‘Brazil on the right track to recover investment grade’ – 06/16/2023 – Market

The revision from “stable” to “positive” of the perspective of the Brazilian economy by the risk classification agency S&P Global Rating crowns the good moment of the Brazilian economy, but there is still a long way for Brazil to recover the investment grade. So says Martín Castellano, research director for Latin America at the IIF (International Institute of Finance), an association that brings together 400 representatives of the financial sector from 60 countries.

For him, the economic policies of the government of Luiz Inácio Lula da Silva (PT) are on the right track and the conditions are favorable for the current bonanza in exports to be sustainable in the long term. In an interview with SheetCastellano defends, however, that it is necessary to keep the monetary policy tight, to control inflation and praises the work of the Central Bank.

This week, S&P Global improved the outlook for Brazil from “stable” to “positive”. Mr. Do you see room for Brazil to regain investment grade? We have been very optimistic about Brazil for a long time at the IFF, our projections pointed to a growth forecast for this year that was higher than the consensus. We noticed that part of the uncertainty after the change of government is decreasing, and this also happened in the market, which was very anxious and worried about the changes in policy. We also remain very optimistic in relation to the external accounts and highlight the structural improvements that are taking place in Brazil, with an increase in the current account surplus and trade surplus and a reduction in the current account deficit. I believe all steps are in the right direction, the pieces are coming together.

There is a long way to go to regain investment grade, as the country is still a few positions below. But policies are moving in that direction and some of the uncertainty the market had has eased, which is positive in terms of capital flows. Despite some challenging conditions, I believe Brazil will benefit from the geopolitical landscape. Tensions such as the War in Ukraine and elsewhere in the world have changed investor preferences, and Brazil ranks very well against other emerging markets on several fronts. Then you are on the right path.

And what needs to be done to regain investment grade? Maintain very consistent fiscal and monetary policies. One of the main objectives of monetary policy, controlling inflation, is a challenge throughout the world. The Central Bank has been doing a very good job in terms of managing inflation expectations, tightening monetary conditions, and the cost of missing targets is higher now. The fiscal picture is more sensitive, it is necessary to avoid more adverse scenarios, considering that public finances are still fragile in Brazil compared to other countries. The fiscal framework is more realistic than the previous one. It’s still challenging, but it looks like the authorities are committed to passing it and sticking to it. It will require revenue increases, but the positive news in the external environment offers opportunities in terms of revenue growth.

Are you optimistic about the approval of reforms, even considering the difficulties that Lula has had with Congress? Yes. At first there was uncertainty due to the results of the elections, with the center-right skewed Congress. In addition, there is a very broad ruling coalition, in which several parties with different and sometimes diverging interests are involved, which created some noise initially. However, I believe this has stabilized as they are all seasoned politicians. Markets realize that the noise surrounding some policy proposals and implementation is part of the negotiation process. At the end of the day, everyone is playing by the rules, the political system is well established, the political institutions are strong in Brazil. When a new government takes over, it makes proposals that are discussed, some of them are changed and adjusted, but it is part of the process. I believe the system is working in that sense.

Is the increase in exports sustainable in the long term? Conditions are favourable. It will also depend on market conditions and the international scenario, with commodity prices. But the productivity gains we have seen in the agricultural sector are quite significant. Brazilian exports are much more diversified than most countries in Latin America, for example, where major countries rely mainly on one or two commodities. In Brazil, we have a variety of commodities and also significant exports in the manufacturing sector. This diversification of exports helps to make it more sustainable.

So, you believe that we are in a virtuous cycle of the economy. Yes, with the caveat that it’s not yet a supercycle, so external conditions are more challenging for everyone, with higher interest rates globally. Within this context, Brazil seems attractive to investors compared to other markets. It still has above-target inflation, there are many challenges, as in most countries in the world right now. But under these conditions Brazil looks very attractive, as well as others in Latin America.

The free trade agreement between Mercosur and the European Union was threatened by issues involving the environment. How is the image of Brazil to the world in this area? Investors see Brazil as having a lot of potential in this regard too, with the current government willing to play a proactive role. Demand for green assets and sustainable projects is very strong globally and is growing in Brazil. The country has enormous potential and opportunities in this regard when looking at commodities, natural resources and infrastructure.

Does the American investor give the same importance to the theme as the European one? Yes, this is gradually increasing. Also, I would say that institutional issues are more important for investors. It’s a gradual process too, but it’s becoming more and more important and a priority.

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Martín Castellano Economist and head of research in Latin America at the IIF (International Institute of Finance), based in Washington. He holds a master’s degree from the University of Chicago and the Centro de Estudios Macroeconómicos de Argentina (CEMA), in Buenos Aires. He was also Chief of Staff, Deputy Chief of Economic Research and Executive Advisor to the Central Bank of Argentina.