By Jamie McGeever
BRASILIA (Reuters) – Developing countries face a delicate balancing act of responding forcefully to coronavirus-triggered recessions without causing long-term damage to public finances, currency or inflation-fighting credibility. None more so than Brazil.
Latin America’s largest economy is hurtling toward its biggest ever downturn already shouldering one of the largest debt loads, widest budget deficits and weakest exchange rates of any emerging market in the world.
Deutsche Bank estimates that Brazil’s fiscal and monetary support, from deficit spending to liquidity injections in financial markets, could reach 30% of gross domestic product.
Little wonder, perhaps, that the government and central bank have given clear signals that the end is in sight for two major sources of stimulus – fresh spending and interest rate cuts.
Economy Ministry officials say some emergency measures may be extended if the crisis stretches past the three to four months now in the budget. But none will include fresh spending.
“There is no money for that,” Adolfo Sachsida, special secretary to the Economy Ministry, told Reuters.
“When the pandemic is over, our debt will be more than 90% of GDP. We have to show that debt-to-GDP is falling. If not, no one will come here. Who is going to a country where debt is rising?” he said, referring to foreign investment flows.
(GRAPHIC-Brazil debt-to-GDP link: https://fingfx.thomsonreuters.com/gfx/mkt/azgvomlwrvd/DEBTGDP.png)
Brazil’s debt and budget deficit are significantly higher than the average of other emerging nations with a similar credit rating profile. Both are set to rise sharply this year.
That is also true of Latin American neighbors, but most are starting from a stronger position. Colombia’s debt is around 50% of GDP, and Chile’s and Peru’s is around 30%.
By contrast, Brazil’s heavy spending as a commodities boom fizzled led to a crushing 2015-2016 recession and meager recovery. The country’s GDP per capita has stagnated over the past decade as public deficits exploded.
In lowering its outlook on Brazil’s sovereign debt last month, ratings agency Fitch said the government deficit including interest payments will widen to 13% of GDP this year, almost double the median 6.8% for countries with the same “BB” credit rating.
Brazil’s expected debt-to-GDP ratio this year of 90% is considerably higher than the current median of 58.4% across countries with a “BB” rating. Private-sector forecasts suggest the ratio could reach 100% within a couple of years.
Brazil’s central bank has already taken measures worth more than 16% of GDP, according to its own estimate, to boost liquidity and lending across the financial system.
It has also been granted special emergency powers to buy public and private sector securities. But bank president Roberto Campos Neto has made clear his preference for small and targeted interventions rather than the blanket “quantitative easing” or QE bond-buying in many developed economies.
Minutes of the bank’s last policy meeting showed growing concern that cutting rates much further than the current record-low 3.00% could destabilize financial markets and drive up already-high risk premiums.
“In light of the elevated uncertainty domestically, the remaining scope for monetary policy is unknown and may be small,” the minutes said, even though the bank left the door open to one final rate cut next month.
RECORD OUTFLOWS
In other words, policymakers are warning they could soon turn off the taps for the fiscal and monetary stimulus, despite the looming crash that has some calling for them to do “whatever it takes,” in the famous words of former European Central Bank chief Mario Draghi.
Even in the best-case scenarios, millions will lose their jobs, the poorest will suffer disproportionately and productive capacity will be ravaged. The economy will likely shrink this year at its fastest rate on record.
Yet scarred by Brazil’s history of currency crises, capital flight and hyper-inflation, policymakers are wary that excessive stimulus might trigger a repeat.
The real has depreciated more than 30% against the dollar this year to its lowest level ever, in large part due to plunging interest rates and huge capital outflows.
(GRAPHIC-Brazil portfolio flows link: https://fingfx.thomsonreuters.com/gfx/mkt/oakpezrkrvr/PORTFOLIOFLOWS.png)
Brazil posted a record portfolio outflow of $22.2 billion from stocks and bonds in March, as the coronavirus crisis, oil price collapse and rising political risks in Brasilia prompted investors to flee local markets.
Interest rate spreads blew out, reflecting intensifying capital flight, market volatility and deteriorating investor sentiment stemming from the weak currency. After a period of stability, they are widening sharply again.
(GRAPHIC-Brazil rates futures link: https://fingfx.thomsonreuters.com/gfx/mkt/azgvomjdwvd/RATESPREAD.png)
Julia Braga, associate professor of economics at the Universidade Federal Fluminense in Rio de Janeiro state, agrees there is a limit to how low interest rates can go without negative ripple effects in financial markets.
But she said it is not only mistaken but dangerous to say the government and central bank cannot provide further stimulus. While Brazil’s debt is large, it is mostly denominated in reais, so can be financed by domestic savings without the risk of foreign investors turning sour on Brazil.
As Treasury Secretary Mansueto Almeida has noted, the debt profile can be shortened, meeting demand for shorter-dated bonds and easing any refinancing pressures the Treasury may face.
“The central bank is the lender of last resort and can – and should – buy bonds on the secondary market,” Braga said.
“If the government doesn’t expand fiscal policy, getting out of the hole will be much more difficult. For the good of the economy and society, the government and central bank must resist their cautious instincts and throw all their efforts into supporting the economy,” she said.
(Reporting by Jamie McGeever in Brasilia; Editing by Matthew Lewis)
