Investors are wary after federal government’s recent measures to contain fuel prices
06/27/2022
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Mariana Dreux — Foto: Ana Paula Paiva/Valor
The resurgence of fiscal and political risks in recent weeks has further clouded the horizon for Brazilian assets. Market mistrust has increased with the federal government’s recent measures to contain fuel prices, so that uncertainty about the public accounts has once again penalized domestic markets, in an environment aggravated by the tightening of financial and monetary conditions that has been generated, in a synchronized manner, by central banks.
Among the main risk metrics, the long-term real interest rate stands out for remaining close to 6%, while the Brazil risk measured by the five-year CDS returned to levels not seen since 2020 and is worse, in absolute terms, than in emergent peers like Mexico, Colombia and South Africa in 2022. Long-term nominal interest rates have also risen consistently; Brazil’s benchmark stock index Ibovespa has fallen below 100,000 points; and the foreign exchange rate is again above R$5.2 to the dollar.
“No doubt the fiscal risks have increased. Most of the current deterioration in the public accounts leaves scars, and that will make the work of the next administration difficult, especially on the tax front. The domestic economy has been very robust, but all the drivers indicate a much more pronounced deceleration ahead, with a contractionary level of interest rates and downward revisions in world growth. We are going to navigate through more turbulent seas,” said Mariana Dreux, a partner and macro funds manager at Truxt Investimentos.
She said the country collecting extraordinary revenues due to the cycle of high commodity prices, but when demand cools down, the economy will be exposed. She sees a much more complicated debt trajectory ahead. Despite recent gains, a reversion towards 100% debt-to-GDP ratio could be very fast, she says. She notes that Brazil’s potential growth has proven low and that the natural interest rate is no longer as low as imagined and may have risen.
Julio Fernandes, a partner and manager of multimarket fund strategy at XP Asset Management, shows similar concern. He points out that Brazil has a high debt problem and continues to discuss how to ease the spending cap rule, which limits public spending to the previous year’s inflation. And, since the fiscal situation is complicated, the government must be careful not to give up revenue permanently.
He wonders if the next federal administration will automatically resume taxes at the beginning of next year in case there is some kind of exemption, which would mean a gasoline and diesel price shock on the first day in office. Lowering taxes is easy, he says, but the problem is that if taxes are not resumed, the incoming government will see revenues plummet.
“If the hole becomes permanent, it tends to make the long end of the yield curve rise even more and cause the real to depreciate more than its peers. The uncertainty about the size of the fiscal hole is what leaves doubts in the market and increases the risk premium on assets. Part of the fall in the stock market is also due to the rise in interest rates, which affects stocks in the domestic sector.”
Drausio Giacomelli, the chief strategist for emerging markets at Deutsche Bank, said that at a time when several countries are experiencing the same problem of rising fuel prices, global agents are looking at the quality and magnitude of measures taken by each government to ease prices without deteriorating public accounts.
“We have a global risk reduction movement, and emerging markets are risk markets, which is part of the problem. In addition, when looking at how each country deals with fuel hikes, investors understand that focused and temporary spending is more desirable than dispersed and permanent spending. Brazil is lucky to have strong revenues in commodities. It can’t use something that is positive to cause structural damage,” he said.
Along these lines, according to Marcos Mollica, a manager at Opportunity Total, there is an important external component in the most recent stage of deterioration of Brazilian assets. After the 75-basis-points hike in U.S. interest rates by the Federal Reserve, the market began to price greater risks of a global recession. This, along with the lackluster signs from the Chinese economy, had an important impact on commodity prices.
“This is a very negative backdrop for Brazil. The stock market is impacted by it and there is great pressure on the exchange rate due to the worsening terms of trade. Vale has plummeted to R$70 from nearly R$90, and this had little to do with the Brazilian domestic risks,” the manager said. On top of that, however, there was also all the recent discussion of the government trying to bring fuel prices down. “We still haven’t managed to figure it out, as measures [studied by the government] started at R$20 billion and now are reaching R$50 billion.”
André Kitahara, AZ Quest’s macro portfolio manager, understands that, like several other governments around the world, the federal government is trying to attack an exogenous problem with the least damaging solution it can find. His major concern is that none of the solutions presented solve the problem in the long term, since no investment has been made for decades to expand the global supply of the commodity.
“As we are in the final year of a presidential term, we can’t expect anything great to happen. The more pressure the energy industry is under, the more heated the debate will be. But I am not pessimistic about Brazil. We are great exporters of commodities, the growth revisions have been positive, and the end of the monetary tightening cycle is also expected to help,” he said.
*By Victor Rezende, Matheus Prado, Gabriel Roca — São Paulo
Source: Valor International