Perspectives

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21  
EcoPerspectives // 4 quarter 2018  
economic-research.bnpparibas.com  
Brazil  
Radical political changeover?  
The economic, political and moral crisis that has held Brazil in its thrall for several years has crystallised in general elections that  
have seen a section of the electorate swing to the right. The Roussef and Temer presidencies  marred by corruption scandals and  
two years of deep recession in 2015 and 2016  have provided a fertile ground for a further fragmentation of Brazil’s political  
landscape. The swinging of the political pendulum risks increasing social tensions at a time when the macroeconomic environment  
deteriorates as growth loses steam, investment contracts, government debt builds up and the external environment looks  
increasingly uncertain.  
A possible shift to economic liberalism?  
1
- Growth and inflation  
GDP Growth (%)  
In a national context where corruption, violence and unemployment  
have been key preoccupations of the electorate, and with the  
country ranking last (137 ) on the criteria “public trust in politicians”  
 Inflation (%)  
Forecast  
Forecast  
th  
9.0  
8.7  
(
component of the World Economic Forum’s Global  
Competitiveness Index 2017-18), Brazilians headed to the polls on  
th  
October 7 to elect their President, 54 of their 81 Senators, all of  
3.7 3.7  
3.4  
3.0  
their federal and regional Parliamentarians and their 27 State  
Governors. The polls predictions of recent weeks were borne out in  
the first round of the presidential elections as Jair Bolsonaro of the  
Partido Social Liberal (PSL) and Fernando Haddad of the Partido  
dos Trabalhadores (PT, or WorkersParty) found themselves  
through to the second round.  
1.5  
18  
1
.0  
-
3.5 -3.5  
1
5
16  
17  
19  
15  
16  
17  
18  
19  
Sources: National statistics, BNP Paribas  
Over and above the marked polarisation of the electorate, two  
important developments - largely underestimated by polls - defined  
the elections: Bolsonaro’s score (46% of the popular vote, or 49  
million votes, 18 million more than his challenger); and the major  
shakeup in both the Senate (87% of new entrants out of the 54  
seats in contention) and the lower house where the PSL markedly  
improved its footprint (52 seats out the 513, from just one in 2014),  
making it the second most represented party after the PT). Financial  
markets - which had partly anticipated the showdown between  
Bolsonaro and Haddad in the run-up to the vote - welcomed the  
results favourably. Equity markets soared, anticipating a wave of  
privatisations in the event of a Bolsonaro victory. The real made  
gains against the dollar, continuing its upward trend initiated at the  
end of September. The currency which has experienced bouts of  
volatility during the year is still down 14% year-to-date.  
2
- Market rally ahead of the elections  
Ibovespa Stock Index (lhs)  
▪▪ Nominal Exchange Rate USDBRL (rhs, inverted)  
89 000  
84 000  
79 000  
74 000  
69 000  
3.2  
Elections  
(1st round)  
3.4  
3.6  
3.8  
4
4.2  
On the economic policy front, Bolsonaro is a liberal. To address the  
country’s fiscal challenges he proposes a drastic scale back of  
government through large-scale privatisations, spending cuts and a  
transition towards a funded pension scheme. If elected, he will most  
likely “depoliticise his cabinet appointing prominent figures from the  
military and the business world. Paulo Guedes, an economist  
trained at the University of Chicago, would be his Finance Minister.  
Haddad, on the other hand, would prioritise job creation and the  
revitalisation of the economy over fiscal consolidation. If elected,  
Haddad intends to reverse the Temer government’s reforms, which  
would entail lifting the cap on public spending (in real terms),  
suspending privatisation initiatives, repealing the labour code reform  
and reintroducing minimum local content requirements (in terms of  
both goods and services) in the energy sector. In addition to  
introducing a unified value-added tax, he would also seek to  
April-18  
June-18  
August-18  
October-18  
Sources: Thomson Reuters, BNP Paribas  
reinvigorate the role of publicly-owned banks in the economy and  
would pursue a policy of concessions based on Public-Private  
Partnerships (PPP).  
A lacklustre recovery  
The economic recovery, initiated in 2017, has struggled to latch on.  
Tainted by the truckers’ strike , GDP only progressed by +0.2% q/q  
in Q2 in seasonally adjusted (sa) terms, and by +1% y/y. Consumer  
spending barely held on (+0.1% q/q sa) while investment, which had  
experienced an upturn for a year, contracted sharply (-1.8% q/q sa)  
1
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rd  
Eco Perspectives, 3 quarter 2018  
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22  
EcoPerspectives // 4 quarter 2018  
economic-research.bnpparibas.com  
most likely affected by the wait-and-see attitude ahead of the  
elections. Ultimately, growth was kept afloat thanks to an uptick in  
public expenditure (+0.5% q/q sa), and more importantly a strong  
positive contribution from stock building which offset a negative  
contribution from net external demand.  
3
- Budget: little room to manoeuver (2017)  
%
of total spending  
Interest  
Payments  
21%)  
Mandatory  
Expenses:  
Social Security  
benefits  
(
On the supply side, the service sector alone helped bolster growth,  
with a rise of +0.3% q/q sa. Manufacturing and construction saw a  
contraction of -0.8% q/q sa, while growth in the agricultural sector  
was muted. That being said, Brazil Services PMI remains below the  
(
34%)  
Discretionary  
Expenses  
5
0-point mark (46.4 in September).  
At the end of June, the statistical carryover for 2018 stood only at  
%. The latest indicators show mixed signals regarding the  
(
16%)  
1
Other  
Mandatory  
Expenses  
Mandatory  
Expenses:  
Payroll  
evolution of economic activity in Q3. On the one hand, industrial  
production and the consumer confidence index have deteriorated.  
On the other hand, the upturn in credits to household combined with  
a slight improvement in the labour market (marked by a one point  
reduction in the unemployment rate to 12.1% over the period March  
to August and the acceleration of wage growth in real terms in  
August) should help support consumer spending.  
(11%)  
(18%)  
Sources: Tesouro Nacional, BNP Paribas  
government spending and 6.1% of GDP in 2017) and potential  
growth is significantly lower than 10 years ago (4.5% versus 2.5%).  
Against this national backdrop, the external environment is expected  
to be less supportive due to the reorientation of China’s growth  
model, the slowdown in global growth and trade, tighter global  
liquidity conditions and higher oil prices. Faced with these  
headwinds, the future government will find itself in a delicate  
position as it seeks to reform the pensions and social security  
systems at a moment where markets remain on close watch.  
Despite stable inflation at 4.5% in September, and a continued  
modest capacity utilisation rate, the yield curve appears to anticipate  
a tightening of monetary policy by year end. At a time where further  
currency depreciation can be expected - following a general retreat  
of non-resident portfolio investments from emerging markets -  
inflation is likely to pick up as a result of the pass-through  
associated with increases in certain commodity prices. In contrast to  
neighbouring Argentina, the weakness of Brazil’s currency does not  
reflect balance of payments imbalances (the financial account is  
largely positive, thanks to direct investments), but rather echoes  
concerns over fiscal consolidation in an uncertain political  
environment. Since 2013, the government has not been able to  
extract a primary budget surplus (-2.3% of GDP expected in 2018)  
to offset the cost of interest payments (expected to absorb 16% of  
government receipts by end-2018) and thus contain the march  
forward in gross debt to GDP ratio (77% expected at end-2018  
versus 51.5% at end-2013). Other constraining factors include low  
economic growth and high mandatory spending which are  
characterized by poorly targeted social security transfers and very  
generous pensions. The weakness of the BRL produces an  
additional constraint for stabilizing the debt ratio, in spite of public  
Translating the candidates’ electoral platforms into policies will also  
be constrained by the increasing political fragmentation in Congress  
which may hinder governability. Given the new distribution of seats,  
the lower house will be even more fragmented than it was before,  
with 9 parties having between 25 and 40 seats each in a house  
where no fewer than 30 parties are represented (against 26 prior to  
the elections). In this potentially deleterious policy environment, it  
remains to be seen if coalition-building will embrace a partisan look  
and potentially translate into political inertia. High levels of political  
fragmentation are also not likely to encourage the political class to  
reform itself, at a time where hundreds of politicians are still  
implicated in corruption scandals. Brazil’s political life will no doubt  
continue to live at the rhythm of prosecutions and plea bargains.  
The election of Mr Haddad would not only result in the potential  
rolling back of the Temer reforms but would also not meet the  
aspirations of a large section of the population to witness a radical  
political changeover as well as see a deep clean-up of Brazil’s  
governance act. A Bolsonaro victory on the other hand could lead to  
potential abuses at the hands of the security forces; coupled with  
greater economic austerity and an overhaul of Brazil’s social model,  
this could lead to an intensification of social unrest and a surge in  
political violence.  
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external debt only accounting for 3% of total public debt .  
A complicated heritage, a challenging governability  
and a risk of social tensions  
st  
When he takes office on January 1 2019, the elected President will  
inherit a macroeconomic environment characterized by a dual reality.  
While on the one hand inflation is stable and moderate by historical  
standards and the country boasts a solid net external asset position  
thanks in part to the continued resiliency of foreign direct  
investments (Brazil was the 3rd largest recipient of FDI in 2017  
according to UNCTAD), on the other hand fiscal accounts exhibit  
very little room to manoeuver, debt service costs are high (16% of  
2
Eco Perspectives, 2nd quarter 2018.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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