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A Glance Back, and a HardLook Forward
‘October 2015
Geert AalbersSenior Managing Director &
Head of BrazilSão Paulo
2
Marcos CasarinSenior Economist Brazil
London
RISKMAP
2015
Region is facing external headwinds
• End of commodities super cycle
• The China factor (instability, demand)
• Middle-income “trap”
And also internal vulnerabilities
• Low productivity and large informal economy
• Lack of investment, infrastructure
• Weak governance and rule of law
And Brazil...changes ahead?
Lula (2003-2010)
External tailwinds(commodities, China)
Macroeconomic “tripod”(primary surplus, inflation targeting, floating FX)
Social programs; active (and leftist) foreign policy
High approval rating + consensus-building skills = political stability
Rousseff (2011-)Same party, different policies
Less favourable external scenario, lack of competitiveness
“New economic matrix”
Social programs expanded + state intervention (BNDES, Selic, gasoline,
electricity)
Riffs with PMDB = defeats in Congress since 2012
Rousseff’s approval ratings nose-dive to single digits (9%);
mass anti-government rallies
2015 The “perfect storm”?
• Weak mandate and low approval ratings
• An unruly ruling coalition
• Petrobras scandal
• Need to implement a unpopular austerity plan
• Possible water and energy crisis
• Loss of investment-grade status
Gavin commentary on Car wash
• Reach of investigation?• Reach of litigation: international, class action?• Limits of institutional stress?• Regional contagion?
Car Wash investigation: What next?
Gavin commentary on Car washDesigning a New Brazil Playbook
• Corruption risk has increased: H x H• Risk Assessment: deepen the exercise• Tailor training: behaviours, not laws• Third parties: deepen pre-transaction scrutiny and DD• Monitoring and audit rights: use them, and lower the threshold• Whistleblowing lines: never a better moment
Car Wash investigation: What does this mean for you?
Impeachment?
Court of Audits(TCU)
The TCU recommends government accounts for 2014 be rejected; the Rousseff administration is being accused of “fiscal maneuvering”
Supreme Electoral Court
(STE)
Opposition PSDB claims that Rousseff received illegal funds
during the 2014 presidential campaign
Petrobras scandal
Allegations could emerge, specifically implicating RousseffMust relate to offenses made since January 1, 2015
A shrinking coalition
PT + PMDB • Two largest parties in Congress• A marriage of convenience during much
of PT’s term in power (since 2003)• PMDB has traditionally focused more on
power than ideology• Relationship turned sour under
(because of?) Rousseff, particularly since 2012
• PMDB currently split between supporters and opponents of Rousseff
• Key stakeholders• Michel Temer (VP)• Eduardo Cunha (speaker of Chamber
of Deputies)• Renan Calheiros (speaker of Senate)
The “new normal” in Brazil
Politics- Opposition to Rousseff will remain fierce, in Congress and in the streets- Political uncertainty to persist- Silver lining: Rousseff has never been more market-friendly!
Corruption- Petrobras scandal will continue to broaden; reputational risks - Silver lining: part of a wider improvement, business practices are changing
Economy- Recession in 2015, poor 2016- Silver lining: change in economic policy is real, the government is truly concerned about rebalancing public finances
Where are the opportunities?
Consumer goods
Health and education
Renewables (wind, solar) Agriculture Petrobras
assets
Construction and
infrastructure
Several mid-sized companies, lack of dominant players; low penetration for certain sub-sectors
Installed capacity for solar to increase from to 35 MW to 3.5GW by 2023; positive precedent from wind power
Divestment plan worth USD 15bn - 30% E&P, 30% downstream and 40% gas & power
Local firms enduring a credit crunch and in need of cash
Middle class under strain, but still sizeable
Brazil is a powerhouse
Economic outlook for Brazil:
No pain, no gain
October 2015
Marcos Casarin│Senior Economist
Oxford Economics• Oxford Economics is one of the world’s foremost
independent providers of global economic research and consulting
• Founded in 1981 as a joint venture with Templeton College in Oxford University
• Team of more than 150 in-house economists
• Forecasts for 200 countries, 100 industries and 3,000 locations globally
• Unique Global Economic Models
• Detailed scenario capability
• Links to Oxford University and other leading research institutes
Agenda
• A glance back…
• How did we end up here?
• Why now?
• …and a hard look forward
• Is there a way out?
• The adjustment scenario: no pain, no gain
A glance back…
How did we end up here?
How did we end up here?
• It’s impossible understand ‘where we are now’ without
going back and looking closely to what happened to:
• Labour market
• Credit and leverage
• Supply and demand balance
• Fiscal policy
Labour market: more is better, isn’t it?
4
5
6
7
8
9
10
11
12
13
8
9
10
11
12
13
2003 2005 2007 2009 2011 2013 2015
Brazil: Employment and unemploymentMillions
Source: Ministry of Labour and Employment and Haver
Formal employment (LHS)
Unemployment rate (RHS)
%+145%
90100110120130140150160170180190200210220230240250
2003 2005 2007 2009 2011 2013 2015
Brazil: WagesQ1 2003 = 100
Source : Ministry of Labour and Employment
Nominal wages
But what about productivity?
4
5
6
7
8
9
10
11
12
13
8
9
10
11
12
13
2003 2005 2007 2009 2011 2013 2015
Brazil: Employment and unemploymentMillions
Source: Ministry of Labour and Employment and Haver
Formal employment (LHS)
Unemployment rate (RHS)
%+145%
+32%
+16%
90100110120130140150160170180190200210220230240250
2003 2005 2007 2009 2011 2013 2015
Brazil: Wages and productivityQ1 2003 = 100
Source : Ministry of Labour and Employment, IBGE, Haver
Nominal wages
Real wages
Labour productivity
No wonder Brazil lost market share in world trade!
+50%
-40%50
75
100
125
150
175
200
2003 2005 2007 2009 2011 2013 2015
Source : Oxford Economics
Mexico
Brazil
2003Q1=100
Source : Oxford Economics/Haver Analytics
Relative unit labour costs in US$
Credit and leverage: the only way is up!
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
90
110
130
150
170
190
210
230
250
2003 2005 2007 2009 2011 2013 2015
Nominal wages (LHS)
Retail sales (LHS)
Consumer Credit (RHS)
Brazil: Wages, credit and consumptionQ1 2003 = 100
Source : Ministry of Labour and Employment
% of GDP
But there’s no free lunch: leverage also went up!
15
16
17
18
19
20
21
22
23
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: BCB\Haver Analytics
Brazil: Household debt service ratio% of disposable income
Peak level in the US in 2007
What about the supply side?
90100110120130140150160170180190200210220230
2003 2005 2007 2009 2011 2013 2015
Retail sales (LHS)
Brazil: Supply and demandQ1 2003 = 100
Source : Ministry of Labour and Employment
What about the supply side? Well, not so great…
+100%
+17%
90100110120130140150160170180190200210220230
2003 2005 2007 2009 2011 2013 2015
Retail sales
Industrial production
Brazil: Supply and demandQ1 2003 = 100
Source : Ministry of Labour and Employment
And what happens when demand outpaces supply?
2.53.03.54.04.55.05.56.06.57.07.58.08.59.09.5
10.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Brazil: Inflation (IPCA)% year (end of period)
Source: IBGE
Inflation target
Linear trend
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: BCB\Haver Analytics
Brazil: Current account balance% of GDP
Linear trend
Fiscal policy: spending like there’s no tomorrow!
-1.0
0.0
1.0
2.0
3.0
4.0
2003 2005 2007 2009 2011 2013 2015
Source: BCB\Haver Analytics
Brazil: Public sector primary surplus% of GDP
50
52
54
56
58
60
62
64
66
68
70
2003 2005 2007 2009 2011 2013 2015
Source: BCB\Haver Analytics
Brazil: Gross government debt% of GDP
Where do we end up? With a collection of imbalances
Q1 2008 Q2 2015**Public financesFiscal balance (% GDP) -2.2 -8.2Primary fiscal balance (% GDP) 3.7 -0.8Interest payments (% GDP) 5.9 7.3Gross public debt (% GDP) 57 63
External accountsCurrent account (% GDP) -1.1 -4.3FX reserves (months of imports) 15 21External debt (% GDP) 13 16
Economic activityGDP growth (2-year average) 5.2 0.1Inflation (2-year average) 3.8 6.7Public banks' balance sheet (% GDP) 19 26
Brazil: Summary of macroeconomic imbalances*
** Arrows denote improvement/deterioration since Brazil's upgrade to investment grade in Apr-08* 4-quarter moving average, unless otherwise stated
A glance back…
Why now?
Why now?
• We just saw that Brazil has been accumulating macro
imbalances for quite some time…
• …but why are we in crisis only now?
Because we no longer have the two sources of easy growth1. Commodity super-cycle (2003-11)
90
100
110
120
130
140
150
2003 2005 2007 2009 2011 2013 2015
Brazil: Terms of tradeQ1 2003 = 100
Source: Funcex
2. Cheap money for EMs (2011-14)
65
70
75
80
85
90
95
100
105
110
115
120
100
200
300
400
500
600
700
800
900
1000
1100
2001 2003 2005 2007 2009 2011 2013 2015
EMBI+ (LHS) US$ vs major currencies (RSH)
EMBI+ sovereign spreads & US dollar bp
Source: Oxford Economics/Haver Analytics
Mar-73=100
Why is it important?
Growth model would have imploded sooner? Less portfolio inflows (and BRL appreciation)?
-6.1
-40
-20
0
20
40
60
2002 2004 2006 2008 2010 2012 2014
Brazil: Trade balanceUS$ billions
Source : Oxford Economics
Brazil: Trade balanceUS$ billions
Source : Oxford Economics
-6.1
-27.2
-40
-20
0
20
40
60
2002 2004 2006 2008 2010 2012 2014
Actual At 2002 prices
Brazil: Trade balanceUS$ billions
Source : Oxford Economics
Brazil: Trade balanceUS$ billions
Source : Oxford Economics
140
190
240
290
340
390
440
490
02-Jan-2013
06-May-2013
05-Sep-2013
07-Jan-2014
09-May-2014
10-Sep-2014
12-Jan-2015
14-May-2015
15-Sep-2015
EMBI+ Brazil
Source: Haver Analytics
Brazil: Exchange rate and risk premiumEMBI+ Brazil
140
190
240
290
340
390
440
490
1.90
2.10
2.30
2.50
2.70
2.90
3.10
3.30
3.50
3.70
3.90
4.10
4.30
02-Jan-2013
06-May-2013
05-Sep-2013
07-Jan-2014
09-May-2014
10-Sep-2014
12-Jan-2015
14-May-2015
15-Sep-2015
BRL per USD (LHS)
EMBI+ Brazil (RHS)
Source: Haver Analytics
Brazil: Exchange rate and risk premiumBRL per USD EMBI+ Brazil
A hard look forward…
Is there a way out?
Is there a way out?
• Brazil entered 2015 full of macro imbalances as policymakers
didn’t do their homework in the ‘bonanza’ years…
• …now the country needs to prepare for a ‘new normal’ of:
• China slowing (implying lower for longer commodity prices)
• Stronger US$ and higher borrowing costs in hard currency
• More selectivity from investors towards EMs
Who will benefit from this environment?
• Countries with:
• Limited exposure to the Chinese slowdown
• Fewer domestic headwinds (strong domestic demand)
• Good fundamentals (those who did their homework)
• Benefit from lower oil & commodity prices
• Can Brazil still thrive in such a challenging environment?
A hard look forward…
No pain, no gain
Yes, but policies need to be adjusted…
• Our baseline scenario is one of a political and economic
muddle-through…
• Political uncertainty, volatility, but no impeachment
• Very limited progress in structural reforms
As a result, growth will remain moderate…
-4
-2
0
2
4
6
8
2003 2005 2007 2009 2011 2013 2015 2017 2019
Source: Oxford Economics
Brazil: GDP growth% year
Forecast
…and debt will be unsustainable in the long-term
50
55
60
65
70
75
80
85
2003 2005 2007 2009 2011 2013 2015 2017 2019
Source: Oxford Economics
Brazil: Gross government debt% of GDP
Forecast
Alternative is to adjust policies and push through reforms
• Using our macro model, we ran an adjustment scenario.
• Key assumptions include:
• Restoring primary surpluses through tax hikes & spending cuts
• Limiting growth of gov’t spending to that of GDP
• Progress on productivity-enhancing reforms
First things first: put public finances back in order
-2
-1
0
1
2
3
4
5
2003 2005 2007 2009 2011 2013 2015 2017 2019
Baseline Adjustment
Source: Oxford Economics
Brazil: Primary fiscal balance% of GDP
Forecast
50
55
60
65
70
75
80
85
2003 2005 2007 2009 2011 2013 2015 2017 2019
Baseline Adjustment
Source: Oxford Economics
Brazil: Gross government debt% of GDP
Forecast
No pain, no gain
6
8
10
12
14
16
18
2003 2005 2007 2009 2011 2013 2015 2017 2019
Baseline Adjustment
Source: Oxford Economics
Brazil: Unemployment rate (PNAD)%
Forecast
-4
-2
0
2
4
6
8
2003 2005 2007 2009 2011 2013 2015 2017 2019
Baseline Adjustment
Source: Oxford Economics
Brazil: GDP growth% year
Forecast
Bottom line• Where we are today is a result of imbalances accumulated in the past
• From now on, it will be the survival of the fittest – and Brazil needs to work out more!
• First things first: put the public finances back in order to build a bridge for growth-enhancing reforms once the storm is over
• No pain, no gain: any positive results from the macro adjustment will only show up after 3-4 years
• Hence, we see the adjustment as an unlikely scenario – politicians have no incentives to pursue adjustment now.
Perguntas?
[email protected]@controlrisks.com