Brazil’s political saga-a pity for the largest Latam econ

Over the past months, one of the most precious emerging countries in terms of economic contribution in the region which stormed over the headlines was undoubtedly Brazil. Considered as one of the largest emerging market economies, Brazil has moved from being the envy of other neighbouring emerging countries to being a country embroiled in corruption claims and a share deterioration in the country’s credit metrics. Ever since the ‘lava jato’ scandal linked to state owned Petrobras broke out, the Brazilian economy deteriorated significantly. Till date further scandals unfolded, political responsibility was not shouldered and thus further risk-aversion re-appeared, with investors’ sentiment being weighted by lack of governance and a deteriorating economy.

In February 2016, Moody’s credit rating agency was the last (out of the big 3) credit rating agencies to revise their credit ratings on the Brazilian sovereign to ‘junk’ status, i.e. below Investment Grade (BBB-). This has resulted in a marked increase in the country’s borrowing costs and has had widespread repercussions on its economy. The Brazilian Real weakened whereas sectors such as the financial sector are beginning to feel the pinch. In its rationale, Moody’s pointed out that the fiscal implications are expected to produce materially weaker credit metrics with the government debt burden expected to exceed 80 per cent of debt to GDP. Other than that, the most concerning issue which was highlighted Moody’s are the challenging political dynamics which will complicate fiscal consolidation efforts and delay structural reforms.

Latin America’s largest economy is lumbering into its second year of recession with a consequence of shedding more than 1.5m jobs throughout 2015, with the unemployment rate in 2015 averaging 8.5 per cent, up from the 6.8 per cent in 2014. Now the nation’s unemployed population rose to circa 8.6 million on average in the year from 6.7 million in 2014, according to the statistics institute. Projections in terms of unemployment rate are also very concerning with forecasts unemployment figures pointing to 9.80 per cent in 2016 and 10.9 per cent in 2017.

From a GDP perspective negative growth in 2015 was recorded at -3.84 per cent down, remarkably lower from the 3.94 per cent recorded in 2011, which was the highest registered growth over the past five years. Moving forward, projected figures for quarter one are shocking with a median estimate of 32 economists now projecting a negative growth of 6.2 per cent from the previous estimate of 5 per cent.

The outlook is not rosy as weakness is widespread. On the supply side, industry’s growth remained unsurprisingly weak, whilst the services sectors, which had been resilient in previous cycles, are also on the decline. Investment dropped sharply whilst household consumption contracted by 4% in 2015.

In my view the political saga is the main dragger for the countries fiscal adjustment. The last controversial news that hit the headlines was the move by Brazil’s President to appoint her predecessor and her mentor as her chief of staff, who was also recently interrogated on corruption scandals. The move was blocked through an impeachment on the basis of harming the money-laundering investigation. Thus further political uncertainty is surely a blocking factor for the economy to recoup from its current economic turmoil.

From a markets perspective, the risk-aversion pushed the equity market lower, yields surged, while the currency declined notably when compared to the dollar. However, despite specific risk is always a negative, the latest move from the Federal Reserve to refrain from a rate hike, offered some respite to emerging market debt denominated in hard currency, including Brazilian issuers.