Rising global interest rates and risk aversion have put many emerging market currencies to the test in the last months. In Latin America, Brazil is the worst hit after Argentina. The Brazilian real already lost around 25% of its value vis-à-vis the USD on a year- on-year basis (last observation: 5 September 2018). Brazil is particularly vulnerable due to increasing political uncertainty ahead of the presidential and legislative elections in October. Indeed, growing polarisation makes it less certain that a candidate who will be willing and able to tackle the unhealthy fiscal situation will win the elections.

Impact on country risk

Economically, the country is doing better. Brazil is enjoying its second consecutive year of positive real GDP growth after a deep recession in 2015-2016. Despite a petrol strike in May, the IMF expects a real GDP growth of 1.8% this year. Furthermore, the current account deficit is rather small (projected at 1.2% of GDP in 2018) thanks to the historically lower oil import bill and rising demand of important export products (especially of iron ore and soybeans). Besides, the elevated external debt vis-à-vis current account receipts (which stood at about 250% at the end of 2017) is on the decline.

However, the weak fiscal situation remains the Achilles heel of the economy. Despite some modest fiscal reforms, the public debt is expected to stand at a high 88% of GDP at the end of this year and is mainly held domestically. Also, in the coming years, public debt is expected to continue to swell towards an unsustainable level, owing to the prominent fiscal deficits (in 2018 forecasted at -8.3% of GDP). Therefore, the fiscal consolidation plans of the next president will be crucial. Additionally, it remains to be seen if this president will have a strong mandate. A broad majority in Congress will be necessary to push through the likely unpopular reforms. However, polarisation will probably lead to fragmentation in Congress with parties from a broad range of the political spectrum. The stakes for pushing through fiscal reforms are quiet high. Continuation of the current trend can trigger sovereign downgrades by rating agencies, put further pressure on the currency, spur inflation (which reached a record low level in 2017), tighten the monetary policy and even lead to a recession.

The short-term political risk – which represents the liquidity – is in category 2/7 with a stable outlook. The country indeed enjoys a high level of foreign exchange reserves which can cover almost 5 times its elevated external short-term debt and almost 15 months of imports. The medium- to long-term political risk – which represents the solvency – is in category 5/7 with a stable outlook too. Brazil´s elevated rating reflects its elevated external debt and debt service vis-a-vis current account receipts, weak GDP growth and unhealthy public finances whereas it is characterised by modest current account deficits and low inflation.

Analyst: Jolyn Debuysscher - J.Debuysscher@credendo.com