Thu | Dec 14, 2017

Walter Molano | Brazil: On the mend

Published:Friday | October 27, 2017 | 12:00 AM
In this June 7, photo, a demonstrator wearing a mask depicting Brazil's President Michel Temer performs during a protest outside the Superior Electoral Court in Brasilia, Brazil.

After enduring its worse recession, Brazil is on the mend.

Economic activity in July expanded 1.48 per cent y/y in July, up from 0.8 per cent y/y the month before.

Although the political crisis keeps rearing its ugly head, the worse seems to be over, allowing an air of optimism to spread through the private sector. This was highlighted by the all-time highs that were registered in the Bovespa. And FGV reported that consumer confidence was at 82.3 points in September, compared to 80.9 in August and 82 in July.

There is ample room for the optimism. The trade balance has been on a tear.

In September, the country posted a trade surplus of more than US$14 billion, and the year-to-date surplus is in excess of US$51 billion. This has allowed the country to virtually eliminate its current account deficit, which hit a high of US$101 billion in 2014.

This is one of the most extraordinary reversals in current account balances. It parallels the turnaround that was posted by Argentina in the aftermath of its maxi-devaluation and default in 2001. The extent of the improvement in the current account highlights the depth of the Brazilian recession.

Another indicator that underscores the magnitude of the adjustment is the inflation rate. Consumer prices have been plunging. In September, the national statistics agency, IBGE, reported that the IPCA consumer price index increased only 2.5 per cent y/y.

Some analysts worry that at the current trend, the country may actually slip into deflation by the start of the new year. This has allowed the central bank to slash interest rates, with the COPOM cutting the benchmark SELIC interest rates by 600 basis points during the last 12 months.

Nevertheless, there is still room for further cuts. Fortunately, all of the good news have not been concentrated on the economic front.

Despite a deluge of corruption charges, the Temer administration continues to push ahead with the economic reforms. A slew of privatisations have been announced, including the sale of most of the thermoelectric generating plants at Eletrobras, the partial privatisation of the company and the sale of Petrobras' network of gasolene stations.

The government expects the Eletrobras sale to be completed by the first half of 2018, and it will divest itself of all of the power plants, except for the mega-facilities at Itaipu and Angra. The IPO of BR Distribuidora, which holds the Petrobras gas stations, is expected to value the company at about US$9.5 billion.

The asset sales also include a slew of airports, port terminals and port authorities. This should boost the level of foreign investment in the country above the US$70 billion that was recorded last year.

Another positive development on the policy front is the approval of the labour reform. Although it was far from perfect, the reform provided additional flexibility to the labour regime. In the end, it should allow firms to expand their payrolls and boost economic activity.

Yet another important development was the new limitations on the preferred interest rates that BNDES charged. These highly subsidised rates were abused by political allies of the PT to amass huge corporate empires. Along a similar line, the government took steps to reduce the red tape and streamline bankruptcy proceedings to boost recovery rates.

Last of all, the government continued to push ahead with the much-needed pension reform. The legislation is moving at a glacial speed, but the Lower House is expected to vote on it by next month.

The improvements on the economic and policy front were somewhat met by the situation on the political front. On the positive side, the PT appears to be dead. Former President Inacio Lula da Silva was found guilty for accepting R$3.7 million in bribes from OAS Engineering, and was sentenced to 10 years in prison.

Nevertheless, a recent poll found that 35 per cent of the respondents indicated that they would vote for him in the 2018 presidential elections. This has raised some consternation in political circles, but his rejection rate of 46 per cent to 60 per cent, depending on the pollster, makes it unlikely that he could win.

The more serious threat comes from the far right, in the form of Congressman Jair Bolsonaro. Hailing from the State of Rio de Janeiro, he is a former military paratrooper. He is known for his homophobic stance and misogynist comments. Hoping to emulate the success of Donald Trump, he is capturing the overall contempt for the mainstream political parties.

After veering far to the left, Brazil's political pendulum may be swinging in the opposite direction. Some investors may take this as a positive development. However, we must recall that the right's record of economic management in Brazil was disastrous.

Nevertheless, the developments on the economic and policy front, as well as the demise of the political left, are reasons to be extremely optimistic about Brazil. It is as if rays of light were finally shooting out from behind the dark clouds that have obscured the Brazilian horizon for years.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com