Brazil in retrospect
2023 marked the end of a challenging period for the Brazilian economy. Starting with the international scenario, several significant events unfolded. First, the Russian-Ukrainian war led to a significant but temporary increase in energy prices. Second, ongoing tensions between China and Taiwan continue to impact the entire semiconductor supply chain. Third, high inflation and global monetary tightening prompted a shift in capital towards developed economies and exerted pressure on corporate profitability, particularly affecting major technology companies (big techs).
Internationally, various factors have influenced macroeconomic indicators, leading to the need for interest rate adjustments to counter inflation in energy and food prices. Despite external challenges and political polarization, previous investments in infrastructure have aided the recovery of the labor market, resulting in a return to pre-pandemic employment levels. This has positively impacted household consumption and investment, which are critical drivers of GDP growth.
Until the middle of this year, the political impasse created by the demands of the Legislature undermined several guidelines previously established by the new government during the political campaign. The lack of leadership within the Executive and the ongoing internal conflicts within the ruling alliance confirm this evidence.
Nevertheless, the recently established regulatory frameworks have yielded a positive impact on investment figures, particularly in comparison to previous electoral transitions. From a microeconomic standpoint, the Federal Government has also made notable strides in other areas. Including the development and promotion of innovative methodologies for pre-and post-evaluation of infrastructure projects, along with the centralization of accounting through the Investment Monitor. Additionally, significant milestones have been achieved, such as the privatization process of Eletrobrás, which was facilitated by the enactment of dedicated legislation. Furthermore, the adoption and utilization of integrated planning tools, exemplified by the establishment of the PILPI (Integrated Long-Term Infrastructure Plan) for the period 2021-2050, contribute significantly to the enhancement of the country’s institutional framework.
One of the indicators of the progress within this new context has been the frequency of auctions conducted in recent years, despite the challenges posed by the COVID-19 crisis and, more recently, the government’s operational slowdown under the current federal administration.
The “rebound” effect from the external macroeconomic landscape is starting to materialize. Following a challenging year for numerous developed economies, we are witnessing the subsiding of inflationary pressures, encouraging outcomes in the global labor market, stabilization of the impact of COVID-19 (leading to a halt in the disruption of the global supply chain), and a pause in the upward trajectory of interest rates in the United States, among other factors. These developments collectively contribute to an enhanced domestic outlook for Brazil.
Furthermore, the recent upward revision of Brazil’s sovereign credit rating by S&P has bolstered investor confidence in Brazilian assets. This optimism can be attributed to three key factors: Firstly, the interest rate futures contract set to mature in January 2027 witnessed a decline from 11.65% to 10.53% between September 5th and June 16th. Secondly, the exchange rate experienced a decrease, reaching 4.82 Brazilian Real per US Dollar on June 16th, resulting in an accumulated appreciation of approximately 8% thus far this year. Lastly, the Ibovespa, Brazil’s main stock market index, has surged to levels close to 120,000 points, representing a year-to-date appreciation of approximately 8.3%.
Internally, the Brazilian economy is experiencing a noteworthy trend of disinflation, which is transpiring concurrently with an improvement in economic activity. To illustrate this point, consider the IPCA (Broad National Consumer Price Index) over 12 months: between April 2023 and May 2023, it decreased from 4.18% to 3.94%, which can still be attributed to the monthly deflationary periods observed from July 2022 to September 2022. Furthermore, the core IPCA, which excludes volatile items, declined from 7.32% to 6.73%, marking the lowest level since September 2021. Looking at the IGP-M, we observe a period of deflation: May 2023 reported a deflation rate of 1.84%, resulting in a significant historical deflation of 4.46% over 12 months.
While the short-term news appears positive, it is important to recognize that if sustained, it could pose challenges. An increase in economic activity coupled with rising public debt can potentially lead to higher inflation and extend the time required for inflation to converge to the central target level. Simultaneously, the decline in commodity prices may have a favorable impact on “imported” prices, but the overall effect remains uncertain due to the persistently high levels of several other commodities.
Regarding economic activity, the unexpected increase in GDP by 1.9% in the first quarter of 2023 surpassed market forecasts. However, making a definitive prognosis for future periods is challenging due to a mixed climate of positive and negative surprises. In April, industrial production experienced a decline of 0.6%, while expanded retail sales (including various retail sectors, vehicles, auto parts, and construction products) plummeted by 1.6%. On the other hand, the coincident indicator of GDP, measured by the Brazilian Central Bank’s IBC-Br, exhibited a 0.56% increase in the same month, potentially attributed to the positive effects of agribusiness and export activities, considering that the global economy, for the time being, remains relatively robust.
Brazil in perspective
On the international front, the ongoing Russia-Ukraine conflict and the potential for a global recession remain significant concerns that could impact the trajectory of the Brazilian economy. Although the conflict has shown some signs of stabilization, it has had notable effects on energy prices and the importation of key consumer goods in Brazil, such as wheat. Meanwhile, the possibility of a recession continues to pose challenges for major economies, particularly in Europe, which heavily rely on Russia’s energy resources.
Internally, the disinflationary process in Brazil persists, primarily influenced by fluctuations in food and fuel prices. The stabilization of commodity prices below the average of 2022, combined with the appreciation of the real, will facilitate the maintenance of deflationary pressures in wholesale prices. This, in turn, is expected to be partially transmitted to consumers in the following months, thereby supporting disinflationary trends in goods prices. As a result, it is projected that the IPCA by the end of 2023 will likely converge around 5.5%.
It is anticipated that the Brazil Central Bank (BCB) will initiate a gradual decline in the Selic rate starting from August 2023. The recent decrease in inflation expectations is expected to persist in the coming weeks, providing a level of certainty for this shift in the interest rate direction. However, some potential risks could potentially delay the start of the easing cycle. These risks include the finalization of the fiscal framework rules, the revision of the inflation target during the upcoming meetings of the National Currency Council (CMN), and the government’s implied intention to expand credit through public banks. Furthermore, a political risk that should be considered in the coming months is the government’s expressed desire to revise the law governing the independent governance of the BCB.
The unexpectedly strong performance of the GDP in the first quarter of 2023, along with the positive reading of the IBC-Br economic activity indicator in April 2023, has reinforced the perception of the economy’s resilience and prompted upward revisions in GDP growth forecasts for 2023. According to a survey conducted by Agência Estado with economic analysts, current projections range between 1.6% and 2.8%. Despite a slowdown in the pace of growth in service activities from January 2023 to April 2023, it remains consistent with a growth rate of 1.5% to 2% for the year. The economy’s favorable performance has supported the labor market, and when coupled with disinflation and government assistance programs, it suggests that domestic consumption may continue to exhibit strength.
Uncertainties surrounding the business environment have dampened optimism regarding fixed capital investment, despite a significant portion of the infrastructure sector already being contracted. However, the observed decline in interest rates in the futures market, particularly for longer maturities, could potentially foster a gradual rebound in investment, though this trend is expected to become more evident in the second half of 2023. Additionally, revisions to budgets based on improved GDP expectations for the year, as well as favorable interest and inflation conditions, contribute to a less challenging environment for companies’ investment plans.
Regarding public finances, it is worth noting that the fiscal framework represents an expansion of public spending and a potential increase in the tax burden. However, the financial market has shown support for the project approved in the Senate (which will be revisited by the Deputies’ Chamber) and recognizes its role in containing the uncontrolled growth of public debt in the short term.
Concerning the exchange rate, the US dollar is expected to weaken against major currencies due to the pause in the interest rate hiking cycle in the United States. In this context, the country’s external sector fundamentals (such as a high trade surplus and an increase in foreign investment inflows) and the significant interest rate differential, even amidst a downward trend in the Selic rate, could justify some appreciation of the Brazilian Real (BRL) over the next 12 months. However, the increasing uncertainty caused by government actions, including a fiscal framework favoring the expansion of public spending, potential changes to the inflation target, and the intention to review structural reforms, raises concerns and may keep investors cautious. Consequently, in the medium term, expectations lean towards a relatively depreciated BRL.
Politically, the government has identified two priority projects: tax reform and the revision of fiscal and economic austerity laws implemented during the Temer-Bolsonaro administrations. The tax reform aims to bring significant changes to the Income Tax table and consolidate state and municipal taxes. However, the specific details and methods for implementing these changes remain uncertain, leading to fundamental disagreements and challenges in garnering political support. Regarding the revision of fiscal and economic austerity laws, it will put various fundamental aspects to the test, including labor reform, laws governing state-owned companies, sanitation, railway regulations, Central Bank independence (along with the inflation target), TLP, BNDES, and S/A Law among others remain to be seen.
Currently, the international impacts on the Brazilian economy are being effectively managed. Moreover, domestically, a more favorable outlook is on the horizon. Key indicators such as inflation are nearing target levels, there are prospects of declining interest rates, and there has been an increase in employment and income. Additionally, exchange rates have been relatively stable. These factors collectively contribute to a positive momentum that is expected to further stimulate economic growth.
Economic activity is expected to continue largely supported by the positive performance of the agribusiness sector, as a new record harvest is anticipated for this year. This, in turn, is likely to stimulate income and credit, leading to increased consumption and positively impacting the service and retail sectors. However, the industrial sector continues to face challenges and is seeking support through subsidies or lower interest rates for financing to help revitalize its operations.
At the political level, a significant degree of uncertainty persists. The federal government has yet to implement any of the proposed changes that were promised during the campaign. Additionally, it has faced setbacks in major political disputes, as evidenced by the reversal of sanitation decrees and recent clashes between Congress and the Executive branch. The continued presence of unresolved proposals and the resulting political and institutional support further contribute to the diminished productivity effects for the economy.
 To recall, as listed by the last report of the Infra 2038 Project, in the last four years the Law of Agencies, Law of Economic Freedom, Law of Business Environment, New Telecommunications Framework, IoT Exemption, Improvement of the 5G Auction, Norm on Antennas, Law of the New Regime of Concession of Railways, BR do Mar or Law of Cabotage, Air Sector Liberalization Law, Gas Law, Ethanol Producer Direct Sale Law, the Pro-Consumer Law of the Electric Sector and the New Law of Bids and Administrative Contracts, as well as several infralegal and regulatory initiatives.
Authors: Frederido Turolla and Yan Cattani