KEY RATING DRIVERS
Brazil's ratings are supported by its large and diverse economy, high per capita income relative to peers and capacity to absorb external shocks underpinned by its flexible exchange rate, moderate external imbalances, robust international reserves and deep domestic government debt market. This is counterbalanced by Brazil's high financing needs and government indebtedness, a rigid fiscal structure, weak economic growth potential and a difficult political landscape that hampers timely progress on fiscal and economic reforms.
The Negative Outlook reflects risks to fiscal consolidation and economic recovery needed for medium-term public debt stabilization following the sharp deterioration in Brazil's fiscal accounts and public debt burden in 2020, particularly in light of the uncertain evolution of the pandemic, the vaccination process, and economic fallout. Public spending pressures persist and additional fiscal support to address the fallout from the pandemic cannot be ruled out. Continuing fiscal fragilities as well as shortened debt maturities make Brazil vulnerable to shocks.
Fitch forecasts GDP growth to reach 3.3% in 2021, after contracting by 4.1% in 2020 (BB median: -4.4%), before slowing to 2.5% in 2022. A strong statistical carryover as well as external factors including higher commodity prices and the rebound in global (and China) growth support growth in 2021. Tightening macroeconomic policies and uncertainties related to next year's election race could weigh on investment and growth in 2022. Downside risks stem from the uncertain evolution of the pandemic and potential delays in the vaccination process. Delays in vaccine supply from abroad and inputs for domestic vaccine production could postpone the authorities' timeline of vaccinating the vulnerable population by the end of 2Q21 and a substantial portion of the entire population by yearend. Any loss of confidence in the trajectory of public finances could also undermine the recovery.
Inflationary pressures have increased significantly, with IPCA inflation surging to 6.8% in April from a nadir of 1.9% in May 2020. Higher commodity and food prices, and a weak (albeit recently appreciating) BRL have put pressure on prices. Inflation is expected to exceed the target of 3.75% in 2021. After cutting the Selic interest to a historically low of 2% in 2020, the central bank has reversed course by hiking rates by 150 bps (with more in the pipeline) since March 2021 to fight price pressures and to prevent a deterioration of inflation expectations.
Fiscal challenges persist with the general government (GG) deficit reaching around 14% of GDP in 2020 compared with 7.2% for the 'BB' median. Fitch forecasts the GG deficit to remain relatively large at 7.4% of GDP in 2021 (BB median: -5.2%). The reduction in the deficit will be underpinned by the recovery in revenues as well as partial withdrawal of the 2020 fiscal support. The possibility of further extension of pandemic-related spending represents a downside risk to our fiscal projections for 2021. Sharper-than-expected increases in the sovereign's borrowing costs could also weigh on consolidation prospects. The recent Supreme Court ruling on the exclusion of ICMS taxes from the calculation of the PIS/COFINS tax base that is levied by the federal government would further weigh on Brazil's public finances over the medium term.
While Fitch expects the government to comply with the spending cap this year, we highlight that over BRL100 billion (over 1% of GDP) of COVID-19-related temporary spending will remain outside the cap. Even with the exclusion of such spending, the government will face challenges to comply with the cap. As part of the agreement on the 2021 budget, the government cut discretionary spending to extremely low levels to make room for some congressional spending amendments, which will severely constrain flexibility during budget execution. Pressure to create new social programs for coming years persists and potential addition of such spending commitments without offsetting measures could increase budgetary rigidities.
Brazil's general government debt burden reached 88.8% of GDP in 2020, which was significantly higher than the current 'BB' median of 59.3%. However, the decline in the central government interest-to-GDP ratio to 3.6% of GDP in 2020 from 4.2% in 2019, has supported affordability. Despite the large fiscal deficit in 2021, Fitch forecasts the debt/GDP ratio to dip slightly to 86.8% due to temporary factors such as the significant prepayment by the BNDES development bank of its loans from the Treasury for BRL100 billion (1.2% of projected GDP) and high nominal GDP growth. Debt is expected to climb modestly thereafter. A slower economic recovery and fiscal adjustment as well as higher sovereign borrowing costs are the main downside risks.
Brazil's large funding needs and shortened debt maturities make it vulnerable to shocks. Debt maturities amount to BRL1.35 trillion (around 17% of GDP) in 2021. But a diverse domestic institutional investor base and its domestic bias mitigates rollover risks. Moreover, the Treasury's liquidity buffer reached BRL1.1 trillion (around 14% of forecast 2021 GDP) in March, which gives it flexibility to remain out of the domestic markets for several months. However, a de-anchoring of fiscal expectations might worsen domestic borrowing conditions.
Brazil's government has resumed its economic reform agenda in 2021. It secured the approval of the central bank autonomy law and laws to upgrade the regulatory frameworks for the sanitation and gas sectors. Congress also passed a 'fiscal emergency' constitutional amendment that would give the government the power to invoke certain spending adjustments should federal government's mandatory spending exceed 95% of the total primary spending, although this threshold is unlikely to be reached in the coming years. The Lower House has recently approved the legislation to privatize Eletrobras, paving the way for the bill to be discussed in the Senate.
A tax reform to simplify the complex system and a public sector reform to contain payroll costs over the medium term and improve public sector efficiency have been submitted to congress. However, it is unclear how much reform progress is possible given vested lobbies, fluidity of the congressional dynamics, and uncertainty around the pandemic. The window of opportunity to pass reforms could close by early 2022 as the focus shifts towards next year's presidential and congressional elections.
Brazil's current account deficit (CAD) shrank to less than 2% of GDP in 2020 from 3.5% in 2019 and despite its fall, FDI continued to fully finance the CAD. Fitch expects the CAD to shrink further in 2021 due to a surge in the trade surplus, underpinned by higher exports that will benefit from higher global (and China) growth and commodity prices. Brazil's international reserves remain strong at around USD350 billion despite FX spot sales in 2020-2021.
The banking system's adequate capitalization, modest non-performing loans ratio and continued credit growth highlight its resilience to the economic fallout from the pandemic.
ESG - Governance: Brazil has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Brazil has a medium WBGI percentile ranking of 44%, reflecting a recent track record of peaceful political transitions even amid heightened political uncertainty, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a high level of corruption.
Acesse: www.jacksoncampos.com.br
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