Is Brazil's recovery durable?

Liseth Galvis - 03 January 2018

Belief in Brazil’s emergence from the 2014-16 slump has grown substantially over the past year. While the latest growth performance, 1.4 per cent annually in Q3 2017, remains tepid, there are confident expectations of 2-3 per cent growth this year. Business and consumer confidence is booming: according to the Getulio Vargas Foundation (GVF), both surveys finished 2017 at multi-year highs. Much of this optimism appears to revolve around the economic reforms introduced by president Temer.

The Central Bank attributes a rebound in annual real employee earnings, to 2.8 per cent, to the positive impact of labour market reforms approved last year by Congress. Their objective is to make the labour market more flexible through measures such as easing the hiring processes for part-time workers, allowing companies to deploy staff more efficiently, and facilitate the extension of temporary contracts.

Some of the reforms, such as the cap on government spending, will have long term effects on the Brazilian economy. In December 2016, the Brazilian Congress approved the limitation of government spending increases to the extent of inflation for 20 years, subject to revision in 10 years’ time.  The prospect of better fiscal discipline has boosted investor confidence, supporting the local equity market and currency.  Despite the political scandals that Brazil has suffered, such as the impeachment of Dilma Rouseff and the corruption allegations relating to current president Michael Temer, the Bovespa index closed nearly 27 per cent higher in 2017 (Figure 1).  However, as we argued in our September blog, the implementation of pension and social security reforms and the continuity of the privatization policies is far from guaranteed.

In Michael Temer’s absence, hopes of ongoing reform rest with Jair Bolsonaro, who will contest October’s elections for the far right. While his popularity has improved to 17 per cent, according to a recent Datafolha poll, the ex-president Lula da Silva has increased support from 30 per cent in July 2017 to 35 per cent in October 2017. Marina Silva from the green party is in the third place.

Given the improving economic outlook and favourable trends in core inflation, the Central Bank cut the base (Selic) rate of interest on 6 December by 50 basis points to 7.0 per cent, its lowest level since 1986. The annual consumer price inflation rate has dropped from 5.3 per cent in January to 2.8 per cent in November 2017. However, some inflationary pressures have arisen recently, principally from food inflation due to the expected negative impact from the “la Niña” phenomenon. Financial markets seem unconcerned, expecting inflation to remain below the target rate of 4 per cent for 2018.

Over the past year, Brazil has been a significant beneficiary of China’s import boom (figure 2). Brazil exports mainly commodities to China; for example, China is its main buyer of crushed soybeans, accounting for 78 per cent of the Brazilian production.  The revival of bilateral trade with China since late-2016 may hold the key to the durability of Brazil’s economic rebound. While the Bovespa will well have run ahead of itself, there is substance to Brazil’s economic rebound that stands apart from the hoped-for reforms.

Figure 1

Data Source: Thomson Reuters Datastream

Figure 2

Data Source: CEIC

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