Slow recovery and the impulse from the Pension Reform

BRAZIL ECONOMICS - Report 11 Mar 2019 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

In the projections formulated here we assume that a pension reform near the original version proposed by Minister Guedes will be approved, creating the necessary conditions, in the second half of the year, for the Central Bank to administer an additional monetary stimulus dose, cutting the SELIC rate by 100 basis points. Based on this hypothesis, we project modest growth in 2019, of around 2%, but with a risk of a weaker result. For 2020, the uncertainties are greater. The reason for the modest forecast for 2019 is the absence of forces to boost aggregate demand, while for 2020 the problem is the total lack of information about what the government intends to do to achieve an increase in the investment rate and growth of total factor productivity.

Our estimate is that the IPCA will close 2019 with a rise of 3.8%. In 2020, the SELIC rate should return to 7%, with inflation hitting the target dead on (4%). With the sovereign risk premiums already reflecting a high likelihood of approval of the pension reform package, there is no room for intense appreciation of the real, a situation that will be combined with worse terms of trade due to the behavior of commodity prices. For this reason, we project an average exchange rate of R$3.78/US$ in 2019 and a bit weaker one in 2020.

In 2019, exports should amount to US$ 245 billion, while imports will tally US$ 190 billion. In 2020, the figures for exports and imports should be US$ 260 billion and US$ 220 billion respectively. Thus, there will be a small reduction in the trade balance, and the current account deficit will increase slightly, easily financed by the inflow of foreign direct investments.

We stress that these projections depend crucially on approval of a reform of the social security system near the original version proposed by Guedes. Failure on that front will alter the picture of risks, with negative reflections on Brazilian asset prices – CDS, exchange rate, yield curve slope and stock prices – inhibiting growth and causing higher inflation and interest rates.

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