Brazil. Mauricio Oreng Senior Brazil Strategist Aug-17. Macroeconomic outlook. Marketing communication

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1 Mauricio Oreng Senior Brazil Strategist Aug-17 Brazil Macroeconomic outlook Marketing communication

2 Brazil s worst recession on record % real annual growth GDP forecast 2017: 0.1% E Real GDP growth (4-year average) Source: IPEA, IBGE, Rabobank 2

3 ..has fiscal roots: a slow fix ahead % GDP 58.0% 80.0% 54.0% 50.0% 46.0% 42.0% 75.0% 70.0% 65.0% 60.0% 38.0% 55.0% 34.0% 50.0% Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 General government's gross debt deducting FX reserves Public sector's net debt deducting loans to govt. banks General government's gross debt (right) % GDP % GDP, public sector 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% 2.1% 1.8% 1.4% -0.3% -1.9% -2.3% -2.2% -2.6% Revision of loan subsidies -1.1% -0.2% 2.1% 1.7% 1.3% 0.7% 1.0% e 2018e 2019e 2020e 2021e 2022e 2023e 2024e 2025e Conventional primary balance Debt-neutral primary balance New targets? Brazil needs about USD 100 billion in tax hikes, spending cuts to stabilize the debt. We project debt stabilization only in 2025, with gross debt likely reaching around 85% of GDP (today: 73%). Source: Brazilian Central Bank, Rabobank 3

4 Limited margin of maneuvering 25% 20% 15% 20.0% 12.6% 18.6% 18.8% 15.1% 15.8% Investment, 5% Other discretionary, 9% % GDP 10% 7.3% Other mandatory, 9% 5% 2.1% 3.5% 3.0% Jobless insurance, 3% Pensions, 52% 0% -1.9% -5% -2.8% * Tax collection Mandatory expenses Fiscal 'leeway' Primary balance Mandatory Entitlements, 8% Mandatory Payroll (active workers), 14% Mandatory Mandatory expenses account for about 85% of the Brazilian federal budget. Gap between those expenses and tax collection continues to narrow, limiting the government s capacity to deliver primary surpluses. Source: National Treasury Secretariat, Rabobank 4

5 The urgency to reform social security Pension outlays (% GDP) Italy Greece Belgium France Portugal Austria Denmark United States Switzerland Brazil Spain Germany Poland Hungary Japan Czech Republic Netherlands United Kingdom Sweden Australia Turkey Canada Israel Norway New Zealand Ireland Chile Korea Mexico Tax burden (% GDP) Poland Japan Italy Hungary Greece France Denmark Austria Sweden Belgium Netherlands Norway Germany Portugal Brazil Czech Republic New Zealand United Kingdom Turkey Israel Canada Australia Switzerland Korea United States Ireland Chile China Mexico Share of population older than 65 (%) Per capita income (USD thous., PPP-adjusted) Source: OECD, Heritage Foundation, Rabobank 5

6 Brazil: low savings, resource exposure World % Advanced economies % 8% Emerging Europe % Emerging Asia % Emerging and developing economies Latin America Brazil % GDP Average: Gross national savings 2% 3% 4% Soya Meats Sugar & ethanol Auto & parts Coffee Other products 5% 6% 6% Iron ore Oil & fuel Steel products Pulp & paper Aircraft & parts Brazil s low level of domestic savings increases dependency on foreign capital and vulnerability to global monetary conditions. In aggregate, commodities account for about 2/3 of Brazilian exports. Source: International Monetary Fund, Ministry of Commerce, Rabobank 6

7 Scheme: short-term BRL drivers Local Interest Rate Global Interest Rates FX Rate: USDBRL Raw Material Costs Global Risk Aversion Brazil Credit Spread Expected Macro Fundamentals for Brazil Source: Rabobank 7

8 Mild impact on BRL, country risk basis points (bps) May 17, FX Rate: USB/BRL Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 Brazil country risk (5-year CDS) FX rate (USD/BRL) We believe Brazilian asset prices largely price in the approval of key macro reforms Source: Brazilian Central Bank, Rabobank 8

9 Asset prices fator in a lot of good news Total contribution for year-to-date FX change 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -3.0% Global drivers -19.1% 2.7% Changes from Dec 31, 2015 to Aug 11, 2017 Domestic drivers Other factors -11 FX rate: USD/BRL Changes from Dec 31, 2015 to Aug 11, 2017 Commodity prices Global drivers Risk sentiment Global rates Country risk Domestic drivers Other factors 0.11 What factors drove Brazil CDS down across 2016 and 2017? 96% of the decline follows domestic drivers, including expectations of fiscal reforms -279 Source: Brazilian Central Bank, Rabobank External Domestic 9

10 Solid BoP, FX swaps as buffers 6.0% 120 % GDP, 12m 4.0% 2.0% 0.0% -2.0% Jun-97 Jun-01 Jun-05 Jun-09 Historical CAD: 2.1% Jun-13 Jun-17 Em bilhões de dólares (US$) - posição vendida em US$ ago-13 ago-14 ago-15 ago-16 ago-17 Direct investment Current account deficit Estoque de swaps cambiais do Banco Central Brazilian FX reserves stands at US$ 381 billion more than 3 years of imports! Source: Brazilian Central Bank, Rabobank 10

11 Activity: stabilization trend in place Index (2011=100) Jul-11 Jul-13 Jul-15 Jul-17 Business confidence ("all economy") Consumer confidence % IBC-Br (monthly GDP) growth 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% May-11 May-13 May-15 May-17 % y/y 3m % q/q saar While 17Q1 GDP rebound was highly (and temporarily) boosted by agricultural output, the recovery is now more widespread as urban sectors (such as manufacturing) firm up. Source: FGV, IBGE, Brazilian Central Bank, Rabobank 11

12 (Structural) rate cuts to help in 2018 % 12m (IPCA) 12.0% 10.5% 9.0% 7.5% 6.0% 4.5% 3.0% center target lower target 1.5% 2Q13 2Q14 2Q15 2Q16 2Q17 2Q18 2Q19 Market scenario (consensus for BRL, Selic) Hybrid scenario (consensus Selic, stable BRL) Consensus Forecast BCB forecast upper target Nominal rate (% p.a.) Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Benchmark Selic rate Dec-14 Rabo forecast Dec-16 Dec-18 BCB and market forecast inflation around 4.3% for relevant horizons (i.e., 2018YE) under scenarios with Selic rate cuts to 8.0% Source: Brazilian Central Bank, Rabobank 12

13 Macro forecasts Brazil E 2018E Real GDP Growth - % National Unemployment - year avg. - % IPCA Inflation - % Selic Rate - yearend - % FX Rate (USD/BRL) - yearend Source: Rabobank 13

14 Growth beyond the crisis Average annual growth (or contribution) 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% 2.2% 3.8% 1.1% 0.1% 1.5% 2.4% 0.2% 1.0% 1.3% 1.1% 2.0% 1.0% 0.4% 1.1% 1.2% 0.9% 0.7% 0.5% % Labor Capital Productivity (TFP) Potencial GDP growth We see improvement in sustained growth following the approval of fiscal reforms (.e.g, pensions) and streamlining of business conditions (e.g., less red taping) Source: Rabobank 14

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