Brazil: Economy may have bottomed – RBS

Brian Daingerfield, Research Analyst at RBS, suggests that after several years of contraction, Brazil’s economy may have bottomed even though the industrial production growth is still negative on a y/y basis, but has improved after plunging as much as 13.5% in January 2016.

Key Quotes 

“Erosion in domestic demand has also contributed to rebalancing of the current account – Brazil briefly ran monthly current account surpluses in 2016 for the first time since 2009. The BRL benefits not only from its balanced / small deficit current account, but also from its relatively small direct exposure to export growth among EM economies. Exports as a percent of GDP total just 13% in Brazil. That sits below most of its peers in Latin America (excluding Argentina) and well below most major EM nations as well, a relative shield from rising protectionist policies.”

“On the fiscal front, the Temer government is awaiting approval on a constitutional amendment that will cap fiscal spending for a period of 20 years, allowing for a revisit of the provision after 10 years. The government has also made social security reform a top priority in early 2017. Brazil’s next federal election is not scheduled until late 2018, but a deepening of unpopularity with the current administration is a risk, especially as austerity continues to grip throughout 2017.”

“The BCB has begun the process of gradually normalizing interest rates by cutting the SELIC rate to 14.0% in October. The BCB has made it clear that the progress of the government’s reform process and the path of actual inflation will be critical to the pace of rate cuts over 2017. Inflation remains in a disinflationary trend, owing to a tepid domestic growth outlook, the alleviation of impacts of prior hikes in regulated prices, and a strengthening of the FX rate. We expect a disinflationary trend to continue in 2017, allowing for a continued gradual pace of rate cuts to continue throughout 2017. We expect only modest rate cuts early in 2017, with risks of more pronounced cuts rising later in the year if the BCB gains confidence that disinflation will continue.”

“While we retain an overall cautious view on EM as we head in 2017, we will look for opportunities to pick up value in Brazil. Brazil’s carry advantage remains sizeable, even in an environment where policy rate cuts continue from their current 14.0% level and Fed rate expectations are rising in the US. Brazil’s central bank has sufficiently adequate reserves to continue to smooth volatility in the currency, and its current account has improved.”