Brazil

Walking a fiscal and political tightrope

SENSITIVE RISK

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Updated in September 2021.

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GDP	USD 1444bn (World ranking 12, World Bank 2020)
Population	213 mn (World ranking 6, World Bank 2020)
Form of state	Presidential republic
Head of state	Jair Bolsonaro (President)
Next elections	2022, presidential and legislative

Important role on an international and regional scale
Diversified economy
Growing middle class
Robust foreign direct investment inflows, high level of foreign exchange reserves and low external debt
Support for IFIs likely if needed

Vulnerable to global commodity prices
High production costs
High taxation and red tape ("Brazil cost")
Large fiscal deficits and increasing public debt
Political and social tensions on the back of corruption and high income inequality

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Timid recovery as Covid-19 exacerbated an already fragile growth outlook

Brazil had a fragile pre-pandemic growth and fiscal outlook as it was still recovering from the severe 2015-2016 recession. The government’s pro-business reforms had nonetheless put the economy on track for a more robust rebound in 2020. The authorities had approved a pension reform in 2019 to stabilise pension spending as a share of GDP, which, coupled with the fiscal rule approved in 2016, participated in the compression of the risk premium between 2016 and 2020. However, the pandemic shock halted the already sluggish growth and reform momentum.

The economic rebound is likely to be moderate due to slow vaccination, a phasing-out of support measures and monetary tightening. We expect real GDP growth to rebound to +5.1% in 2021 following a contraction of -4.1% in 2020, and then reach +1.4% in 2022. The rebound will be driven by strong base effects, a gradual re-opening of the economy and higher commodity exports, given the rebound in prices and demand from the US and China. In addition, we expect a mild boost in private consumption as the gradual phasing-out of support measures partially offsets the effects of pent-up demand due to a drawdown of savings accumulated in 2020. We also assume a milder impact of new waves of Covid-19 cases as economic actors adapt.

Liquidity concerns remain limited but public debt sustainability is a longer-term risk

The fiscal deficit widened substantially in 2020 to -13.4% of GDP from -5.9% of GDP in 2019 and the government is likely to consolidate slowly. However, access to domestic markets remains adequate despite rising yields. The potential tapering of the Fed is unlikely to have a substantial effect on further monetary tightening at this stage as Brazil's central bank has already increased policy rates quite rapidly.

Public debt rose sharply to 99% GDP in 2020 as a result of large fiscal deficits and a contraction in nominal GDP. We expect debt to stabilize at around 100% of GDP in 2022 and 2023 as fiscal deficits remain high and medium-term growth prospects are limited. The large share of domestic and local currency public debt is a mitigating factor to public debt sustainability risks.

Brazil’s large international reserves reaching 15.5 months of import coverage in June 2021 provide a substantial buffer against further pressures on the real. The currency has depreciated substantially since the onset of the pandemic, but we expect the pressures to continue to subside given the BCB's credible commitment to monetary tightening. In addition, we expect the BCB will let the exchange rate absorb the brunt of a potential external shock as it has a track record of letting the exchange rate fluctuate.

The general government debt’s exposure to FX risks is very limited, with less than 5% of total debt denominated in foreign currency. External debt remains contained at 49% of GDP in 2020 and external debt service remains moderate. The substantial FX reserves provide a buffer against risks of an increase due, for example, to a depreciation of the real.

Challenging political landscape and poor business environment

First, the absence of a stable government coalition in Congress could hamper policymaking and slow down the approval of key structural reforms. Second, the current investigation into the government’s handling of the Covid-19 crisis could complicate the end of President Bolsonaro’s term. Third, social risks are on the rise as the Covid-19 crisis has exacerbated pre-existing income inequalities. Fourth, the 2022 presidential elections are a risk to policy continuity and the run-up to the elections might put pressure on spending.

The orientation of the economically liberal government and center-right-leaning momentum in Congress has allowed for the implementation of several pro-business “quick win” policies since Bolsonaro’s inauguration, in addition to a flagship pension reform. However, Brazil’s business environment remains poorer than that of peers as it ranks 124th on the World Bank's Doing Business Index compared to 60th for Mexico. It scores particularly poorly on paying taxes, dealing with construction permits, resolving insolvencies, getting credit and protecting minority investors.

Trade structure by destination/origin

(% of total, annual 2020)

Exports	Rank	Imports
China 32.4%	1	23.2% China
United States 10.3%	2	16.7% United States
Argentina 4.0%	3	5.9% Germany
Netherlands 3.5%	4	5.3% Argentina
Canada 2.0%	5	2.8% South Korea

Trade structure by product

(% of total, annual 2020)

Exports	Rank	Imports
Metalliferous ores and metal scrap 17.3%	1	9.6% Electrical machinery, apparatus and appliances, n.e.s.
Oil seeds and oleaginous fruits 15.8%	2	7.2% Petroleum, petroleum products and related materials
Petroleum, petroleum products and related materials 8.7%	3	7.1% Road vehicles
Meat and meat preparations 6.2%	4	6.3% Organic chemicals
Iron and steel 4.7%	5	5.6% Fertilizers other than group 272

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