Brazil Update

Brazil’s economy is expected to contract by as much as 3.0% in 2015 and 1.0% in 2016, according to the IMF. In August, the country entered into a recession after reporting two consecutive quarters of negative growth. Brazil’s GDP shrank 1.9% between April and June 2015, after contracting 0.7% during the first quarter. The downward trend has been fueled by currency volatility, high inflation, rising unemployment, and political turmoil intensified by a widespread corruption scandal involving state-run oil company Petróleo Brasileiro SA (Petrobras).

The Brazilian real has depreciated 60% against the U.S. dollar over the past 12 months. On September 22nd, the real weakened past R$4.00 per U.S. dollar, its lowest level since its introduction in 1994. Since then, the real has improved slightly to R$3.87 per U.S dollar. The real’s deterioration in recent months can be attributed to political and economic concerns, putting additional pressure on credit ratings. On September 9th, Standard & Poor’s cut Brazil’s sovereign debt rating to junk status with a negative outlook, raising fears of a massive sell-off of Brazilian assets by large U.S. pension funds and other investors required to hold investment-grade securities. Fitch Ratings and Moody’s Investors Service still rate the nation investment grade.

Brazil’s inflationary pressures, meanwhile, have risen dramatically despite consistent hikes in the Central Bank’s benchmark interest rate. The benchmark rate was raised to its highest level in nine years (14.25%). Inflation currently tops 9.5%, well above the Central Bank’s self-imposed upper limit of 6.5% and its 4.5% target. Unemployment is far above original forecasts, soaring to 7.6% in August, a five-year high. In the last 12 months to September, Brazil lost nearly 1.0 million payroll jobs.

The swift deterioration of Brazil’s job market is taking a toll on President Dilma Rousseff, whose approval ratings have plunged to 10% just ten months into her second term. The President’s popularity has been weighed down by a massive corruption and money-laundering scandal tied to Petrobras. Though she has not been directly implicated in the scandal, she chaired the Petrobras board from 2003 to 2010, when part of the alleged corruption took place.

Faced with a troubled economy, President Rousseff is trying to get Brazil’s finances in order via spending cuts and tax increases. In mid-September, the government announced nearly US $17 billion of new austerity measures to close a gaping budget hole and restore investor confidence. The proposed measures are aimed at delivering a primary surplus equal to 0.7% of GDP next year. Moreover, President Rousseff recently reduced the size of her Cabinet from 39 to 31 members. Her administrative reforms also include a 10% cut in ministry salaries, a 20% cut in ministry expenses, the elimination of 3,000 positions and spending limits on telephone calls and travel. Together, the measures are estimated to save about US $50 million.

The bigger challenge, however, will be reducing Brazil’s debt load, which has reached a record 64.6% of GDP. Uncertainty looms over how President Rousseff’s administration will fare in making deep changes to restore economic activity. Despite recently voting to uphold certain key presidential vetoes on US $31.5 billion in additional expenses, repeated clashes between the President and opposing lawmakers have made it difficult for President Rousseff ’s economic team, led by Finance Minister Joaquim Levy, to move forward with economic reforms designed to correct fiscal imbalances. As political turmoil and the recession continue to feed each other, the economy may continue to struggle at the outset of Q4.

Authored by: Lorena Reategui