The risk rating agency Fitch Ratings reaffirmed the sovereign rating for Brazil at BB- and kept the outlook stable but highlighted high uncertainties ahead regarding the elected government’s plans and its impacts on economic and fiscal challenges.
The agency stressed that Brazil’s ratings are underpinned by its large and diversified economy, high per capita income, the sovereign’s local currency financing capacity, and shock absorption capacity underpinned by a flexible exchange rate, low external imbalances, and robust international reserves.
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On the other hand, the ratings are constrained by high government debt, a rigid fiscal framework, weak economic growth potential, and a history of governance challenges that have hampered efforts to address these fiscal and economic issues and obscured policy predictability.
“The stable outlook reflects Fitch’s expectation that growth will slow next year and that the recent fiscal improvement will be eroded under a new government but within a margin consistent with the current rating and a better starting point than previously expected.”
“Uncertainty is high regarding the new government’s plans and the extent to which they may ease or worsen fiscal and economic challenges. However, Fitch does not expect policies that compromise overall economic stability,” it points out.
Fitch points out that Luiz Inacio “Lula” da Silva of the Workers’ Party (PT) will take office as president in January after a narrow victory over incumbent Jair Bolsonaro in the October 2022 election and that the petista promises a departure from the liberal economic agenda of recent years.
“But it is unclear how strong a policy shift he will seek, which has been a source of market volatility since the election.”
“Changes in fiscal and microeconomic policies are likely, but concrete proposals have yet to emerge, and Fitch expects monetary/exchange rate policy and Central Bank (BCB) autonomy to remain unaffected,” he points out.
Furthermore, a fragmented Congress, in which conservative parties have increased their space, may represent a constraint to Lula’s agenda, but it is not certain to represent a force for fiscal discipline in Fitch’s view, given the expansionary fiscal measures taken before the elections and currently considered, during the transition period.
Fitch projects 3.0% GDP growth in 2022, reflecting surprisingly strong momentum in the year, supported by the final stages of the post-pandemic economic reopening, stimulus measures, and a strong labor market. “Growth is cooling, however, due to the lagged effect of substantial monetary tightening, and the expected global slowdown will be an additional drag,” it points out. The agency expects growth to slow to 0.7% in 2023 and may be sensitive to expansionary fiscal policies, as these can fuel domestic demand, but also adversely affect confidence and force the central bank to extend or tighten monetary policy.
The agency also reinforces that a liberal economic agenda has taken shape over the last five years (labor reform, concessions/privatizations, regulatory changes) and helped improve the business climate as public investment has declined and investment/GDP has increased to 19% from a previous value of 15%. “This agenda will diminish under Lula, who has promised to stop privatizations and advocated a return to a state-led growth model. But concrete plans are yet to take shape. The government has indicated that its short-term priorities may include tax reform, to reduce complexity and potentially increase revenues, and changes in labor laws,” it assesses.
For Fitch, it is likely that the government will seek to redirect the corporate strategies of state-owned companies, such as oil company Petrobras (PETR3;PETR4) and development bank BNDES, having criticized their downsizing and shift to market-based pricing policies in recent years. Fitch expects such a shift to be gradual, rather than a full return to aggressive interventionism and parafiscal policy.
Interest, current transactions, and foreign exchange
Fitch says the Brazilian Central Bank is conducting one of the “most aggressive and proactive” monetary policy tightening cycles in the world, which has helped contain inflation expectations. The CB has reinforced a hawkish bias in the face of risks to inflation posed by current fiscal uncertainties, the agency says. “Should this persist, the BCB could prolong the period of ultra-tight monetary policy or even raise interest rates further.”
According to Fitch, Brazil has a current account deficit that should rise to 3.0% of GDP in 2022, higher than previously forecast, with strong domestic demand, but also methodology revisions, and follow fully financed by “robust” foreign direct investment.
The real, meanwhile, has held up well amid global volatility in 2022, but tight domestic monetary policy has offset lower risk sentiment, although some volatility points are related to “domestic political uncertainties,” the agency comments. International reserves fell 9% in the year to mid-December, but largely due to valuation effects, and continue to represent an ample cushion, it points out.