Global growth is revised downwards in 2015, to 3.4%. The global economy would then recover in 2016, with a 3.8% expansion. Developed economies continue to exhibit favourable growth expectations, helping to limit the impact of the slowdown in emerging countries.
Brazilian financial markets have been hit by political turmoil, economic deterioration and external factors. Turbulence resulted in a 14% depreciation of the exchange rate, a 12% contraction in equity markets and a 36 bp increase in sovereign spreads over the last three months.
The sharp economic deterioration is one of the factors behind this correction, but the main driver is political upheaval, characterised by the spillovers from the Petrobras bribery scandal, the worsening of the relationship between the executive and legislative branches and the sharp decline in President Dilma Rousseff’s approval ratings. In this context, S&P revised the country’s rating outlook from “stable” to “negative”and Moody’s cut Brazil’s rating to Baa3, which means the country could soon find its investment grade withdrawn. Regarding external drivers, we highlight the imminent start of US monetary tightening, concerns about the Chinese economy and the fall in commodity prices.
The Brazilian economy will contract sharply in 2015 and stagnate in 2016. The severe deterioration in confidence indicators and labour markets are some of the signs suggesting that GDP will contract significantly –by around 1.4% QoQ– in 2Q15, after a drop of 0.2% QoQ in 1Q15. The most likely result is that the economy will continue in recession, at least during the third quarter, and that GDP will fall to 1.5% in 2015.
The worst of the current crisis should be left behind in 2016, at least if the political situation stops deteriorating and the government manages to prevent a further worsening of fiscal prospects. Even though we do not expect a sharp turnaround in the economy next year, there are some factors (improved external environment, inflation moderation, the end of monetary tightening and the lagged impact of the exchange rate depreciation on net exports) which support the emergence of a less negative scenario in which GDP would grow 0.5%. Given the poor macroeconomic performance in the last few years, the lack of an agenda to increase productivity and investment and the gradual ageing of the population, long-term potential growth is now estimated to be only 2.2%.
Inflation is expected to remain under pressure. The effect of the contraction in domestic demand will be offset by the upward adjustment in regulated prices (in 2015) and inertial factors (mainly in 2016). The significant currency depreciation will also put pressure on inflation (in both 2015 and 2016), even though there is no evidence of a higher exchange rate filtering through into prices.
We forecast inflation will end 2015 at 8.9%, starting to decelerate during the first half of 2016 when the effect of the adjustment in regulated prices implemented at the beginning of 2015 will begin to fade. It will then close 2016 at 5.3%.
The larger-than-expected monetary tightening is over. The next easing cycle is still far away –second quarter of 2016– and will not be as aggressive as the previous ones.
Economic and political headwinds will produce a more gradual adoption of the fiscal adjustment, hindering the recovery in confidence and leaving the country on the verge of losing its investment grade. Due to the impact of the contraction in domestic demand on public revenues and the problems in getting some fiscal measures approved by the Congress, the government cut its primary targets to 0.15% of GDP in 2015, 0.7% in 2016, 1.3% in 2017 and 2.0% in 2018 (vs a previous 1.1% in 2015 and 2.0% from 2016 onwards). We think the 2015 and 2016 targets will be reached, but that will not prevent the fiscal accounts from deteriorating. It will be difficult for the government to avoid losing its investment grade.
The exchange rate will depreciate further in the future than it has in the past years. We expect it to average 3.2 reals to the US dollar in 2015 and 3.4 in 2016, compared to 2.4 in 2014. The currency depreciation and the contraction in domestic demand should reduce the current account deficit from 4.5% in 2014 to 3.9% in 2015 and 3.1% next year.