Fiscal uncertainty weighs on Brazil’s GDP growth outlook

After bets on Selic rate cuts reversed in financial markets following the surprise outcome of Brazil’s presidential election runoff, analysts are now forecasting an even more challenging 2027 for economic growth. Expectations that the benchmark interest rate will remain unchanged for an extended period, or even rise again, add to signs that economic activity is losing momentum more rapidly this semester, reducing the statistical carryover into next year.

In a revised outlook released Friday (30), Itaú Unibanco said it now expects GDP to grow 1.6% this year, down from its previous forecast of 1.7%. For 2027, it cut its estimate from 1.2% to just 0.5%.

“The revision reflects the incorporation of higher interest rates and weaker economic activity over the coming year. The need to maintain restrictive monetary conditions for longer is expected to intensify the cumulative effects of monetary tightening on consumption, investment and credit conditions,” wrote the team led by former Central Bank director Diogo Guillen. The bank now expects the Monetary Policy Committee (Copom) to halt its rate-cutting cycle and keep the Selic policy rate unchanged at 13.75% through the end of 2027, in an effort to curb inflation, which it projects will reach 6.1% by the end of next year.

Economic weakness and high inflation “limit growth in real income and consumption, with a particularly significant impact on lower-income households. At the same time, high household debt makes consumption more sensitive to tighter financial conditions. Against this backdrop, we expect domestic demand to remain sluggish in 2027, with the balance of risks to growth still skewed to the downside,” Itaú said.

ABC Brasil has also removed Selic rate cuts from its baseline scenario through the end of 2027. “With tighter financial conditions and less fiscal stimulus, we have lowered our GDP growth estimate from 1.9% to 1.7% in 2027 and to 1% in both 2027 and 2028,” the bank said. It had previously forecast growth of 1.5% for 2027 and 1.6% for 2028.

President Lula’s election victory on Sunday (25) caught much of the market off guard and triggered a sharp sell-off in domestic assets, prompting analysts to revise their forecasts. With expectations that the necessary fiscal adjustment will not materialize, risk premiums have risen, as have longer-term inflation expectations. Despite Central Bank interventions, the dollar rose 9.04% last week, its biggest weekly gain since the 2008 financial crisis. The benchmark stock index Ibovespa also posted its steepest weekly loss since the pandemic. In the interest-rate market, 10-year yields climbed back above 15%.

“The selloff in Brazilian assets poses a greater threat to growth than to inflation in the country,” Capital Economics said in a report. “The most immediate effect will be exchange-rate pass-through to inflation, but this should be limited. If the exchange rate remains at current levels, the pass-through should add 0.3 percentage points to headline inflation over the next six months,” analyst Liam Peach wrote.

The greater threat comes from tighter financial conditions, he said. “The economy is vulnerable to higher interest rates because of the deterioration in public- and private-sector debt. Household debt service has reached a new record of 29% of income, while borrowing costs and corporate defaults are at historically high levels. Even if Copom keeps the Selic rate unchanged at its next meetings, borrowing costs are likely to rise. Combined with the fact that the economy was already showing signs of slowing before the election, tighter financial conditions reinforce our forecast that GDP growth will decelerate to 1% next year.”

Asset manager ASA has an even gloomier outlook. Although it still expects further rate cuts by the end of 2027—forecasting that the Selic rate will resume its decline at some point between the second and third quarters—it has cut its GDP growth forecast for next year from 1% to zero. The revision reflects the delayed impact of measures announced this year, “regardless of any fiscal measures that may eventually be announced.” The firm also warns of a risk of recession, depending on how economic agents respond.

“Without expectations of a credible fiscal adjustment, inflation expectations are likely to remain unanchored, and may even deteriorate further, making the Central Bank’s job more difficult. The monetary authority is expected to resume rate cuts only around mid-2027, as the sharper loss of momentum in domestic activity becomes more evident. In any case, the new reality will involve a higher neutral interest rate, with the Selic ending 2027 at 13%,” ASA said.

“In this scenario, with lower GDP growth, interest rates remaining at higher levels and technical and political obstacles to a faster fiscal adjustment, we project a further deterioration in the trajectory of gross public debt, which is expected to rise more rapidly in the coming years. We forecast general government gross debt at 88.5% of GDP in 2027, a new record for the series, surpassing the level reached during the pandemic.”

At Terra Investimentos, the expectation is that worsening inflation forecasts in the Focus survey will feed into the Central Bank’s own projections and force policymakers to raise interest rates in 2027, even as the economy undergoes a pronounced slowdown.

“We were already working with an inflation forecast above the market median for next year, at around 5.3%, because we were factoring in effects that no elected government can control, such as the impact of El Niño on food prices. But there was some expectation that a new government might offer a more constructive approach to fiscal policy, help anchor expectations and stabilize the exchange rate, which would help keep industrial goods and services prices in check. Without that, our forecast rises further,” said Homero Guizzo, the brokerage’s chief economist. He currently forecasts a Selic rate of 14.50% and IPCA inflation of 5.7% next year, but stressed that the estimates are preliminary and could rise.

With higher benchmark interest rates and a likely deterioration in the business environment, Guizzo has also provisionally lowered his GDP growth forecast for next year from 1.2% to 0.9%. “The main factor behind the slowdown will be developments in the credit market, which has been deteriorating for some time. More investment and consumption plans will be put on hold,” he said. The slowdown will be less severe only because the next government’s fiscal policy is expected to remain expansionary, preventing a sharper contraction in economic activity, he added.

*By Marcelo Osakabe — São Paulo

Source: Valor International

https://valorinternational.globo.com/