Brazil Economic & Political Outlook

Brazil’s economic performance continues to be strained by political turmoil and the widespread corruption and money-laundering scandal involving state-run oil company Petróleo Brasileiro SA (Petrobrás) and other state-owned companies. Brazil’s economy contracted for a fifth consecutive quarter in Q1 2016 amid the country’s deepest recession in recent history. GDP contracted 3.8% in 2015 and is expected to decline 4.3% in 2016 and 1.7% in 2017. Former Vice President and current interim President, Michel Temer, faces an uphill battle in restoring stability and investor confidence amid the impeachment of Dilma Rousseff and corruption allegations of his own.

Interim President Temer took over the presidency in May 2016 when former President Dilma Rousseff was forced to step aside to face a Senate impeachment trial on charges of doctoring the country’s accounts to mask a growing budget deficit. She denies any wrongdoing. Barring an unlikely scenario in which Rousseff’s suspension is overturned, Temer will serve as president through 2018. However, questions surrounding Temer’s administration, and his centrist Brazilian Democratic Movement Party (PMDB), have arisen. He was recently accused by Sergio Machado, former head of Petrobrás Transporte SA (Transpetro), of arranging illegal campaign contributions for PMDB in 2012, implicating him in the scandal related to Petrobrás. Even though Temer denies those allegations, the charges laid out may not be quickly or easily dispelled. Indeed, they implicate over 20 politicians from seven political parties, including Temer’s tourism minister, Henrique Eduardo Alves, who resigned after Mr. Machado’s testimony alleged he received bribes.

On the economic front, high inflation, unemployment, currency volatility, persistent budget deficits and increasing debt will complicate policymaking in the near term. In the last 12 months through June, inflation reached 9.0%, well above the Central Bank’s 4.5% target and its 6.5% ceiling. By year-end 2016, inflation is forecast to decrease to 6.9% and reduce further to 4.7% in 2017. At a policy meeting in early June, the Central Bank’s monetary policy committee (Copom) kept its benchmark interest rate at 14.25% (a near 10-year high). A reduction is not expected until December. Unemployment, meanwhile, increased to 11.2% between February and April 2016, compared with 9.5% in the previous three-month period. The unemployment rate is expected to continue rising and unlikely to decrease before 2018.

Although the Brazilian real has surged 19% this year to R $3.20 per U.S. dollar from R $3.96 per U.S. dollar on speculation Temer’s administration will bolster the economy and shore up the budget, ongoing impeachment proceedings and fiscal adjustment advances will contribute to continued exchange rate fluctuations. Externally, renewed U.S. dollar appreciation and China’s financial market developments will put additional pressure on the currency. Economists surveyed by the Central Bank forecast the currency to end 2016 at R $3.60 per U.S. dollar, 12% weaker than current levels.

The Temer administration is also under significant pressure to curtail the government’s growing budget deficit and increasing debt. The nation’s budget deficit reached over 10% of GDP in the last 12 months through April 2016. Gross debt reached 67.5% of GDP in the past year. This, after years of heavy public spending and steep tax breaks led to a credit-rating downgrade to BB+ from BBB- in September 2015. In February 2016, S&P further downgraded Brazil’s credit rating deeper into junk territory, to BB from BB+ with a negative outlook. Although the government does not plan on cutting spending on key social programs, such as education, health and social security, Temer has announced plans to overhaul Brazil’s pension and tax systems to address the budget deficit. Still, political tension fuels concern he may not be able to gather support in Brazil’s fractured Congress to pass such measures.

A protracted impeachment process, a second consecutive year of economic contraction, and a challenging political environment due to the Petrobrás scandal are likely to postpone Brazil’s economic recovery. Interim President Temer will have to find support in Congress for structural and fiscal reforms to stabilize the government’s finances and boost investor confidence, while contesting alleged corruption allegations of his own.

Authored by: Roberto Erana & Lorena Reategui

Sources: BBC, Bloomberg, Focus Economics, Forbes, Fortune, Latin America Monitor, Market Watch, NYT, Reuters, Scotiabank, The Rio Times, WSJ