Emerging

An increasingly preoccupying situation

nd  
Eco Emerging // 2 quarter 2021  
economic-research.bnpparibas.com  
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BRAZIL  
AN INCREASINGLY PREOCCUPYING SITUATION  
The health crisis continues to worsen – undermining the economy to a point of entertaining a recessionary risk in the  
first half of 2021. In this context, confidence has plummeted and financial markets have retreated. The vaccination  
campaign – after facing significant logistical challenges – has finally begun to accelerate since mid-March and with  
the concomitant introduction of new restrictive measures, the hope is that the epidemic curve will reach an inflection  
point over the next two months. Faced with rising inflation and inflation expectations, the Central Bank launched its  
monetary tightening cycle, which – against a backdrop of slowing economic activity and a high sovereign interest  
burden – has exacerbated budgetary pressures and risks. Although weakened by the crisis, financial soundness  
indicators of the banking sector remain very favourable.  
COVID-19: A CRITICAL SITUATION…  
with shortages of drugs and oxygen – Brazil has been experiencing  
its darkest hour of the pandemic so far. The epidemic continues to  
accelerate in most regions with the exception of a few states in the  
South where the situation has stabilized. The variant, which is between  
FORECASTS  
Confronted with the spread of the P1 variant of the coronavirus  
(
emanating from the Amazon region) while simultaneously dealing  
2
019  
2020e  
2021e  
2022e  
Real GDP growth (%)  
1.4  
3.7  
-5.8  
74  
-4.3  
3.2  
2.5  
6.5  
-9.4  
91  
3.0  
4.0  
-8.2  
94  
Inflation (CPI, year average, %)  
Fiscal balance / GDP (%)  
-13.2  
89  
1
.4 and 2.2 times more contagious – is responsible for the majority of  
Gross public debt / GDP (%)  
Current account balance / GDP (%)  
External debt / GDP (%)  
new cases and is increasingly affecting younger people (over 30% are  
under the age of 60). The mortality rate has doubled in a month to  
such extent that at the end of March, Brazil accounted for a quarter  
of new deaths worldwide. In 17 of the 26 states, the occupancy rate of  
intensive care units is higher than 90% including three states which no  
longer have any beds available. Recent studies show that the variant  
could be resistant to antibodies produced by (a) previous infections and  
-2.7  
37  
-0.9  
43  
-0.4  
41  
-1.9  
39  
Forex reserves (USD bn)  
357  
17  
356  
21  
350  
19  
346  
18  
Forex reserves, in months of imports  
e: ESTIMATES & FORECASTS  
TABLE 1  
SOURCE: BNP PARIBAS GROUP ECONOMIC RESEARCH  
DAILY COVID-19 VACCINATIONS  
(
b) certain vaccines – thereby facilitating reinfections.  
The deployment of vaccines – launched in mid-January – has so far  
been insufficient to slow the progression of the epidemic. At the end  
of March 8.5% of the population had received a first dose of a vaccine  
9
8
00 000  
00 000  
(
about 2% had received two doses). Faced with vaccine shortages,  
several states have had to halt their vaccination campaign (including  
Rio de Janeiro). Since mid-March however, the pace of vaccinations has  
accelerated and is expected to ramp up in April as more doses become  
available (Brazil has called upon virtually all vaccine suppliers for  
doses and federal authorities have authorized local governments and  
private companies to place orders). Assuming the pace of vaccinations  
holds at some 600,000 shots per day and lockdown restrictions,  
recently imposed by local officials, are effective (including curfews, the  
closing of non-essential businesses, moving up school holidays) – the  
epidemic could reach an inflection point towards the end of May. Brazil  
is still aiming to vaccinate at least half of its population by the end of  
700 000  
600 000  
5
4
3
00 000  
00 000  
00 000  
200 000  
1
00 000  
-
Jan-21  
CHART 1  
Feb-21  
Mar-21  
2
021.  
SOURCE: OWID  
WITH POTENTIALLY HIGH POLITICAL STAKES  
Faced with an increasingly dire health situation, rising inflation and  
the return on the political scene of former President Lula (2003-2011),  
President Bolsonaro has come under increased pressure and his  
HEADING TOWARDS A CONTRACTION OF GDP IN Q1... AND Q2  
popularity – once bolstered by a generous emergency aid package in Undermined by the worsening dynamics of the epidemic and the  
the wake of the first epidemic wave – is eroding, even within parts of withdrawal of fiscal support measures, activity indicators in Q1 have  
his own political base. Also, the decision in February by the Republic’s lost steam and are pointing to a likely contraction of sequential GDP  
Public Prosecutor to dismantle the anti-corruption operation Lava in the first quarter. January’s resilient performance proved to be short-  
Jato (which sent Lula to prison), and the annulment of the former lived as industrial production reversed in February (-0.7% m/m) –  
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President’s sentence by a judge of the Supreme Court have revived contracting for the first time in 10 months driven by lower automotive  
speculations about a possible electoral battle between the two men and mining production. According to March PMI indices, activity conti-  
in 2022.  
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Lula was however not exonerated and will be judged by a Federal court in Brasilia deemed “more competent” to examine the four existing cases against the former President.  
The bank  
for a changing  
world  
nd  
Eco Emerging // 2 quarter 2021  
economic-research.bnpparibas.com  
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nued to contract in the services sector for the third consecutive month,  
and manufacturing production also declined. On the demand side, the  
expiration of emergency support measures reduced the consumption  
capacity of households. Lastly, despite the depreciation of the BRL  
and large improvements in the country’s terms of trade, net exports  
will likely make a more modest contribution to growth than originally  
anticipated owing to the faster increase in imports (largely due to  
purchases of oil rigs by Petrobras). As such, the Q1 trade surplus  
USD BRL VS TRADE-WEIGHTED DOLLAR INDEX  
105  
103  
101  
2.5  
DXY index (lhs)*  
USDBRL (rhs - inverted)  
3
3.5  
4
9
9
9
9
9
8
8
8
9
7
5
3
1
9
7
5
(
USD 1.65 bn) was two times smaller than market forecasts.  
4
5
.5  
The short-term outlook has also weakened and there is an increasing  
risk that the economy could experience a technical recession in H1.  
Granted, household consumption will get a boost from a new round  
of emergency aid voted in March, but the package will be much more  
limited in terms of size and reach. Also, rising inflation and plummeting  
household confidence (-10 points in March) point to increased caution  
on the part of consumers. On the supply side, although agriculture  
should continue to be resilient, the services sector will suffer from  
recently imposed mobility restrictions. Several factors are also likely  
5.5  
6
2
015  
2016  
2017  
2018  
2019  
2020  
2021  
*A rise in the index indicates an appreciation of the USD  
CHART 2  
SOURCE: MACROBOND  
to undermine industrial activity, including (i) slowing production in rates in the US. The appreciation of the US dollar that it sustains  
the manufacturing sector as new orders have declined, (ii) the likely could indeed incur a greater inflationary risk by increasing the price of  
continued slowdown in civil construction seen since January, and (iii) imports. However, as the epidemic escalates and the economy slows  
the temporary suspension of production by seven big automotive down, rising rates represent an additional source of fiscal risk. A one  
manufacturers in April. The automotive sector, which saw its sales percentage point (pp) increase in the SELIC represents an additional  
collapse in 2020 (-21.6%), was also marked by the shut down in interest charge of about BRL 30 bn to 35 bn for the Treasury amounting  
rd  
January of three Ford production plants – the company having decided to about 2/3 of the emergency aid approved in March. This comes  
to pull out of the Brazilian market. Economic prospects should be more at a time when pressures on the spending cap have been mounting,  
favourable in the second half of the year (wider rollout of vaccinations, culminating in a deadlock between congressional leaders and the  
stronger global growth). The extension in time of lockdown restrictions government over final approval of the budget. The government’s  
will remain an important downside risk to growth (according to the manoeuvring room to increase –already quite limited– discretionary  
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Independent Fiscal Institute, when 50% of activity is paralysed, GDP spending (about 5% of the budget) will likely be even tighter this year .  
falls by about 1 percentage point).  
The weakness in the stock market (-6%) and the currency (~10%)  
witnessed since the beginning of the year are symptomatic of the  
concerns hovering over the economy. Such retreats are also a reflection  
of a rise in political risks due to (i) fears of greater state interventionism  
BANKING SECTOR: STRONG RESILIENCE  
In 2021, as repayments on loans (restructured during the crisis) pro-  
gressively come due, banks will witness an increase in non-performing  
loans. A weaker repayment capacity on behalf of both households and  
corporates will in part drive this process. Household debt has risen and  
so has unemployment (14.7% s.a, in January); the labour market parti-  
cipation rate declined by some 5.1 pp in 2020 while the real wage bill  
continued to contract early in 2021 – pushing household debt service  
ratios to rise rapidly. Corporates – which have now experienced their  
third recession over the past 6 years – also report higher debt ratios.  
However, thanks to higher precautionary savings and emergency credit  
support programmes (Pronampe, PEAC), they exhibit better liquidity  
ratios, notably with respect to short-term debt.  
(
the appointment by Bolsonaro of an army reserve general at the head  
of Petrobras has temporarily caused the oil giant’s stock price to lose  
0%), but also (ii) concerns over a rise in populism with increased risks  
of fiscal slippage. The market’s perception of increased sovereign risk  
the 5-year CDS has increased from 145 bps to 224 bps since January,  
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(
while sovereign risk premia on 10-year yields are close to their 2015  
peak ) – has materialized just as BRL 350 bn (4.7% of GDP) of sovereign  
bond debt matures in April – a record.  
MONETARY TIGHTENING CYCLE AND FISCAL PRESSURE POINTS  
Banks – despite experiencing sharp falls in profits and ROE– are still  
The faster-than-expected rise in the IPCA consumer price index (+5.2%, well positioned to absorb losses on their balance sheet as well as han-  
in February, driven by higher transportation costs in particular), has dle liquidity shocks. The banking system displays (i) high capital ade-  
prompted the Brazilian Central Bank (BCB) to lift its policy rate in quacy ratios (regulatory capital to risk-weighted assets of 16.7%) (ii)  
March – a first in 6 years. The 75 bps hike in the SELIC (previously held very good coverage of short-term liabilities by liquid assets (iii) low  
at 2% since August 2020) is the first of several tightening actions aimed dependence on market financing, with a loan-to-deposit ratio of more  
at normalizing monetary conditions in the economy. The BCB foresees than 90% (iv) relatively low non-performing loans ratios (90-day delin-  
inflation at 5% at the end of the year, close to the upper range of its quencies have oscillated between 3% and 4% over the past five years)  
target (3.75%, +/- 1.5 pp).  
and (v) banks’ balance sheets tend to have little exposure to currency  
risk. Even if they have declined, banks’ intermediation margins remain  
high (interest rate spreads of 15.6 pp). Finally, the BCB’s stress tests  
also demonstrate a good resistance of banks’ portfolios to a rise in  
interest rates.  
The BCB wants to avoid a de-anchoring of inflation expectations in a  
context of the continued weakness of the BRL, rising commodity prices  
and higher risk premia –driven by increased fiscal uncertainty. The hike  
in rates also comes at a time when investors’ appetite for emerging  
markets assets is somewhat waning with the rise in real terms of long  
Salim Hammad salim.hammad@bnpparibas.com  
2
The Treasury and the Independent Fiscal Institute noted that the budget approved by Congress in March significantly underestimated mandatory spending. Once adjusted, this will lead  
to a further decline in discretionary spending (the budget in its current form would otherwise break the spending cap, the Federation’s main fiscal rule).  
The bank  
for a changing  
world  
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