Risk Brazil detaches from the dollar and falls since the elections

By Hamilton Ferrari

The 5-year country risk, or CDS (Credit Default Swap), closed 2022 at 250 basis points. It is at the same level on Wednesday (4.jan.2023). It rose 48 points last year, but dropped 30 points since October 28 – before the 2nd round of the presidential elections.

The Brazil risk was at 280 points before the election. It retreated to 232 points on Dec. 5, but has since risen 18 points. The CDS has a function similar to the dollar exchange rate, which is to assess the degree of uncertainty in a country. It is a contract in which it is possible to assume the credit risk of another person or company. For example: a creditor chooses CDS to offset or exchange the risk of possible default on a loan.

The indicator also historically has movements similar to the dollar. The greater the uncertainties about the country’s economy, the higher the score will be.

The CDS increased in countries at the beginning of the covid-19 pandemic, for example, when there were doubts about the future of the global economy. It reached 377 points in Brazil, the peak of the Jair Bolsonaro (PL) government. The former president took charge of the country with the indicator at 206 points.

In July 2022, it reached 325 points after the advance of the Kindness PEC, which allowed increasing the value of the Brazil Aid before the elections. This was the maximum level of last year.

“ALLIGATOR’S MOUTH”

The Brazil risk has detached from the dollar since the elections. It created a distance that, in the language of economists, is called the “alligator’s mouth”. While the US currency rose to R$5.45, evidencing the market’s concern with the economic policies of the government of Luiz Inácio Lula da Silva (PT), the CDS has dropped 30 points since the elections.

The market’s negative reaction was also demonstrated in the Ibovespa, the main index of the B3 (São Paulo Stock Exchange). Under Lula da Silva’s 3rd term, it had the worst post-election performance, with a 7.1% drop between election and inauguration. In the 3 working days of 2023, until this Wednesday (4 Jan.), the B3 accumulates a drop of 4.01%

OPINION OF ANALYST

Claudio Pires, director of investments at MAG Investimentos, said that the behavior of CDS in Brazil has improved, but it is worse than in other countries. He stated that, historically, Brazil’s country risk is below that of other developing nations, but the scenario changed after Lula’s election.

There are several platforms that measure the CDS in Brazil. Poder360 uses data reported by Investing. Pires used Bloomberg data to assess the behavior of Brazil risk.

According to a survey carried out by MAG Investimentos, the CDS Brazil has dropped 4 points since the elections, while the indicator for emerging countries has dropped 53 points.

“Historically, Brazil has always had a better CDS than emerging countries, but in recent months there has been a clear improvement in the general risk [of countries] with the stabilization of covid and [world] monetary policy reaching an already high level in developed countries”, said Piers.

The improvement in the health crisis scenario and the expectation of lower interest rates in the world benefits emerging countries.

It is possible to see in the graph below that the Brazil risk spent most of 2022 below the CDS of emerging nations. It surpassed the others after the elections, which demonstrates that the country has greater risks than its peers.

“There is a better mood for emerging countries, but in relative terms, Brazil has deteriorated. It stopped being better than average and started to be worse than average”, summarizes the analyst.

The reason is due to investors’ concerns regarding the economic policy with Lula, mainly in the fiscal area. In addition to the constitutional amendment that authorized the government to spend R$ 170 billion outside the spending ceiling, the extension of the exemption from federal taxes on fuel surprised the market. The measure reduces the Union’s revenue in 2023.

The speech by the president and ministers of greater use of state-owned companies to foster growth also put agents in a state of alert.

For this reason, analysts raised the projection for the basic rate, the Selic, to 12.25% per year by the end of 2023, according to the Focus Bulletin. The quotation of futures interest contracts indicates that there will be no cut at the current level, of 13.75% per year.

According to Pires, some investment houses estimated a fall in the Selic in the middle of this year. Now, the bets are that the interest rate cut will start in September.

“I dare say that next week’s Focus Bulletin will get even worse, and will continue to get worse until all this lack of definition in relation to the Brazilian fiscal framework is put in place”, said the MAG Investimento analyst.

Finance Minister Fernando Haddad said that by August he would submit a proposed legislation to replace the spending cap. Until now, there is no counterpart that keeps Brazil in a scenario of fiscal balance.

“The fact is that August is very far away. Are we going to live from here until August with this lack of definition of this fiscal framework? If it’s going to be loose, if it’s going to be tight, if credible and bold goals are going to be set. We started to navigate a great uncertainty. And the Central Bank has already signaled that, if the fiscal policy is disturbing inflation expectations, it is even possible that the next step in monetary policy will not be a decrease, but an increase”, he declared.

INTERNATIONAL WAITING

Economist André Perfeito stated that the reason for the CDS at a lower level is the expectations of international investors regarding the country’s economic measures.

“The perception of Brazil abroad has not necessarily worsened, despite the dollar having risen. It is due to a [government] transition that was smooth [than expected]. There was a lot of fear about Brazil’s policy. […] Strictly speaking, the current rise in the dollar is very much driven by speeches by the economic team, but the speech has much less an objective question in the sense of worsening the perception. So far PT has said it doesn’t want to do it. Now it remains to say what you are going to do, ”he said.

Perfect said that the CDS does not show, however, that there was an improvement in the perception of risk in Brazil. And he said that the dollar exchange rate demonstrates a scenario of concern.

“There is still a lot of uncertainty in the air, and this translates into increased risk aversion, which results in a stronger dollar”, said the analyst.

CDS AND DOLLAR

Luis Otávio de Souza Leal, chief economist at Banco Alfa, said that, at some point, the dollar and the CDS will converge again. “According to my calculations, considering the current CDS, the dollar would be at a level close to R$5. And if the CDS were consistent with the dollar level we have now, it would have to rise to levels close to 300 points”, he declared.

The dollar rose from R$5.30 to R$5.45 since the elections. It reached a low of R$5.06 after the election, but then rose.

Leal said that there are two responses to the different behavior of the CDS against the US currency. The 1st is that the indicator responds to risks of external defaults, which would not harm Brazil as it has large volumes of international reserves.

“As Brazil has a very large reserve and has a small external debt, the problems we are having here are more related to the internal debt”, he said. “I think it’s not quite there, because we’ve already seen at other times last year when the 2 [dollar and CDS] moved together and we didn’t put the external debt at risk”, he added.

He cited as an example the period of voting on the PEC of kindnesses, when both the dollar and the country risk rose with the increase of uncertainties.

Another hypothesis, according to him, is that Brazilian investors are more concerned with the initial confusions of the Lula government, while foreigners are waiting to see what measures will be adopted.

“If the gringo were more exposed to Brazilian assets, maybe the CDS would be accompanying the dollar. […] The gringo is on hold. You’ll see what will come out of this mess. It’s wanting to see what’s sound and what’s noise,” he said.

With information from Poder360