Brazil’s growth trajectory has been rocky. Retail sales in May were -3.2 per cent – a disappointment compared to expectations of -1.8 per cent. The Brazil economic activity index also disappointed in May, decreasing at 0.5 per cent (month-on-month) compared to consensus for 0.2 per cent growth. Inflation has fallen below the 4.5 per cent target since March, and is now at its lowest level since 1999.
Many economic indicators in Brazil have bottomed, so the worst may be over for the Brazilian economy. Growth rebounded strongly in the first quarter – the first positive GDP print in two years. However, we had never expected growth to be strong for 2017 as a whole.
Domestic conditions remain challenging: unemployment is high, credit is hard to access, and consumer and business confidence has improved, but remains subdued. We have further moderated our expectation of growth this year after the recent political developments: June numbers already show a dip in consumer and business confidence.
As a whole, we had expected 0.7 per cent GDP growth in Brazil for 2017 and now expect only 0 per cent (this is still better than the -3.5 per cent recession of 2015 and 2016). The outlook for 2018 is very difficult to predict because Brazil will have presidential elections and the continued political uncertainty can continue restricting growth, so we are pencilling in around 2 per cent GDP in 2018.
Risks to inflation are on the downside, and we believe the Central Bank of Brazil could continue to cut the interest rate at a pace of 100 basis points per meeting, until it is around the 8 per cent mark. This is high for other countries, but historically pretty low for Brazil, and a big improvement from 14.25 per cent rates in 2016.
Our view on Brazil’s economic growth has become more downbeat since the recent political developments, but our view on inflation and lower interest rates remains the same. Brazil will hold general elections in October 2018. Reform is crucial for the fiscal balance in Brazil and the elections may prove to be a distraction or even delay reform agenda. Reforms to policies on pensions, labour and a spending cap have been in focus with fiscal consolidation imperative in the face of a worsening debt-to-GDP ratio.
Near-term volatility in the Brazilian debt and equity markets should be expected. This has been evident so far this year as the MSCI Brazil Index produced total returns of 13 per cent by May, but with concerns over a halt in progress in reform, this has fallen back to around 7 per cent as the summer has gone on. We can expect this kind of volatility to continue as we try to look through the cloudy political scene in Brazil.
The most market-friendly outcome would be the election of a government that can demonstrate a willingness and ability to move forward with reform.
There has been some positive news for businesses and President Temer as the senate has approved his labour reform bill. This should reduce labour costs and make the job market more flexible and importantly reduce the scope for legal action in labour disputes.
As a result, we still see investment opportunities in Brazil: these are centred on the lower inflation and lower rates theme, and not on expecting strong growth. We see opportunities both in Brazilian local currency bonds (because lower yields mean higher prices) and in equities (lower interest rates mean less interest cost and higher earnings for companies).
We will be watching closely the polls for next year’s presidential election to see if any of these themes change – for better or for worse.
Nandini Ramakrishnan is global market strategist for JP Morgan Asset Management
Chart Source: Thomson Reuters Datastream, JP Morgan Asset Management. Data as of 30 June 2017.
