If a week is a long time in politics, a few months is a long time in global pandemics. This is especially the case for Brazil, which having gone through an economic and political rollercoaster over the last few years – corruption scandals, presidential impeachment and its greatest-ever recession – seemed to be finally turning the corner.
When President Jair Bolsonaro´s administration entered power last year, the signs were good. Respected Finance Minister, Paulo Guedes, who promised pro-market policies and structural reforms, scored some early wins. GDP growth in 2019 was 1.1%, inflation and interest rates were at historic lows while the stockmarket hit record highs, growing 32%. Brazil was also the world’s fourth-largest destination for foreign direct investment and M&A activity grew.
However, as 2019 turned into 2020, the Covid-19 hurricane hit. As Nassim Taleb put it: “fragility is the quality of things that are vulnerable to volatility”. When the WHO officially called it a global pandemic on the 12th of March, Brazil had officially confirmed only 71 cases. But with lockdowns and social distancing measures announced by local and state governments, jitters transformed into concerns about the impact of the Covid-19 and the underlying strength of the Brazilian economy. By the end of March, with more than 5,700 cases confirmed and 201 fatalities, the real was at record lows to the dollar, and the country’s main stockmarket index, the Ibovespa, had fallen 37% since the start of the year.
For Guedes, Covid-19 was a “fleeting crisis, with a wave of impact which will also [subside] strongly”. He warned against suffocating the economy. Nonetheless, the federal government response escalated as the dual health and economic challenges became clearer. With the Senate passing the so-called ‘War Budget’, the government had more room for manoeuvre, allowing coronavirus-related spending to bypass constitutional spending limits.
Powerful economic response
Brazil’s combined fiscal and monetary package to support the economy and reduce economic contagion was R$1.6trillion, which is around 20% of GDP and a big increase on the initial emergency measures of R$150billion. The package was not all new money, as some had been previously announced. On the fiscal side, it included: R$150billion of deferred tax collections and advanced social assistance payments, R$50billion in emergency aid to informal workers, another R$90billion in supplementing furloughed company payrolls plus R$88billion for state governments. The fiscal measures add up to 5.2% of 2019 GDP and, according to UK-based consultancy, Capital Economics, this would push Brazil’s public debt ratio above 90% of GDP from the current level of 76%.
“ratings agency Fitch estimates that a quarter of Brazilian companies are highly sensitive to the financial impact of coronavirus…”
Separately, the Government has also announced the “Pro-Brazil” recovery plan led by the Presidential Chief of Staff, which aims to coordinate economic measures on job creation and infrastructure investment. The plan, initially criticised for a lack of details, projects R$280billion in PPPs, infrastructure concessions and fixed investment, and is expected to be rolled-out by October.
Monetary policy action also ramped up quickly to R$1.2trillion, which is 16.3% of GDP, in central bank liquidity injections, bank loans and reductions in compulsory reserves. The combined fiscal and monetary response is the largest in the region – yet Brazil may have to go further still.
Government action will be necessary to support the economy as it is widely expected that Brazil’s GDP will contract sharply this year. By how much is, in the words of Treasury Secretary Mansueto Almeida, “guesswork”. At the time of writing, the country’s coronavirus outbreak hasn’t yet peaked, with 67,000 cases and 4,555 deaths, mostly concentrated in São Paulo, the country´s economic capital, Rio de Janeiro and the northern states of Amazonas, Ceará and Pernambuco. This adds to the uncertainty, so it’s hard to tell just how bad the economic impact will be. The efficacy of government measures announced so far, post-lockdown activity and effect on major trading partners, especially the US, China and Argentina, all remain unclear.
Nonetheless, it’s obvious that the 2% projected GDP growth in 2020, that many analysts held as late February, is now impossible. Itaú, the country´s largest commercial bank, estimates the contraction in Brazil could be 6.4% of GDP. The unemployment rate is projected to rise to 16.2% in the second quarter, up from 11.65% – a potential loss of 5 million jobs.
And despite operating margins of public companies improving to 22% in 2019 from 12% in 2015, ratings agency Fitch estimates that a quarter of Brazilian companies are highly sensitive to the financial impact of coronavirus, due to low liquidity, currency risk and credit supply issues. Around 90% of SMEs have already seen revenues fall and many companies will not survive to see the recovery. Only the most optimistic forecasts now see the stock market above 100,000 points by year-end.
With economic activity under pressure, and despite currency turmoil, inflation is projected to dip below 3%. That will allow the central bank to cut interest rates from the current 3.75%.
The recovery is not likely to be linear or even similar across sectors and regions. Many major cities and states have started to slowly ease lockdowns. One of greatest country risk factors this year may be political. Hugely popular Justice Minister, Sergio Moro, the well-known hero of the Lava Jato corruption probes, resigned in April, citing political interference in Federal Police investigations, shaking the Government and shocking the country. While Brazil has seen three health ministers in less than three months. With political stress likely to remain elevated over the near-term, keeping the economy afloat – and Guedes onboard – will be key in helping to limit downside pressure to the country´s outlook.
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The three Ds – depth, duration and deflation – of the Covid-19 recession will help define the shape of Brazil’s recovery. Unlike previous recessions there is no major systemic cause of the downturn. Therefore, the uptick can be swift but certain parts of the economy could remain damaged and impaired well into the future. Some sectors, such as agribusiness, should remain robust. On a positive note, the market consensus expects an uptick in a basket of economic indicators from next year. Bradesco forecasts average annual GDP growth at 3% to 2023. It will be necessary however, to resume the path of reforms and stabilise the debt trajectory to ensure medium-term economic sustainability. Brazil’s initial economic and financial response has been impressive – now it needs to plot a return to growth.