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The IPO of BR Distribuidora, which holds the Petrobras gas stations, is expected to value the company at about $9.5 billion. (Photo: CEA)
Wednesday, October 25, 2017

Brazil Economy: Rays of Light

Economic improvement, government reforms are helping Brazil.           




After enduring its worse recession, Brazil is on the mend. Economic activity in July expanded 1.48 percent y/y in July, up from 0.8 percent y/y the month before. Although the political crisis keeps rearing its ugly head, the worse seems to be over. This is allowing an air of optimism to spread through the private sector. This was highlighted by the all-time highs that were registered in the Bovespa. FGV reported that consumer confidence was 82.3 in September, compared to 80.9 in August and 82 in July.

There is ample room for the optimism. The trade balance has been on a tear. In September, the country posted a trade surplus of more than $14 billion, and the year to date surplus is in excess of $51 billion. This has allowed the country to virtually eliminate its current account deficit, which hit a high of $101 billion in 2014. This is one of the most extraordinary reversals in current account balances. It parallels the turnaround that was posted by Argentina in the aftermath of its maxi-devaluation and default in 2001. The extent of the improvement in current account highlights the depth of the Brazilian recession. Another indicator that underscores the magnitude of the adjustment is the inflation rate. Consumer prices have been plunging. In September, the national statistics agency, IBGE, reported that the IPCA consumer price index increased only 2.5 percent y/y. Some analysts worry that at the current trend, the country may actually slip into deflation by the start of the New Year. This has allowed the central bank to slash interest rates, with the COPOM cutting the benchmark SELIC interest rates by 600 bps during the last twelve months. Nevertheless, there is still room for further cuts. Fortunately, all of the good news has not been concentrated on the economic front.



Despite a deluge of corruption charges, the Temer Administration continues to push ahead with the economic reforms. A slew of privatizations have been announced, including the sale of most of the thermo-electric generating plants at Eletrobras, the partial privatization of the company and the sale of Petrobras’ network of gasoline stations. The government expects the Eletrobras sale to be completed by the first half of 2018, and it will divest itself of all of the power plants, except for the mega-facilities at Itaipu and Angra. The IPO of BR Distribuidora, which holds the Petrobras gas stations, is expected to value the company at about $9.5 billion. The asset sales also include a slew of airports, port terminals and port authorities. This should boost the level of foreign investment in the country above the $70 billion that was recorded last year. Another positive development on the policy front is the approval of the labor reform. Although it was far from perfect, the reform provided additional flexibility to the labor regime. In the end, it should allow firms to expand their payrolls and boost economic activity. Another important development was the new limitations on the preferred interest rates that BNDES charged. These highly subsidized rates were abused by political allies of the PT to amass huge corporate empires. Along a similar line, the government took steps to reduce the red tape and streamline bankruptcy proceedings to boost recovery rates. Last of all, the government continued to push ahead with the much-needed pension reform. The legislation is moving at a glacial speed, but the lower house is expected to vote on it by next month.


The improvements on the economic and policy front were somewhat met by the situation on the political front. On the positive side, the PT appears to be dead. Former President Luiz Inacio Lula da Silva was found guilty for accepting R$3.7 million in bribes from OAS Engineering, and was sentenced to 10 years in prison. Nevertheless, a recent poll found that 35 percent of the respondents indicated that they would vote for him in the 2018 presidential elections. This has raised some consternation in political circles, but his rejection rate of 46 percent to 60 percent, depending on the pollster, makes it unlikely that he could win.

The more serious threat comes from the far right, in the form of Congressman Jair Bolsonaro. Hailing from the State of Rio De Janeiro, he is a former military paratrooper. He is known for his homophobic stance and misogynist comments. Hoping to emulate the success of Donald Trump, he is capturing the overall contempt for the mainstream political parties. After veering far to the left, Brazil’s political pendulum may be swinging in the opposite direction.


Some investors may take this as a positive development. However, we must recall that the right’s record of economic management in Brazil was disastrous. Nevertheless, the developments on the economic and policy front, as well as the demise of the political left, are reasons to be extremely optimistic about Brazil.


It is, as if, rays of light were finally shooting out from behind the dark clouds that have obscured the Brazilian horizon for years.

Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development. 


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