Alphacast Highlight - Brazil December 2022 Macro Brief

Although Brazil's growth has been stagnant for a decade, investment led the best performance since the 2014 crisis. That said, output is expected to continue growing but at a more moderate pace. Regarding price dynamics, inflation it is already cooling down due to hiking interest rate and tax cuts, mainly on fuels, and energy. The BCB warned that if inflation does not ease, it could increase the Selic rate even more. Despite the electoral cycle and an early, aggressive monetary policy tightening, Brazil is performing a strong fiscal consolidation in 2022. On the other hand, uncertainty prevails regarding the fiscal direction. Brazil awaits the resolution of Congress, aiming to strongly expand the ceiling on public spending in order to meet campaign promises.

Activity

Brazil's economic activity fell in October by 0.05% due to the effects of the monetary restriction. Although the Central Bank Economic Activity Index (IBC-Br) stood positive ​​(+3.83% YoY), growth has been cooling down since July (+5.7% YoY). Simultaneously, industrial production increased 0.28% monthly, after two months in negative ground. With this result, the industrial sector increased 1.7% YoY but is still 2.1% below the level prior to the pandemic (Feb-20). Results reflect the obstacles faced by the sector, mainly due to the increase in production costs and the limitations on the availability of inputs and components for the production of the final good. Although growth expectations for BCB have improved so far this year (from 0.3% in January to 2.9% in December), the slowdown in the economy is beginning to show up. As a result, a moderate growth rate is expected for 2023 (+0.75%).

Inflation

In November the Brazilian IPCA-15 increased 0.41% MoM, reaching 5.9% YoY. Inflation has moderated in recent months, after peaking in April (12.2% YoY) held back by a high-interest rate and temporary tax breaks on utilities and fuel. The rise was driven mainly by the transportation category (+0.83% MoM), due to the increase in fuel prices (+3.29%). Despite the recent inflation reduction, it of 5.88% YoY is expected for this year, it continues above the ceiling of the 5% inflation target.

Monetary Policy

The central bank kept interest rates at 13.75% this month for the third time in a row, after taking a notably aggressive stance since March 2021. Aiming to alleviate the high levels of inflation, the Brazilian interest rate suffered one of the fastest hikes in its history, going from 2% in Mar-21 to the current 13.75%. The COPOM noted that the level of the interest rate will remain in force to guarantee convergence to the established inflation target and does not rule out new increases if it does not achieve it. The hawkishness of Brazil's monetary policy has made it the only large economy in Latam with positive real interest rates, at an effective annual rate of 7.8%.

FX & Markets

The year began with a Real Exchange Rate at a 20-year low, around 20% above the 2003 previous low but 30% more depreciated than the 10-year average. A weaker Real was underpinned by an aggressive monetary policy. Nonetheless, since Lula's victory and the subsequent reactions between the two candidates, the dollar appreciated 4.06% (vs. 30-Sep).

So far in 2022, Brazil's equity (EWZ, +13.1% YTD) has outperformed Latam (ILF, +10.5% YTD ) by 612 bps. Nonetheless, the impacts of the presidential elections, in addition to external factors, generated volatility in the markets where the EWZ has fallen by -13.3% since then. Also, its risk premium trades at 268.41bps (-151.37bps vs Latam), -31.39 bps below the highest value reached the week after the elections.

Fiscal

The Bolsonaro government achieved a primary surplus of 0.87% of GDP in October, one of the most balanced results recorded since mid-2014. This improvement was driven by the growth in pension collection and the collection of the Income Tax at the Source of Capital (IRRF Capital), in addition to the temporary reduction of the Import Tax rates and the exonerations of the fuel tax and on industrialized products. Also, If interest on public debt is taken into account, the public sector reached an accumulated deficit for the last 12 months of 4.37% of GDP. Nevertheless, this result is not expected to continue: Congress is debating a bill that would increase the public spending limit to finance President-elect Luiz Inácio Lula da Silva's campaign promises, including subsidies and others welfare programs.

Trade & CA

Brazil's terms of trade remain 2.78% above the close of the previous year. The conflict in Ukraine increased a large part of Brazil's export prices which compensating for the increase in import prices of fuels and fertilizers. In adittion, as a result of the positive shock of commodities and the hiking rates environment, the currency is one of the most appreciated in the region (+7%).

Nonetheless, the country faces a persistent current account deficit, even though having registered the third best trade surplus in history. In October, exports grew by 27.1% annually, while imports growth by 19.8% compared to the same period of the previous year. This contributes to reduce the current account deficit by almost half a percentage point of GDP, after reaching the maximum value in the last two years in September (-3.5% of GDP).

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