The Brazilian ‘relative’ – 05/08/2023 – Ana Paula Vescovi

The recent improvement in Brazil’s credit risk assessment by Fitch Ratings surprised markets as much as the worsening of the US credit rating.

The statement came in line with a more positive view of Latin America —especially after the shocks of the pandemic and the war between Russia and Ukraine (triggering the search for rapprochement of global production chains)—, expectations of an inevitable slowdown in the Chinese economy and deterioration of economic fundamentals in advanced economies.

According to the agency’s statement, in free translation, “Brazil’s ratings are supported by its large and diversified economy, high per capita income, deep domestic markets and a large cash cushion that support the flexibility of sovereign financing and its high share of local-currency debt. The ratings are also supported by shock-absorbing capacity, supported by a flexible exchange rate, strong international reserves and a net foreign-currency sovereign credit position.”

For Brazil, in the current situation in particular, our comparative advantages in sectors that indicate relative scarcity in the long term weigh, especially in the production of agricultural, mineral and energy commodities.

In a previous article, I already discussed the possible effects of such advantages on the country’s potential growth. In a medium-term inference, it would be reasonable to expect benefits for the Brazilian external sector, which already describes a very robust picture. The impacts so far, however, are not very evident.

There is a real improvement in trade flows, in line with commodity exports accounting for around two-thirds of Brazil’s exports. The country’s degree of trade openness reached the highest historical levels, with an increase in terms of trade levels (relationship between export and import prices) after 2020.

Portfolio investments were slightly positive for Brazil in the first half of the year, at US$ 4.2 billion, which is largely due to high interest rate differentials in relation to the rest of the world. The currency cycle has already started its easing here, and interest rate differentials will narrow if we consider that advanced economies are just close to ending their interest rate hikes. This mismatch should be a factor reducing the intensity, or even reversing, the inflow of financial resources.

In turn, direct investments have recovered since the sharp drop suffered during the pandemic and should return to previous levels, close to US$ 80 billion.

In Mexico, it is expected that there will also be an increase in foreign direct investment inflows, largely due to the effect of the reallocation of production chains and its proximity to the US consumer market. It could be a sign for Brazil, but so far there is no evidence of this movement. Something that new international agreements, such as the one being discussed between Mercosur and the European Union, could trigger in longer terms.

There are other points mentioned in Fitch’s statement: “The ratings [do Brasil] are constrained by high government debt, fiscal rigidity, weak economic growth potential, and relatively low governance scores”.

Since the country lost its investment grade status in 2015, it has carried out important economic reforms, aimed at improving the business environment and potential growth and reducing the structural fiscal deficit. This year, there is the promise of approving a historic reform in taxation on consumption (VAT reform).

The new fiscal framework, also under discussion in Congress, has been a promise of consolidation of public accounts, but with a high risk of execution, since it has expenditure limits that differ from the indexation of mandatory expenses and the government’s public policy agenda.

Additionally, the fiscal adjustment commitment is based on raising the tax burden, which can be greatly limited by the contractionary economic cycle, by the resistance of Congress to continue increasing an already very high tax burden or by the eventual difficulty of survival of some companies to a new round of cost increases.

Concretely so far, there are the calculations of experts who point out that the new fiscal framework does not prevent the growth of public debt as a proportion of GDP nor does it ensure its stabilization.

There is also recognition of the conduct of a prudent monetary policy, the independence of the Central Bank and the institutional checks and balances, which have brought political stability, the rule of law, regulatory and institutional quality and control of corruption. On the side of investors, there is recognition of the discipline brought by the markets and the reforms previously approved, as well as the importance of those on the agenda.

Far from being a blank check, the subliminal messages received by Brazil in the recent period, both from rating agencies and the positive view of foreign investors, go through the reform effort and the importance of maintaining the discipline brought by the markets.

Believing that this could be a persistent global benevolence, due to the deterioration of the economic fundamentals of several countries after the most recent shocks, would again be wasting the benefits that this Brazilian “relative” can bring to the general population.

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