Why Brazil Must Build a (Fiscal) Wall

Judging by the reaction of financial markets, the Brazilian economy started the year at high speed. The real is among the world’s best-performing currencies so far in 2019 and the main stock market index Ibovespa hit a string of record highs leading into last week, when it broke the 97,000-point mark. Future interest rates have fallen sharply.

Foreign investors are buying in as well. The premium demanded as compensation for the inherent risk of buying Brazilian bonds, the Credit Default Swap rate (CDS), that in September was above 310 basis points has fallen to around 180 basis points, a range close to that of emerging countries with an investment-grade seal.

Brazil’s new economy minister, Paulo Guedes, is at the heart of markets’ optimism. Starting with his inaugural speech, Guedes’ priorities have been music to financial investors’ ears. He proposes “fiscal walls” to sustain the 20-year public spending ceiling mandated by a constitutional amendment approved by Congress in 2016. These walls would consist of a public expenditure review with substantial pension reform, extensive privatizations – both as a source of extra proceeds and to re-focus companies on their core missions – a simplified tax code and, overall, an improvement of Brazil’s business environment.

There are nevertheless two major “buts.” Current optimism with financial assets is based on confidence that the entire Bolsonaro administration and Congress will move forward along the fiscal adjustment path. Current financial assets already reflect such a belief and we may see further highs as steps are taken down the road. But if the administration or Congress fails to act, or if the measures they take are perceived as weak, confidence may dissipate and bring down asset prices.

The second “but” has to do with the real economy, where private investment, income growth and, with a time lag, job creation take place. There is a stark contrast between the top floor of asset prices and the ground floor of the real economy. Even though agriculture is poised to yield a third super-harvest in a row and mining has maintained reasonable stability since the end of the recession, manufacturing has wobbled, and construction has performed unfavorably since 2016.

Then there is the labor market. Priscilla Burity, in a BTGPactual report, shows that the underlying labor market has crossed a patch rougher than what the headline unemployment rate may suggest. In big cities, unemployment rates are higher than national ones and have not trended down. The share of discouraged workers out of the labor force is near record highs and labor underutilization has risen since the first quarter of 2017. Even assuming annual GDP growth at 2.5 percent, single-digit unemployment rates are not expected before 2021. And an improvement of labor market conditions is necessary to underpin a virtuous cycle of credit and higher private spending.

At the beginning of 2018, conditions seemed robust enough for an acceleration of economic growth. Debt levels for families and companies had come down, interest rates were low and private banks’ ability and willingness to lend money was there. But the actual GDP performance has disappointed. Business confidence was never high enough to lift investments and, in an election year marked by political polarization, the private sector adopted a wait-and-see attitude.

Now the starting point is again one of higher confidence on a fiscal adjustment, while the overall scenario is still of lower household and corporate debt levels, low interest rates, easier financial conditions and idle capacity, including in the labor market. Growth forecasts are in the range of 2.5 percent to 3.0 percent for 2019-2020 with higher expectations for some virtuous cycle between new credit, increased business expenditures and a more active consumer outweighing the fiscal retrenchment.

The bottom-line for 2019 is straightforward. Either confidence in those fiscal walls is reassured and market optimism trickles down to the real economy, or the risks of a crash mounts – particularly as the global scenario looks riskier than in previous years. Given the current landscape, Brazil better build those walls fast.

 

Source: Americas Quarterly

Brazil reclaims status as an emerging-market darling among investors amid new leadership

Brazilian stocks have become one of Wall Street’s favorite destinations for investing this year as investors bet on big changes taking place in Latin America’s largest economy.

The Bovespa index, Brazil’s benchmark stock index, hit an all-time high on Monday and is up more than 8.5 percent thus far in 2019. The iShares MSCI Brazil ETF (EWZ), which tracks a basket of Brazilian stocks, has risen 12.2 percent this year. The EWZ is also outperforming EEM, the broader emerging-markets ETF, as well as funds tracking other emerging-market stocks.

The jump in Brazilian shares comes as investors cheer the possibility of key reforms being passed by new President Jair Bolsonaro, including pension reform. However, Bolsonaro has a limited time period to make these changes. He is also a polarizing figure given racist and homophobic statements he has made in the past.

Bolsonaro is “hitting all the right notes the market has been wanting to hear for years,” said Chen Zhao, chief global strategist at Alpine Macro. “That’s why I think the market reaction has been so positive. If he really delivers on what he promised, I think that could turn out to be a major supply-side story in the EM world.”

Brazil’s new president was elected with overwhelming support. Bolsonaro won the presidency in October with 55 percent of the vote as Brazilians grew fed up with a spike in violence and lackluster economic recovery.

The Brazilian economy contracted all throughout 2016 on the heels of a massive price drop in oil, one of Brazil’s biggest exports. U.S. crude futures briefly traded around $26 per barrel in early 2016 before rebounding; they traded above $51 on Monday. The economy turned around in 2017, but only grew by 1.1 percent. Quarterly GDP growth did not reach 1 percent in the first three quarters, FactSet data show.

Jens Nordvig, founder of Exante Data, said Brazil’s economy should be growing much faster after its collapse in 2016.

“They just had the biggest recession literally in the history of economic statistics. Coming out of a recession like that, you should have like 4, 5, 6, 7 percent growth for a number of years and they just have not had that,” Nordvig said, adding this goes back to some of Brazil’s structural issues, including an overcrowded pension system.

Brazil’s current retirement age is 60 for men and 55 for women. This has led to massive debt in Brazil. As of the end of November, Brazil’s government debt level was more than 75 percent of GDP, according to data from the Brazilian central bank.

But Bolsonaro’s election has increased bets that Brazil would be able to reform the country’s crippling pension system. More than 91 percent of investors surveyed by Bank of America Merrill Lynch believe pension reform will be done in 2019, with one third of respondents expecting it to be approved in the first half of the year.

The newly minted president has already suggested hiking the retirement age to 62 for men and 57 for women. He has also issued a decree that rolls back some benefits.

Investors are also expecting Brazilian shares to build on their hot start to 2019. Sixty-eight percent of investors polled by Santander expect Brazil to be the top-performing country for Latin American equities.

Brazilian stocks are expected to get a boost from a slowdown in rate hikes from the U.S. Federal Reserve, which is also expected to boost broader emerging markets. They are also expected to benefit from a privatization and deregulation push by the Bolsonaro administration.

“Inflation expectations have moderated and the perception of a dovish Fed strengthens the case for [the Brazilian central bank] to stand pat,” strategists at MRB Partners wrote in a note earlier this month. “The new government’s bias in favor of privatization and smaller government will support a re-rating in a number of listed state-controlled enterprises.”

Investing in Brazil does come with its fare share of risks, however.

A formal proposal has not been presented yet and time is of the essence for Bolsonaro. The Bolsonaro administration has its best shot at implementing meaningful pension reform in the next six months, according to Elizabeth Johnson of TS Lombard. After that, it becomes more of an uphill battle.

“They have a debt profile that is unsustainable. They need to address that via pension reform and tax reform. Everybody knows that. It’s just a matter of what flavor those reforms take and how quickly they get through,” said Exante Data’s Nordvig. “If those reforms don’t get done, this administration has already failed. That’s just a must-have.”

 

Source: CNBC

 

Brazil Treasury sees federal debt up as much as 11 pct this year

Brazil’s federal debt rose to 3.88 trillion reais ($1.03 trillion) in December, up 8.9 percent from 3.56 trillion reais a year earlier, and is expected to rise further this year, the Brazilian Treasury said on Monday.

The Treasury predicts public debt this year will swell to somewhere between 4.1 trillion and 4.3 trillion reais, the upper end of which would represent an increase of almost 11 percent, it outlined in its annual financing plan.

Brazil’s net financing needs this year are also expected to increase, by almost 20 percent to 779.7 billion reais from 651.1 billion last year, according to the Treasury’s projections.

The figures are the new government’s first official forecasts for Brazil’s debt and financing needs this year. President Jair Bolsonaro and his administration have drawn up an ambitious economic reform agenda, which foreign investors have welcomed.

Yet their share of Brazil’s debt holdings fell last year, ending December at 11.22 percent, down almost a full percentage point from 2017. Treasury is confident that will rebound this year.

“Foreign investors had a series of problems with emerging markets last year. But I was in New York in December … and investors are quite optimistic: they like the economic agenda we’ve presented,” Mansueto Almeida, Secretary of the Treasury, told reporters on Monday.

Almeida said that quick approval of the government’s reforms would improve Brazil’s outlook and allow Treasury to extend the average maturity of its borrowing and issue more fixed rate paper.

“Ahead of the elections last year they decided to reduce the duration of their borrowing, and they’re basically saying now that they intend to continue this strategy, which makes sense,” said one fund manager in Sao Paulo.

Brazil’s benchmark Selic interest rate is at an all-time low of 6.50 percent, and there is a growing groundswell of opinion that it will not rise much this year, if at all.

According to Treasury forecasts, Letras Financeiras do Tesouro, short-term notes linked to the Selic rate, will account for between 38 and 42 percent of the federal debt this year, up from 35.5 percent last year.

Fixed rate bonds will account for between 29 and 33 percent of the total debt stock, compared with 33 percent last year, while inflation-indexed bonds’ share is expected to be somewhere between 24 and 28 percent versus 27 percent last year, Treasury said.

Source: Reuters

Brazil in Spotlight as Appetite for Latin American Stocks Rises

Brazil is the country of the future, or of 2019 at least, money managers say.

Stocks in Latin America’s biggest economy will be the top performer in the region this year, according to 68 percent of respondents in a survey of investors that attended Banco Santander’s annual Latin American CEO conference. Another January survey by Bank of America Merrill Lynch showed about 90 percent of respondents expected the country’s stock gauge ending the year above current levels.

Brazil’s equity benchmark Ibovespa index is already up 8 percent this year, led by state-run companies, as investors bet the new administration will deliver on its market-friendly promises from privatizing companies to moving forward with pension reform. The index is currently trading at a record high and the median forecast of strategist estimates sees it closing 2019 at 105,950 — an 11 percent upside from current levels.

The Bank of America Merrill Lynch survey found that 91 percent of participants believe the long-awaited pension reform will be approved some time in 2019 and one-third of investors expect its approval in the first half of the year. Almost half of the respondents on Santander’s survey expect approval in the second half of the year.

Argentina, which is going through a presidential election year, was seen as the second best choice by Santander’s respondents, while those surveyed by Bank of America saw a quarter of investors planning to increase their allocations in the country and none reducing them. The benchmark S&P Merval index has gained 15 percent this year in dollar terms, the most among primary indexes, after wiping out more than 50 percent of its value in 2018.

Investors in Latin American stocks will be most focused on reforms and political developments in the region, then trade tensions between China and the U.S., global commodity prices and then the pace of Fed increases, according to the Santander survey.

Source: Bloomber

Brazil Is Back in the Game, Bolsonaro Will Tell Davos Investors

President Jair Bolsonaro will debut in the World Economic Forum of Davos this year with a mission — to present a new Brazil, more open to trade and foreign investment.

Investors will listen for sure. Prospects that the world’s ninth-largest economy may become more business-friendly sounds like music to the ears of oil executives and portfolio investors alike, after more than a decade of interventionist policies from previous governments. Even after a 20 percent rally over the past four months, the main index of the Sao Paulo stock exchange is still 40 percent below it’s all-time high in dollar terms.

For all the potential, investors will want more than just promises. Years of corruption scandals, economic recession and political turmoil that included a presidential impeachment are still fresh in the collective memory. A taste of economic populism in Mexico didn’t help the region either.

Now Brazil’s new leader, a former Army captain who has admitted to utter ignorance of economic issues, will have to convince his audience in the Swiss alps that he can plug a huge budget deficit by cutting expenditures and finding additional sources of revenue. The economic outlook for the country remains stable but disappointing, according to the latest estimates from the International Monetary Fund, which forecasts growth of 2.5 percent this year and 2.2 percent in 2020.

“Brazil is a hot topic for foreign investors,” said Fabio Alperowitch, portfolio manager and founder of Fama Investimentos, a Sao Paulo-based fund manager. “But no one will change their opinion just because of his speech. Investors’ level of skepticism with emerging markets is still high.”

On his long flight to Davos, Bolsonaro will carry the most crucial plan to tackle a budget deficit that hovers around 7 percent of gross domestic product — a draft proposal to cut pension outlays and save as much as 1 trillion reais over 10 years. Whether he will attract enough congressional support for the bill when lawmakers reconvene in February will be a make or break moment for his administration.

In the Spotlight

With the absence of regional leaders such as Argentina’s Mauricio Macri and Mexico’s Andres Manuel Lopez Obrador as well as big names such as Donald Trump or Xi Jinping, Bolsonaro should steal some of the limelight at Davos. While the presidents of Colombia, Ecuador and Paraguay were grouped into the same panel on Latin America, Bolsonaro will give his own “special address” on stage with WEF founder Klaus Schwab.

The president’s entourage will include his anti-corruption czar, former judge and now Justice Minister Sergio Moro, as well as the head of his economic team, Paulo Guedes. The University of Chicago-trained Guedes is expected to outline plans to downsize government, cut pension benefits and slash import tariffs.

“It’s a unique moment that you have a government that is unabashedly liberal,” said Alberto Ramos, chief Latin America economist at Goldman Sachs. “We’ve never seen that in Brazil.”

Many Possibilities

The potential is huge. Brazil not only sits on large energy reserves but it also has a sizable consumer market with pent-up demand for all sorts of quality goods and services, from premier health care to cheaper cars and better roads.

Take the example of solar panels. The sector grew nearly 400 percent last year and still only represents 0.4 percent of Brazil’s power matrix. That compares to around 6 percent of solar energy consumption in Germany, where solar radiation is 40 percent weaker than in Brazil, according to World Bank data.

In a taste of the kind of deals that may flourish under a Bolsonaro administration, the former paratrooper this month signed off on the merger that will give Boeing control over Brazil’s Embraer, the world’s third-largest plane maker.

Options are not limited to the aviation industry, where caps on foreign ownership were lifted last year. Up for sale are as many as 200 state-owned companies, including energy giant Eletrobras. As a result, the head of Brazil’s anti-trust agency, Cade, expects a 30 percent increase in M&A activity this year.

“The opportunities are large,” said Bernardo Schneider, Chief Executive Officer of Icatu Vanguarda, a Rio de Janeiro-based investment management firm with 21 billion reais ($5.6 billion) under management. “It’s not a chicken flight, it’s a long-term opportunity.”

Source: Bloomberg

Brazil Pension Overhaul to Boost Economic Growth

The Brazilian government’s proposed social security overhaul will rely on individual contributions to investment funds instead of guaranteed pensions, to ensure future generations receive pensions while also boosting economic growth, Presidential Chief-of-Staff Onyx Lorenzoni said Wednesday.

He said the government will include a “capitalization system” in a proposal to be sent to Congress in February. He said the plan would boost internal savings and spur economic growth by at least 3 percent a year.

Under the system, private pension funds fed by individual defined contributions would eventually replace the current public system based on a guaranteed package of retirement benefits.

Overhaul of the costly state pension system, or social security, is a top priority for Brazil’s new President Jair Bolsonaro, who blames it for chronic budget deficits and a mounting public debt. Previous governments have tried to reform the pension system before, but have faced years of resistance from public servants, unions and other groups.

The government is determined to send a complete pension reform proposal to Congress rather than partial reforms, to ensure that the benefits last longer, Lorenzoni said.

“We will fix this sinking ship called the pension system which has a hole on its hull,” he said in a radio interview.

The aim is to overhaul the pension system so it does not need to be reformed again for the next 20 or 30 years, he said.

Lorenzoni said no decisions have been made and new proposals will be presented to Bolsonaro next week.

Chile’s example

However, business daily Valor Economico reported Wednesday that the individual private contribution system would be restricted to higher income workers, who are a small portion of the pension system. The story cited anonymous sources close to Bolsonaro’s economic team.

Brazil is expected to follow the example of Chile’s privatization of social security introduced in the 1980s under dictator Augusto Pinochet that boosted savings and added liquidity to the stock market.

The highly privatized Chilean pension system has been widely imitated around the world.

Pensions in Chile are currently managed by six powerful private fund administrators, known as AFPs, holding nearly $200 billion in assets. These pensions have often fallen short of expectations, prompting angry protests in recent years by Chileans saying they have been short-changed.

Source: VOANEWS

China’s greater reform, opening-up to boost partnership with Brazil

China’s decision to open its door wider to foreign companies will help bolster China-Brazil economic, trade and financial partnership, a Brazilian business leader said.

The Chinese government has taken a series of measures, among them supports for foreign companies, and “it seems to me to be very important,” Brazil-China Business Council (CEBC) President Luiz Augusto Castro Neves told Xinhua.

“There are several Brazilian companies established in China, and there will certainly be others that are interested,” said Neves, citing China’s more welcoming regulations.

“Any company that intends to invest wants to know what the regulatory environment is like in the destination market, in other words, what you can do and what you can’t do,” he said.

China is the leading trade partner and largest foreign investor in Brazil while Brazil is looking to diversify its exports to China, said Neves, who served as Brazil’s ambassador to China from 2004 to 2008, a period when the bilateral ties grew remarkably.

The China-Brazil High-Level Coordination and Cooperation Committee was created in 2004. Two years later, the committee held its first meeting, so Neves had the opportunity to witness each step in China’s efforts to perfect its economic policies.

Neves praised China’s decision to modify the government’s role from “ratifying or approving” the establishment of foreign companies to “supporting and serving” them.

“Greater opening-up of the market and less intervention lead to a simple and clear regulatory environment,” said Neves, expressing confidence that the China-Brazil ties will continue to flourish.

The Brazilian businesses are banking on the relationship to keep expanding, he said.

“Brazil’s private sector is also hoping these ties of cooperation with China will grow even more,” said Neves.

More than 200 Chinese companies are operating in 23 of Brazil’s 27 states, said Neves, “so I hope the presence of Brazilian companies in China increases as well.”

To that end, various Brazilian organizations, including the CEBC and the export and investment promotion agency APEX, “which already has representative offices in China, will promote the bilateral economic and trade ties in conjunction with the Chinese government,” said Neves.

Source: Xinhua