&P, given the increased pace of deterioration of the macroeconomic juncture and the disappointment relatively to the agencies’ forecasts. Moody’s could follow suit in the second half of the year, if it becomes clear that the country will fail to achieve real GDP growth and the primary surplus as percentage of GDP near 2%, as the agency expects for 2017. At this point, it is very hard to foresee any meaningful change in the political and/or economic scenario that could avoid such an outcome.
[24]
Finally, in what is always the surest sign that a market-moving rumor is probably true, we got the official government denial this afternoon:
- LEVY SAYS HAS NO PLANS TO LEAVE BRAZIL GOVT: EL PAIS
Underscoring how serious the situation truly is, the headlines are still coming in with Bloomberg reporting that former President Luiz Inacio Lula da Silva "will travel to Brasilia tonight to meet with President Dilma Rousseff" for a one-on-one where the two will discuss "higher pressure on Finance Minister Joaquim Levy, 2016 budget proposal and possible restoration of CPMF tax."
Clearly, this is bad news. All sarcasm and jokes aside, it looks as though Brazil may be about to step off the ledge here. You now have a President with an approval rating of just 8% convening an emergency meeting with the former President, a finance minister on the verge of pulling a Varoufakis, a plunging currency, a hamstrung central bank, and a nightmarish fiscal situation.
So... who wants tickets to next summer's Olympic games in Rio?
