That said, Brazil remains in a fragile situation. Economic imbalances such as weak fiscal accounts, high levels of debt and unemployment need to be addressed. The reforms needed to fix the Brazilian economy are complex and in many instances very unpopular with the public, making this a significant challenge for any government.
But it is political developments that continue to be the main variable in assessing the outlook for Brazil.
…In May, Interim President Michel Temer took office, after Rousseff stepped down to face an impeachment trial. Since then, Temer has had a few successes. In particular, his cabinet appointments were well received by both investors and politicians, which helped strengthen the relationship with Congress. This relationship has been and will be key for the cabinet ability to pass policy measures.
…Progress on policy changes, in turn, may go a long way towards restoring confidence of both consumers and investors. Nevertheless, while many believe the Senate would follow through with Rousseff’s impeachment, we cannot rule out the opposite outcome, which would likely be adverse for risk assets especially given high market expectations. Adding to the already high political uncertainty: the ongoing corruption and money laundering investigations surrounding the country’s largest oil and gas company.
And there’s the rub: Given the sharp rise in the markets this year it seems that investors are making a bet on the best case scenario. Should that fall through, markets are likely to correct, perhaps sharply.
Market Realist – Brazil’s slowing GDP
Brazil’s GDP fell for the ninth consecutive quarter in 2Q16. The country’s GDP dipped by 0.6% in 2Q16 to $1.5 trillion Brazillian reais compared to a 0.4% dip in 1Q16. GDP dipped 3.8% compared to 2Q15 against the market consensus of 3.7%. But the dip was less than the 5.4% dip recorded in 1Q16 or the 6% dip in 4Q15, both on a year-over-year basis.
GDP touched the negative growth mark between 2014 and 2015 for the first time since the global meltdown in 2008-2009. The slump in GDP growth was mainly due to the slowing internal demand. Brazil has recorded an average annual GDP growth rate of 2.7% between 1991 and 2016. The GDP growth rate touched -5.9% in 4Q15. However, the average quarterly GDP growth rate was 0.6% between 1996 and 2016. It reached a rate of -4% in 4Q08.
Reasons behind the slowing GDP
Brazil’s services sector is its key sector and contributes more than 70% to the GDP. The sector has been categorized into five segments. The government, education, and health segment forms 18% of the GDP. The other services segment contributes 16%. The wholesale and retail trade segment contributes 13%. The real estate segment forms 8%. The business and financial services segment contributes 7%.
Industry comprises 25% of Brazil’s GDP and the largest segments within this sector include manufacturing with 13% of GDP, construction with 5% of GDP, and mining with 4% of GDP.
The agriculture and livestock sector accounts for the remaining 6% of GDP.
The changes that Brazil has posted on the expenditure side and the production side on a year-over-year basis in 2Q16 are shown below.
Brazil recorded a dip in household and government expenditures, gross fixed capital formation, and imports, partially offset by growth in exports. On the production side, agriculture, mining, manufacturing, construction, and services dipped, partially offset by growth in utilities and real estate.
Brazil’s rising debt level
Brazil’s external debt fell 0.7% in 2Q16 to $331.4 billion. The country’s external debt had averaged $187 billion between 1980 and 2016. The external debt level started picking up post-2010, gradually breaching the $250 billion mark. The debt level dipped briefly during 2013–2014 from the $325 billion level but again started picking up as Dilma Rousseff began her second term as president. The country’s debt level peaked at $351 billion in 1Q15.
Brazil has recorded a government-debt-to-GDP ratio of 66.2% since December 2015. The country’s government debt for the quarter amounted to 4.2 trillion Brazilian reais. Before that, the ratio mostly remained at the low to mid fifties level except during 2008–2010 when it reached the 59% mark. The ratio started picking up in 2014.
Dilma Rousseff has been accused of unscrupulously borrowing around $11 billion from Brazil’s state banks, which amounts to around 1% of the country’s GDP, after concealing the country’s budget deficit. She allegedly used the same towards long-running social programs for small farmers and the poor in an attempt to get re-elected. Though Brazil’s debt level is not as high as that of Japan, Greece, or Italy, we cannot ignore the high borrowing costs of debt. Among the BRIC nations, Brazil comes after Russia and China in terms of government-debt-to-GDP ratio. The BRF VanEck Vectors Brazil Small-Cap ETF (BRF), the Global X Brazil Mid Cap ETF (BRAZ), and the Global X Brazil Consumer ETF (BRAQ) earned 13-week returns of 30.3%, 17.3%, and 20.8%, respectively.
Within less than a week of the change in leadership, Brazil came across a multibillion-dollar pension scandal involving the CEO of the world’s biggest beef exporter. The country is already reeling under the pressure of the Petrobras fiasco, which allegedly included Dilma Rousseff and former Brazilian president Lula da Silva. The pension scandal also seems to be the outcome of a business and political nexus and has the potential to overthrow the new government.
Brazil’s rising unemployment remains a big concern
Brazil’s unemployment rate rose 11.6% for the quarter ended July 2016 compared to 11.3% in the previous quarter. This has been the highest rate ever and has beaten the market estimate of 11.5%. Brazil’s jobless rate averaged 7.9% between 2012 and 2016. The jobless rate had slumped to 6.2% in December 2013. The rising unemployment level was mainly due to the recession in the country. While the country’s unemployment figure grew by 3.8% to 11.8 million in the quarter ended July as compared to the previous quarter, the employment number saw only marginal growth of 0.2% to 90.4 million for the same period.