Brazil Economic Outlook 3Q18 - BBVA Research · Currency depreciation in emerging countries (*)...

BBVA Research – Brazil Economic Outlook 3Q18 / 1

Brazil Economic

Outlook

3Q18

July 2018

Key messages

Increased financial tensions in emerging markets,

including Brazil, in line with the process of withdrawal of

monetary stimuli in the United States and protectionist threats.

At local level, tensions have been fueled by political uncertainty

and the fiscal imbroglio. The relative strength of the Brazilian

external accounts has prevented the situation from becoming

even more difficult.

Growth prospects deteriorate: the recovery process will be more gradual than previously

expected. Financial volatility, the negative effects of exchange rate depreciation on inflation

and thus on the ability of monetary policy to stimulate the economy, doubts about whether

the next government will face fiscal problems and the consequences of the recent truckers’

strike, among other factors, make it more likely that growth in 2018 and 2019 will be 1.6%

and 2.4%, respectively, instead of 2.1% and 3.0% as previously expected.

BBVA Research – Brazil Economic Outlook 3Q18 _/ 3

Contents

01

02

Global environment: global growth continues,

but risks are intensifying

Brazil: deterioration of the prospects for

economic growth

03 Brazil: forecast table


01Global environment:

global growth continues, but risks are intensifying

BBVA Research - Brazil Economic Outlook 3Q18 / 5

Global growth continues, but risks are intensifying

The pace of global expansion is

being maintained, but is less

synchronized

Growth is robust in the US due

to the fiscal stimulus and stable

in China, but it has been reduced

in Europe

01Increased protectionism

At the moment, its impact

on growth is limited, but it

could be greater if the

measures under discussion

were to be implemented

02Increase in the price of oil

Higher inflation and drag on

growth in oil-importing countries

03

Different pace of monetary

normalization in Europe and

the United States

Strengthening of the dollar

and tightening of global

financial conditions

04More volatility in emerging

markets

Increased financial tensions due

to increased financing costs and

protectionist threats

05Global risks are intensifying

The possibility of a trade war

comes together with greater

risks in emerging economies

and in Europe

06


Robust global economy despite growing uncertainty

Global growth continues,

supported by private

consumption and investment,

but with growing differences

by region

World trade continues to show

a positive trend, although it is

losing momentum and still

does not reflect

the protectionist escalation

Confidence indicators show

some moderation, but remain

at high levels

World GDP growth(Forecasts based on BBVA-GAIN, % QoQ)

Source: BBVA Research

0.4

0.6

0.8

1.0

1.2

Jun-1

3

Dec-1

3

Jun-1

4

Dec-1

4

Jun-1

5

Dec-1

5

Jun-1

6

Dec-1

6

Jun-1

7

Dec-1

7

Jun-1

8CI 20% CI 40% CI 60%

Point Estimates Period average


Limited effect of approved tariff increases, but significant

if those being discussed are implemented

The tariff increases approved by

the US would have a limited direct

impact. Indirect effects, via

economic confidence and financial

channel, could be felt in 2H18

With a protectionist escalation,

the negative effect on growth

would also be significant in

the US

The effect, smaller in Europe,

would differ by country and would,

above all, affect Germany and the

countries in Eastern Europe

The growth of global GDP could

be reduced by around 0.2 pp just

due to the trade channel

Effect on GDP growth of US tariff increases

and the response by other countries(2018-19, pp)

Measures announced: tariff increase to 25% on steel, 10% on aluminium and 25% on Chinese imports for a value

of US$50 billion.

Measures under discussion: Tariff increases up to 20% on cars and Chinese imports for a value of US$200 billion.


-0.45

-0.40

-0.35

-0.30

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

Current measures Measures under discussion

World US China Eurozone


The rise in the price of oil will push inflation

upwards and could weigh down growth

The increase is due to a reduction

in supply. The price will remain

relatively stable in 2018 and 2019

Higher inflation in the euro zone,

although below the target, while

core inflation will increase

gradually from very low levels

In the USA the impact will be

lower, but inflation will remain

above the target in 2018-19

The exit strategy of the Fed and

the ECB is reinforced

Upward revision of the price of oil and inflation(%)


April 2018 July 2018

-2

0

2

4

6

8

10

2018 2019

Brent

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2018 2019 2018 2019

Eurozone inflation US inflation


Fed and ECB return to conventional monetary

policy each at a different pace

Gradual ending of QE

between September

and December 2018

Reduction of US$450

billion in 2018

The pace of rate

hikes accelerates

in 2018

Delay in rate hikes

until September 2019

0.75%

1.5% 2.00%

3.25%0.55%

2016 2017 2018 2019

0% 0% 0%

0.25%

2016 2017 2018 2019

Assessment Interest rates



The strength of the US dollar and higher interest

rates are causing an adjustment in emerging markets

The most vulnerable countries are

those with the greatest trade

deficit and the greatest need for

external financing

Shift towards a tightening of

monetary policy in emerging

countries (except China) to avoid

further depreciation of their

currencies

The increase in financial tensions

also reflects the intensification of

trade disputes

EUR-USD exchange rate and BBVA index of

financial tensions in emerging markets

Source: BBVA Research based on Bloomberg

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Ma

r-1

3

Sep

-13

Ma

r-1

4

Sep

-14

Ma

r-1

5

Sep

-15

Ma

r-1

6

Sep

-16

Ma

r-1

7

Sep

-17

Ma

r-1

8

Financial stress in emerging marketsEURUSD (RHS, inverted)


Protectionism and political factors lead

to a growing risk aversion

Investor sentiment has shifted

from a framework of risk-taking

(and even a certain complacency)

to one of risk aversion

The change is causing a rotation

of flows between assets: from

emerging markets to developed

ones, and from equities to bonds

Trade tensions could lead to an

environment of flight towards

quality

Risk appetite/aversion indicator


-1.5

-1.0

-0.5

0.0

0.5

1.0

Jan-1

7

Apr-

17

Jul-1

7

Oct-

17

Jan-1

8

Apr-

18

Jul-1

8

Average from 2014 (max and min)

"Risk-on mood"

"Risk-off mood"


Stable growth in the US,

but a slowdown in other areas


2018

2.82019

2.8

USA

2018

2.62019

2.0

Mexico

2018

0.92019

2.1

South America

2018

3.82019

3.0

Turkey

2018

2.02019

1.7

Eurozone

2018

6.32019

6.0

China

Down

Up

Unchanged

2018

3.82019

3.8

World


Global risks: the main one is a trade war, but those

associated with emerging economies and Europe are increasing

Sourcce: BBVA Research

USA

EZ

CHINA

Sh

ort

-te

rm p

rob

ab

ilit

y

Severity

EM

CHINA

High indebtedness: more contained but still high

Protectionism: upwards (retaliation) with possible impact on

domestic policies (financial stability, reforms)

USA

Protectionism: upwards

The Fed exit strategy: high.Aggressive rate hikes in the face of a

temporary increase in inflation

Signs of over-valuation of certain financial assets

EUROZONE

Political uncertainty: on the upswing, led by Italy. Brexit: risk of a

rough departure

Protectionism: on the upside with a focus on the auto sector

Exit strategy by the ECB: on the downside (delay of rate hikes)

EMERGING ECONOMIES

Upward. Global risks and domestic vulnerabilities in some countries

are raising the risk of a systemic crisis


02Brazil:

deterioration of the growth

prospects of the economy



Recent financial tensions helped put an end to the excessive

optimism of the markets with regard to Brazil

BBVA index of financial tensions(average since Jan-06 = 0)

Until a few months ago, the markets seemed to be

ignoring the risks related to the increase in interest

rates in developed countries as well as those

associated with political and fiscal uncertainty in

Brazil.

Despite the interventions of the Central Bank (BCB), the

real has been among the currencies most affected by

recent turbulence. The Sao Paulo Stock Exchange has

shrunk 9% and the country risk increased 19% (up to 298

bps) in the last three months

Currency depreciation in emerging countries (*)

(percentage change)

(*) A positive value indicates a depreciation of the local currency. Data up until 13 July.

Source: Bloomberg

-1,5

-0,5

0,5

1,5

2,5

3,5

4,5

Ja

n-1

4

Ap

r-1

4

Ju

l-1

4

Oct-

14

Jan-1

5

Ap

r-1

5

Ju

l-1

5

Oct-

15

Ja

n-1

6

Ap

r-1

6

Jul-1

6

Oct-

16

Ja

n-1

7

Ap

r-1

7

Ju

l-1

7

Oct-

17

Jan-1

8

Ap

r-1

8

Ju

l-1

8

Brazil Emerging Economies

Rousseff's

impeachment

process

News of recording in

which Temer allegedly

endorses bribes

Recent

turbulence

-10

0

10

20

30

40

50

Arg

entin

a

Turk

ey

Bra

zil

Hu

nga

ry

Po

lan

d

Ch

ile

Co

lom

bia

India

Ind

on

esia

Me

xic

o

Ma

laysia

Peru

Ukra

ine

Ru

ssia

Last three months Year-to-date


Recent financial volatility: triggered by global factors,

fueled by local factors

Currency depreciation: weights of global and

local factors in the year-to-dateThe increases in interest rates in

the United States and protectionism

threats were the main triggers of the

recent correction in financial assets

prices in emerging economies,

including the depreciation

of the exchange rate in Brazil

The exchange rate depreciation was

sharper in Brazil than in other regions.

Although the external indicators of

the Brazilian economy are relatively

positive, some local factors have

significantly contributed to weaken

the Brazilian real

Among these local factors are:

• increased political uncertainty

• the fiscal imbroglio


10%

90%

Global factors Local factors


Political uncertainty: the race for the presidency

is still fairly wide open

Presidential poll (conducted between 21-24 June 2018)

There are still many candidates with

possibilities of winning the presidential

elections in October

The biggest favourite would probably be

Lula, who for judicial reasons is unlikely

to be able to run as a candidate

Polls show that the proportion of blank

and spoiled ballot papers could be

exceptionally high

This, as well as the historically low

approval of the current government,

is reinforcing the perception of social

weariness and repudiation of the

political class

* Sum of the candidates with less than 5% of voting intention.

Source: CNI/IBOPE

0

5

10

15

20

25

30

35

J. B

ols

ona

ro

Ma

rina

S.

C. G

om

es

G. A

lckm

in

Oth

ers

*

Bla

nk / s

poile

d

Un

de

cid

ed

vo

ters


(*) Primary expenses and income of the federal government.

Source: IPEADATA, BBVA Research

Political uncertainty fuels doubts about whether the structural deterioration

of public accounts will be reversed in the coming years

Primary expenses and revenues (*)

(% of GDP)

The tax increases and controls on spending (including the

introduction of a ceiling on its growth) announced in recent

years have been insufficient to reverse the negative fiscal trends.

Public debt, for example, continues to rise (77% of GDP in May)

Public expenditure remains high, largely due to

the increase in the expenses in which the

government has no discretionary power to

reduce, as is the case of social security expenses

Breakdown of primary expenses (*)

(% of total expenses)

(*) Federal government expenses.

Source: IPEADATA, BBVA Research

3540 44

3026 22

612 14

2822 20

0

10

20

30

40

50

60

70

80

90

100

1997 2007 2017

Discretionary expenses

Non-discretionary expenses: others

Non-discretionary expenses: wages

Non-discretionary expenses: social security

13

14

15

16

17

18

19

20

21

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Primary expenses Primary revenue


How to deal with the fiscal imbroglio? There are no easy solutions...

The level of taxation in Brazil is already excessively high.

Raising taxes is a politically costly option that, in addition,

would damage the competitiveness of the private sector.

A privatization programme could be an alternative, but

would have a high political cost and a relatively limited

fiscal impact. Another option would be to reduce the fiscal

benefits granted to specific sectors of the economy

Taking into account the high level of public spending, it may

be the best alternative in economic terms. In any case, the

margin to cut costs without a reform of social security or a

reform to reduce the proportion of non-discretionary spending

is very low. These reforms require a government with a high

level of political capital: both Dilma Rousseff and Michel

Temer tried unsuccessfully to adopt measures in this

direction...

A significant increase in growth would increase

the collection of taxes and improve the public accounts, as

was observed between 2004 and 2013. However, an

expansion stimulated by external factors now seems

unlikely given the moderation of the Chinese economy and

of commodity markets. An expansion based on internal

factors is difficult if reforms that increase productivity are

not made and if the fiscal imbroglio is not faced

Without an independent management of monetary policy by

the central bank, there could be a temptation to increase

inflation to facilitate the payment of non-indexed public debt.

It would be a dangerous alternative, with potentially very

negative results, as shown by Brazil’s economic history...

By increasing taxation? By reducing public spending?

By increasing economic

growth?

By yielding to the temptation to increase

inflation to facilitate payment of the debt?

01 02

03 04


Measures to improve the fiscal situation are expected from 2019,

but an ambitious reform of social security seems less likely

Fiscal balance (*)

(% of GDP)Given the political uncertainty, it is

difficult to foresee how the fiscal

problem will be faced in the future

The next government is likely to

announce measures to increase taxes

and reduce spending to calm the

markets and to meet fiscal objectives,

which could even be relaxed

An ambitious reform of social security is

less likely

So is a scenario of fiscal inaction, given

its high economic cost (increase in

financing costs and inflation, a more

depreciated exchange rate, lower GDP

growth, etc.)

(*) (f) = forecasts.

Source: BCB, BBVA Research

-12

-10

-8

-6

-4

-2

0

2014

2015

2016

2017

2018

(f)

2019

(f)

2020

(f)

2021

(f)

2022

(f)

Primary result Interest payments Total fiscal result


Having the external accounts under control has prevented

recent volatility from becoming even more marked

External indicators for selected

emerging economies(Current account balance and reserves / external debt ratio) While political uncertainty and

fiscal problems contributed to recent

financial tensions, the relatively good

state of the external accounts prevented

an even more difficult scenario

Brazil has US$382 billion in international

reserves, equivalent to 19% of GDP or

350% of short-term external debt

The current account deficit is currently

low (0.6% of GDP), lower than direct

foreign investment in the country (3.1%

in May)

We expect the external deficit to remain

at low levels (0.3% of GDP in 2018 and

1.4% of GDP in 2019), in line with a

depreciated exchange rate and weak

domestic demand

Source: : BBVA Research, BIS, IIF, IMF, World Bank, National sources

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

0,80

-6,0 -5,0 -4,0 -3,0 -2,0 -1,0 0,0 1,0 2,0 3,0 4,0

Reserv

es /

exte

rnal debt

ratio

Current account(% of GDP)

Brazil

Russia

Malaysia

Hungary

Poland

Peru

India

Turkey

Argentina

Ukraine

Chile

Colombia

Indonesia

Mexico

+-

+

-


The exchange rate will remain at more depreciated levels

than those observed up until a few months ago

Exchange rate(Real / US dollar)

The depreciation of the real has

been stronger than we expected,

despite the fact that the central bank

has intervened heavily through the

sale of f exchange rate swaps.

There is little margin for the real,

which is at around 3.85 per US

dollar, to appreciate in the short term.

Volatility will remain high at least until

the October presidential elections

The reduction of uncertainty after the

elections and the possible positive

signals of the new government on

the fiscal issue should allow some

appreciation of the exchange rate

from the end of the year on

Source: : BBVA Research

3.1

3.2

3.3

3.4

3.5

3.6

3.7

2016 2017 2018 (f) 2019 (f)

Current forecasts Previous forecasts (April 2018)



The exchange depreciation will generate greater

inflationary pressures

Our estimates suggest that in the current environment a

10% depreciation in the exchange rate has an

accumulated effect on inflation of almost 0.6

percentage points in a 12-month period

They also show that the degree of pass-through in

Brazil is currently lower than 2 or 3 years ago,

although higher than in the previous period (from

2012 to mid-2015)

Effect on the inflation rate of a 10%

depreciation of the exchange rate(cumulative effect, in basis points)

Degree of pass-through over the last years (*)

(in %)

(*) Coefficient associated with external prices / exchange rate obtained from the

estimation of a Phillips Curve for Brazil


0.0

0.1

0.2

0.3

0.4

0.5

0.6

Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8

quarters

2.6

2.8

3.0

3.2

3.4

3.6

3.8

4.0

Jan-1

2

Ma

y-12

Sep

-12

Jan-1

3

Ma

y-13

Sep

-13

Jan-1

4

Ma

y-14

Sep

-14

Jan-1

5

Ma

y-15

Sep

-15

Jan-1

6

Ma

y-16

Sep

-16

Jan-1

7

Ma

y-17

Sep

-17

Jan-1

8


Inflation on the upside

Inflation: IPCA(in %, end of period)

Inflation, which remained below 3.0%

between January and May, reached

4.4% in June, largely due to the

shortages caused by the truckers’ strike

Taking this into account, as well as the

heavy depreciation of the exchange rate

and the higher price of oil, among other

factors, we have adjusted our inflation

forecasts upwards, from 3.7% to 4.5%

in 2018 and from 4.5% to 4.7% in 2019


0

1

2

3

4

5

6

7

2016 2017 2018 (f) 2019 (f)



Less expansionary monetary policy

Interest rates: SELIC(in %, end of period)

The exchange rate depreciation has

caused the BCB to keep interest rates at

6.50% instead of cutting them by 25 bps

in June

They will most likely remain at 6.50%

until the beginning of 2019, when

inflationary pressures will force the BCB

to start a monetary tightening cycle

(earlier and more aggressive than

previously expected)

Guaranteeing the independence of the

BCB in the coming years will be

fundamental: the level of debt and the

spending ceiling rule create certain

incentives to increase inflation in an

environment in which inflation targets are

being cut (4.25% in 2019, 4.0% in 2020

and 3.75% in 2021)


0

2

4

6

8

10

12

14

16

2016 2017 2018 (f) 2019 (f)



The recent truckers’ strike has also had negative effects on

the economic environment...

Indicators of economic activity (*)(change in %)

The truck drivers’ strike, caused by

factors such as the increase in the

price of fuel and supported by a large

part of the population, generated a

situation of shortages in the last days

of May

The situation caused a strong upswing

in prices and a significant reduction in

economic activity, which could be

reversed in the coming months to

some extent

It is also possible that the episode

could negatively affect confidence

during a more prolonged period,

hindering the recovery of the economy

(*) Last month available: May, in the cases of industrial production and retail sales; June, in

the case of confidence indicators. Retail sales: broad indicator.

Source: IBGE, CNI and FGV

-18,0

-16,0

-14,0

-12,0

-10,0

-8,0

-6,0

-4,0

-2,0

0,0

Industrialproduction

Retail sales Consumerconfidence

Businessconfidence

Change in the last month Change in the last three months


...there is, therefore, a series of factors contributing

to a deterioration of growth expectations in Brazil

05Lower

probabilityof fiscal

reforms andadjustments

01Less

favourable global

environment

04Increasedpolitical

uncertainty

02Probable

slowdownof the

Argentinian economy

06Greaterfinancial volatility

07Higher

inflation

08Less

expansionarymonetary

policy

09Effects of

the truckers’strike

03Lower growththan expected

in 1Q18


We have revised the growth forecasts for Brazil downwards;

the recovery will be slower than previously expected

Despite the reduced optimism, the recovery of growth must continue,

supported by relatively solid global demand, the performance of the

agricultural sector, the expansive tone of monetary policy and the

adjustments made in previous years, etc.

Likewise, growth could slow if there is no

progress in resolving fiscal problems,

mainly in the case of a further increase in

global risk aversion

2017 20192018

2.4%

(now)2.1%

(before) 1.6%

(now)

3.0%

(before)

1.0%


The recovery of private consumption and investment will be

gradual, exports will continue to contribute positively

We have revised downwards our forecasts for

private consumption and investments, in line

with the deterioration of the macroeconomic

picture in recent months

Although we expect a lower contribution of domestic demand to

growth, the outlook for external demand is more favorable, due

to the effects of greater depreciation of the exchange rate and

the lower pressure of domestic demand on imports

Growth of GDP and its components(*)

(%)

(*) (f) Forecasts.


-2,5

0,0

2,5

5,0

7,5

GDP Investment Private consumption Public consumption Exports Imports

2017 2018 (f) 2019 (f)


03Brazil:

Forecast table


(f) Forecast

2016 2017 2018 (f) 2019 (f)

GDP -3,5 1.0 1.6 2.4

Private consumption (%) -4.3 0.9 1.7 1.8

Public consumption (%) -0.1 -0.6 -0.6 -0.5

Investment in fixed capital (%) -10.3 -1.9 2.9 5.0

Exports (%) 1.9 5.7 5.5 6.8

Imports (%) -10.2 5.5 4.8 4.2

Unemployment rate (average) 11.3 12.7 12.3 11.0

Inflation (end of period, YoY %) 6.3 2.9 4.5 4.7

SELIC rate (end of period, YoY %) 13.75 7.00 6.50 10.0

Exchange rate (end of period) 3.35 3.30 3.65 3.60

Current account (% of GDP) -1.3 -0.5 -0.3 -1.4

Public sector fiscal balance (% of GDP) -9.0 -7.8 -7.8 -5.8

Forecasts for Brazil


This report has been produced by the Latin America Unit

Head Economist, Latin AmericaJuan Manuel Ruiz

[email protected]

BBVA ResearchJorge Sicilia Serrano

Macroeconomic Analysis

Rafael Doménech

[email protected]

Digital Economy

Alejandro Neut

[email protected]

Global Macroeconomic Scenarios

Miguel Jiménez

[email protected]

Global Financial Markets

Sonsoles Castillo

[email protected]

Long-Term Global Modelling and Analysis

Julián Cubero

[email protected]

Innovation and Processes

Oscar de las Peñas

[email protected]

Financial Systems and Regulation

Santiago Fernández de Lis

[email protected]

Digital Regulation and Trends

Álvaro Martín

[email protected]

Regulation

Ana Rubio

[email protected]

Financial Systems

Olga Cerqueira

[email protected]

Spain and Portugal

Miguel Cardoso

[email protected]

United States

Nathaniel Karp

[email protected]

Mexico

Carlos Serrano

[email protected]

Turkey, China and Big Data

Álvaro Ortiz

[email protected]

Turkey

Álvaro Ortiz

[email protected]

Asia

Le Xia

[email protected]

South America

Juan Manuel Ruiz

[email protected]

Argentina

Gloria Sorensen

[email protected]

Colombia

Juana Téllez

[email protected]

Economic Outlook

Hugo Perea

[email protected]

Venezuela

Julio Pineda

[email protected]

Enestor Dos Santos

[email protected]

Cecilia Posadas

[email protected]

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With the collaboration of:

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