Time to Buy Brazil? The Bearish Case

Written by Armando Castelar.

In a previous post I commented on the views of economists who are optimistic about the outlook of the Brazilian economy, foreseeing GDP growth in the 2% to 3% range already next year (see here). In this post I present the views of economists who remain bearish about the Brazilian economy in 2017.

The OECD economists are an example: in the first week of June they released their revised forecasts, which now foresee a GDP contraction of 1.7% next year, on top of a 4.3% drop in 2016. A week later, the World Bank followed suit, projecting a decline of 0.2% in next year’s GDP. Several Brazilian institutions also doubt that GDP may recover before 2018.

Bearish analysts question the strength of the arguments that support the optimistic view and point to other, less bright ones.

First, they are skeptical about political support to measures that actually tighten public sector spending, pointing to the vote in the Lower House in favor of substantially increasing salaries of civil servants. Indeed, this year the public sector’s primary expenditures should break another record. 

Moreover, they argue that, with the ongoing investigation of the corruption scandal in Petrobras, the political crisis may still be far from over, which will hamper support to harsh measures and affect confidence.

Second, inflation has proved to be much more resistant than earlier anticipated and it is not clear that it will converge to target if interest rates fall soon and substantially. In the last 12 months, prices went up 9.3%, more than their increase a year ago (8.5%). Despite rapidly rising unemployment, inflation in services has declined only marginally, from 8.2% to 7.5% in the same comparison.

Third, it is still far from certain that manufacturing has hit bottom and, if yes, how strong the recovery will be. In particular, if the real strengthens, helping to control inflation, it will stifle net exports. It is not very clear either how fast the new government will solve Petrobras’s financial problems, or launch new infrastructure projects.

In addition, there is much pessimism regarding the recovery of domestic consumption, and thus of sectors such as commerce and other services. Bearish economists point out that the labor market still has room to worsen: unemployment will move higher and real earnings will decline further. In addition, households and firms need to deleverage, meaning domestic credit will continue to contract, boding ill for sectors such as construction and financial intermediation.

Finally, there is a statistical issue: to expand 2% in 2017, after contracting 3.5% in 2016, GDP would have to grow at a seasonally adjusted annualized rate between 4% and 5% in the four quarters of next year. That is, the economy would have to accelerate quite substantially, which would require that confidence and interest rates move fast and substantially in the near future.

How do we balance the contrasting views of bullish and bearish economists about the Brazilian economy in 2017? In my next post I will give my answer to this question.