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Threat of recession should haunt Brazil along with high interest rates and dollar

Economy Dec 29, 2021 14:32
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By Ana Beatriz Bartolo - Brazil is likely to face a very challenging outlook in 2022. Even with the downward trend in inflation, the macroeconomic scenario will consist of high interest rates and a devalued real, in addition to concerns about the country's fiscal situation. The presidential elections at the end of the year should act as an aggravating factor, bringing more volatility to the market.

“For 2022, the expectation for domestic consumption is not good. We expect stability or a small drop, but not growth," comments Rafaela Vitória, chief economist at Banco Inter. "We expect a growth of 0.5%, but this aggregate data reflects little, because we will have sectors in decline and sectors growing. 

Vitória explains that agriculture and some industries, such as extractive industries, are better positioned for next year. On the other hand, the service and retail sectors should be affected by inflation and lower salaries leading to a decrease in families’ purchasing power. 

The consumer durable goods industry may also see weaker performance, since it is lapping a higher base with recent strong quarters. "The overall temperature may point to a recession, because the sectors with strong prospects employ fewer people," explains Vitória.

"It is difficult to have a good year. The fact that Brazil is structurally weak makes it much more vulnerable to shocks of all kinds," says economic consultant Zeina Latif, who foresees a mild recession for 2022.  The country's productivity is low, with a relatively poorly skilled labour force, and national industries are technologically outdated, which, according to the specialist, can be seen in the increase in imports even with the rising exchange rate and weakening real.

"We have a very weak, almost stagnant economy. We had a quick turnaround after 2020, [when the pandemic crisis started], but this brought problems, especially in fiscal matters," comments Latif.

Latif explains that the recent injection of capital into the economy was essential to minimize the economic impacts brought by the pandemic, but the national industry was not prepared to meet the country's repressed demand. "In general, Brazil spent too much and without a clear focus. So part of our inflation, which started already last year, was the result of over-stimulating the economy," he explains. 

Furthermore, the increase in public spending without compensatory measures has generated mistrust about the government's fiscal commitment, which in turn puts pressure on the exchange rate and intensifies inflation and the interest rate. Among the analysts consulted by Brazil, the forecast for 2022 is that the dollar will be in the range of R$ 5.40 to R$ 5.50, with the Selic (Brazilian interest rate) between 10.5% and 12% and an IPCA (inflation mark or CPI) close to 5% year over year., on average.

2022 Presidential Election

Latif explains that in the last year there has been an, "institutional weakening of the (constitutional) spending limit," with off-budget spending and the recent discussions about the PEC of Precatórios, which changes the country's fiscal anchor. This all will have an effect on the presidential elections: "Now the market debate is how committed the competitive candidates are to the cap rule and the fiscal responsibility law." For Latif, long-term or structural projects will only get underway after the election result is clarified.

"There is a favourable situation for a centre-left candidate to win, because the level of activity in Brazil is very weak and the average consumer’s income and purchasing power has dropped a lot, either because the labour market is bad or because inflation is high. In a situation like this it is very difficult to raise a liberal, free-market flag," explains André Perfeito, chief economist at Necton Investimentos.

Although the names of the presidential candidates are not yet defined, Perfeito points out that among the possibilities presented so far, the main centre-left representative that could win the elections next year is former president Luiz Inácio Lula da Silva, of the Workers' Party. With a possible victory for the PT, the specialist believes that the Central Bank would not feel pressured to reduce the Selic, which at Necton is forecasted to reach 11.5% in 2022.

Perfeito explains that although interest rates have reached 2% in recent years, this reduction had no significant impact on the economy; on the contrary, it brought, "a series of dysfunctionalities in the financial system. Besides, the bond and stock markets were very disconnected.

"The moratorium interest rate was well below the perceived risk. When the interest rate goes higher, this will indicate that asset prices are low and this may generate a positive mood in the market in 2022, despite the scenario indicating that Lula da Silva will win the elections," comments Necton's chief economist. 

No help from the international scene

Besides the internal challenges, the international economic climate will also be of little help to Brazil. "World trade should be stagnant and facing an inflation challenge in 2022," Latif says. "With the Fed raising interest rates and world trade growing more modestly, it is a more difficult environment for emerging countries," explains the economic consultant.

For the economist and professor at USP, José Francisco Gonçalves, the expectation is that the United States monetary policy will tighten global financial conditions over the next year, which together with doubts about Chinese demand, should impact commodities. The scenario gets even more complicated with the bottlenecks in the economy and the questions about the Omicron variant of coronavirus.

"There is not much demand coming from abroad for Brazilian exports, so there will be large production in agriculture, but without pricing power. Besides, less favorable financial conditions abroad pose difficulties for investments here, which increases speculative or fixed income positions'', explains Gonçalves. 

Threat of recession should haunt Brazil along with high interest rates and dollar

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