Worldwide hotspot of the covid-19 pandemic while peak is only expected next month
Brazil is currently regarded as the global epicentre of the covid-19 pandemic. Despite likely underreporting as there is fairly little testing for the covid-19 virus in the country, the number of infections is the second highest in the world after the US. What is even more worrisome is that these numbers are still on the rise and expected to overtake the US in the coming weeks. Moreover, the death toll due to covid-19 is the third highest after the UK and the US. The end is not in sight as the peak in Brazil is only expected next month. Hence, a very heavy death toll is in the cards for Latin America’s largest economy.
The reasons why Brazil is the new covid-19 hotspot after China, Europe and North America are manifold. Firstly, the far-right nationalist President Bolsonaro has been minimalising the covid-19 virus as a ‘mere flue’ while ignoring safety advice such as social distancing. Secondly, in contrast to most countries in the world, the president did not enforce a national lockdown or harsh confinement measures. State governors who enforced such measures at state level have been under pressure of the president to ease them – as is the case in Sao Paolo and Rio de Janeiro. Thirdly, in the overpopulated favelas, social distancing is quite impossible and the virus can float freely. Lastly, the large informal economy makes lockdowns hard to enforce and even harder to sustain. Indeed, for informal workers, a day in lockdown is a day without income. Hence, lockdowns increase poverty in such a context and many informal workers ignore lockdown measures in order to get food on the table.
Banging on pots and pans: a strong signal that more is likely to come
The lack of policy response against the covid-19 epidemic has been fuelling political tensions. Indeed, Bolsonaro’s popularity has fallen as the bulk of public opinion is in favour of more stringent lockdown measures. Many people have been banging on pots and pans, a strong signal to voice discontent in Latin America. Nevertheless, the population hasn’t taken the protests against the president to the streets yet. Still, this could change when the virus starts to wane in the country. Furthermore, the possibility is rising that the president will be impeached. Bolsonaro has been losing support of former allies and of congress due to the way he’s handling the covid-19 pandemic. The loss of support and the impeachment probes launched by the opposition increase the risk of impeachment. Nevertheless, impeachment is unlikely to happen in the midst of the covid-19 crisis in order to avoid a larger health and economic crisis. Furthermore, there is currently not enough popular pro-impeachment pressure to push through the impeachment probes. The president is also facing judicial probes after the supreme court began parallel investigations into the president and some of his closest allies. The probes concern the president’s suspected illegal interference in federal police investigations. These judicial probes could also result in his removal from office. Although on the one hand, the position of the president is under pressure, on the other hand, President Bolsonaro has stoked fears over the future of democracy with constant attacks on congress, the courts, the press and civil society. President Bolsonaro often voices his support for a military rule (Brazil’s last military dictatorship lasted just over two decades and ended in 1985). Furthermore, weekly marches by the president’s far-right backers calling for military intervention to close down congress and the supreme court have become more aggressive, with some apparently forming militias. So far, Brazil’s institutions have withstood the pressure with strong public support while the army seems unlikely to support a military takeover. Nevertheless, a political crisis – one way or another – seems to be unfolding while more protests and political tensions are very likely in the coming months.
Sharpest recession in the country’s history likely to lead to many bankruptcies
In 2020, Brazil is forecasted to face a recession of more than 5%. The World Bank even predicts a contraction of 8% this year. As most Latin American countries, this year the expected economic growth forecast will likely be the worst since records began in 1900. Though a recovery is expected next year, the rebound is not projected to be as large as the contraction of this year and is still subject to large uncertainties. Hence, despite large stimulus packages from the central bank and the government, the number of bankruptcies – especially of SMEs – is likely to rise. This is an evolution to be expected in most Latin American countries. The major downside risks to the economic growth forecasts are a sharper-than-expected deepening of the forecasted global recession and a collapse in domestic demand, which is a major growth engine for Brazil. Furthermore, Brazil only quite recently suffered from large recessions in 2015 and 2016 (see graph 1) because of low commodity prices. Hence, the economy will see further jumps in the already high unemployment and inequality levels that will be difficult to reverse in the medium term. It should be noted that Brazil already ranks among the most unequal countries on the planet. Hence, this is likely to be another ground for protests in the future.
Investor confidence is shaken, leading to a plunging Brazilian real and large capital outflows
Many emerging-market currencies have taken a serious hit in the past months, especially in Latin America. Nevertheless, the Brazilian real stands out as one of the world’s worst-performing currencies as it lost roughly 25% of its value compared to the USD year on year (last observation date: 9 June 2020). The severity of the covid-19 outbreak, combined with the historically low interest rates and the lack of a coherent policy response, has shaken business confidence and prompted the currency to plunge. Hopes of fiscal reforms to tackle the high public debt (expected to rise to roughly 100% of GDP in 2020) have evaporated for this year and investors are voting with their feet, resulting in large capital outflows. That being said, in recent weeks the improving global market sentiment and appetite for risky assets due to global monetary stimuli have led the Brazilian real to appreciate while investors are more willing to invest again. Nevertheless, a volatile currency and investor appetite are to be expected in the coming months depending on the global economy, (global) monetary policy and domestic political events.
In general, large capital outflows, wide current account deficits and a lack of investor confidence can trigger a balance of payment crisis. However, this seems unlikely in the case of Brazil. Firstly, the recession and large depreciation can turn this year’s projected current account deficit of 1.8% of GDP – a modest level – into a surplus or a very small deficit. Secondly, the country has a huge buffer of foreign exchange reserves (covering more than one year of imports in April 2020). Lastly, FDI has historically been the largest source of financing for the current account deficit. Though FDI inflows are likely to fall this year, the fact that they are a more stable source of financing makes them unlikely to fall to devastatingly low levels. Hence, as opposed to many of its neighbours, it’s unlikely that Brazil will to need to turn to the IMF to avoid a balance of payment crisis.
ST political risk rating downgraded while MLT political risk rating has a negative outlook
Credendo downgraded Brazil’s short-term political risk rating from 2/7 to 3/7 in April, indicating a still moderate liquidity risk. The main reasons are the rising short-term external debt and declining foreign exchange reserves. Indeed, although the country has a huge buffer of foreign exchange reserves, the nominal foreign exchange reserves have clearly decreased in the past years (see graph 2). On top of that, nominal short-term external debt stands at its highest level ever recorded while its ratio to current account revenues is rather elevated. The medium- to long-term (MLT) political risk rating – in category 5/7 – has a negative outlook. Brazil’s elevated MLT rating reflects its elevated external debt and debt service in relation to current account receipts, weak GDP growth and unhealthy public finances whereas it’s characterised by modest current account deficits and a high level of foreign exchange reserves. The main downside risks are the unfolding political crisis, a slower-than-expected economic recovery, unexpected policy changes and the possibility of an economically devastating ‘second wave’ of covid-19.
Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com