The country's decline in Euromoney’s country risk survey is unlikely to reverse soon.
An indigenous Brazilian receives the coronavirus vaccine. The fiscal package to tackle Covid-19 has left a hole in government finances
In 2020, Brazil’s country risk score deteriorated sharply, seeing the country plunge 42 places in the global risk rankings to 103rd out of 174 countries – below Russia, Turkey and South Africa, and further down the fourth of five broad risk categories.
Just like the calamitous fate that had previously befallen Argentina and Venezuela, struggling for investor safety, all of Brazil’s 15 economic, political and structural risk indicators were downgraded last year by analysts, as well as its score for capital access.
But Brazil is not as risky as those two countries.
It has external strengths, with less dependency on short-term portfolio capital inflows and more reliance on foreign direct investment, and clearly the pandemic has accentuated its risk profile in a similar way to other countries.
With up to 60,000 confirmed Covid-19 cases every day adding to the total of 10.5 million Brazilians that have so far contracted the disease, and with more than 257,000 deaths recorded, the crisis is still a key factor for investors to contemplate.
Last year there were sharp falls in the GDP, employment and fiscal risk components of the survey that reflected this, and the national accounts released this week confirm that the economy shrank by 4.1% in 2020, albeit not as much as Mexico or some of the G7 economies.
A debt burden that had already reached a record high 89.3% of GDP as of the end of last year... will almost certainly require the government to ‘cut its cloth’ accordingly
Encouragingly, GDP is expected to bounce back this year, and the current account deficit has improved – but the crisis has delivered an unwanted fiscal legacy, with a general government financial black hole now in double digits as a proportion of GDP, after the emergency prompted a huge fiscal stimulus package worth some 8% of GDP.
This will begin to narrow, but it will nevertheless remain uncomfortably large over the next few years, adding to a debt burden that had already reached a record high 89.3% of GDP as of the end of last year. This will almost certainly require the government to ‘cut its cloth’ accordingly.
As the IMF pointed out in its latest assessment of Brazil: “The lingering effects of the health crisis and the expected withdrawal of fiscal support will restrain consumption, while investment will be hampered by idle capacity and high uncertainty.”
Digging deep into the accompanying report, the IMF outlines three “highly likely” risks to Brazil, each of which has a “high impact” potential for the economy.
The first is social discontent and political instability arising from an insufficient policy response to Covid-19, causing hardship and aggravating pre-existing socioeconomic inequalities. This would delay fiscal consolidation, weakening market confidence and leading to higher borrowing costs. Debt sustainability would be undermined.
The second refers to “hysteresis” and “negative feedback loops” between the financial sector and the real economy, with the fiscal withdrawal affecting economic growth and poverty as well as corporate viability. This constrains credit availability.
The third is an unexpected shift in the pandemic. It becomes harder to eradicate, and it requires stronger containment measures. This also affects the economy and leads to a repricing of risk assets.
The Brazilian variant discovered in Manaus in December does appear to be spreading faster, and there is concern that it might be more resilient to vaccines, which in turn creates a tail risk if such a large population must be revaccinated, and quickly.
One of Euromoney’s contributing experts is Raphael Lagnado, a risk analyst with Velours International. He is fairly sanguine about the political risks, arguing that they have eased since president Jair Bolsonaro has secured allies in both houses of the legislature, as well as the fact he has toned down his authoritarian rhetoric.
The new political alignment in the wake of the congressional leadership elections should allow reforms to progress. However, he considers the economic outlook “more puzzling”.
“Bolsonaro’s recent replacement of the head of [the state-owned petroleum firm] Petrobras, Roberto Castello Branco, with [former Defence Minister Joaquim Silva e Luna] a loyalist general, at the request of disgruntled truckers, essentially signalled that he would rather risk temporary displeasure from investors than a strike which could bring about massive shortages and severely hamper economic recovery,” says Lagnado.
The action taken in response to rising diesel prices is a worrying indication of interventionism, hitting both Petrobras’ stock price and the currency.
However, Bolsonaro has sent to Congress a bill to privatise the electricity grid operator Electrobras, “as a form of amends”, says Lagnado, and he is expected to step up efforts to approve a renewal of federal emergency aid for the poorest, and advance with some form of tax reform.
Nevertheless, Lagnado says that a significant rise in risk could occur if Bolsonaro “further clashes with his heavily market-oriented minister of economy Paulo Guedes, who had handpicked Castello Branco at the beginning of the term”.
Another expert is Alessandro Rebucci, an associate professor at Johns Hopkins University Carey Business School, who believes that the world economy in 2021 is different to the one anticipated in mid-2020, with US interest rates spiking and likely to keep rising in the coming months.
Unless Brazil deploys an effective vaccination campaign pretty soon, it will end up with a third Covid wave spilling into 2022- Alessandro Rebucci, JHU Carey Business School
“Increasing US interest rates are usually associated with large capital outflows from emerging markets (EMs)," he says. "Brazil's exposure to this risk is significant, both in the government and the private sector's balance sheets, with cumulative current account deficits of about 25% of GDP over the past 10 years.”
Rebucci is also concerned by the fact the Covid pandemic is not over, even in countries where vaccine campaigns are on track to cover the whole population by the summer.
“This means the economy will continue to suffer from low demand and slowing growth potential," he says. "Unless Brazil deploys an effective vaccination campaign pretty soon, it will end up with a third Covid wave spilling into 2022. Evidence based on the 1918 experience is not encouraging.”
Rebucci also points out the risks attached to the next presidential elections, which are now less than two years away.
“Ongoing discussions about another round of Covid stimulus and the country's historical tendency to expand the budget in the run-up to the elections mean that we should expect the government debt-to-GDP ratio to go above 100% by the end of 2022," he says.
“This is more than twice the levels typically regarded as not tolerable in emerging markets. Pile on top of this Bolsonaro's inclination to respond to economic shocks with a ‘martial’ leadership style, as in the recent case of Petrobras, and you can see the spectres of a pre-Real plan past that we all thought long gone coming back with a vengeance.”
In that light, it seems that Brazil will remain a worryingly high risk option for the time being.