Country risk: Brazil is at a turning point ahead of the 2022 elections

Brazil’s fall from grace is close to catastrophic, after grappling with what seems to have been crisis upon crisis in recent years.

The resignation of environment minister Ricardo Salles, who is facing criminal prosecution, and a Senate inquiry into the government’s handling of the pandemic amid allegations of corruption in the vaccine-procurement process are the latest bedevilments to knock investor confidence.

And tens of thousands of protesters in Brazil have taken to the streets to demand the removal of controversial president Jair Bolsonaro.

On that basis, Brazil is struggling to make a convincing argument for asset safety, not least in the wake of Covid-19, which has led to more than 527,000 deaths.

The pandemic is putting the healthcare system under enormous strain, not least with innumerable long-Covid patients and delayed procedures.

Bolsonaro [has] handled the Covid-19 crisis with jaw-dropping incompetence and ham-fisted mismanagement 

 - Steve Hanke, Johns Hopkins University

Euromoney country risk survey contributors Steve Hanke and Guerson Salgado are equally damning of the president’s approach to tackling the coronavirus.

“President Bolsonaro and his administration have handled the Covid-19 crisis with jaw-dropping incompetence and ham-fisted mismanagement,” says Hanke, who is a professor of applied economics at the Johns Hopkins University in Baltimore.

“It has just been one scandal after another. Among other things, it has lifted the shroud off of Brazil’s pathetic healthcare system and virtually all other aspects of the structure of Brazil’s economy.”

Salgado, a professor of economics and finance at the Universidad Nacional de Ingeniería in Nicaragua, adds: “[The president] has been in charge of creating a bad image and rejection of the population due to his public scepticism about the virus.

“He has offered little support from his position to accelerate the vaccination process throughout the country and has left it to the states.”

Affected by deforestation in the Amazon, climate change and El Niño, the country has experienced prolonged drought, causing water shortages that have led to power blackouts, with 65% of Brazil’s electricity sourced from hydropower.

The lack of irrigation is affecting agricultural production and increasing food insecurity for the poorest.

Salgado acknowledges the risks, noting that Brazil is an “agribusiness power”, and drought and climate change will negatively affect productive dynamics, not only of agribusiness but the entire economy “due to a domino effect”.

Borrowing rates have had to be raised to tame inflation, with a 75-basis-point hike announced by the central bank a few weeks ago in response to consumer prices rising by 8% year-on-year in May.

Activities are returning to normal or a new normal a little faster 

 - Guerson Salgado, Universidad Nacional de Ingeniería

Hanke says: "At present, broad money (M3) is growing at 14% per year, almost twice as high as the rate of growth that would allow the central bank to hit its inflation target of 3.75% per year."

With inflation likely to remain above the target range of 2.25% to 5.25%, the central bank has signalled another 75bp hike is likely in August.

The unemployment rate has also hit a record high of 14.7%.

Whereas once Brazil was one of the world’s most enticing and sought-after emerging markets (EMs), the risks of investing in the country have soared.

Brazil now ranks 108th in Euromoney’s global risk rankings of 174 countries, down from 103rd in Q1 2021, and is a mid, tier-four sovereign borrower; out of five categories of risk into which Euromoney divides up the investor world.

It is hard to imagine it now, but Brazil had climbed to 54th just two years ago, when sentiment towards large EMs was at its highest. Now Brazil is a high-risk option, equivalent to Tanzania and Egypt, and one of the riskier large EMs:

Yet not all is lost. The country is fighting back against the pandemic.

“Depending on the total population of each state, activities are returning to normal or a new normal a little faster,” says Salgado.

“For example, in states such as Ceará, with a population of 8.8 million inhabitants, it is estimated that face-to-face classes will begin again in September,” even though for Rio de Janeiro, with a population of 16.5 million inhabitants, it will be March.

Salgado adds: “In the street, most people walk around with mouth covers and are aware of the importance of getting vaccinated and speeding up the vaccination process, which coincides with the contempt they have towards the current president for his poor management.”

The economy has proved fairly resilient to the pandemic, and it will benefit from the tourism sector reopening and improving world trade growth supporting commodity prices.

China’s recovery means that exports continue to grow.

“This is expected to continue as the vaccination process advances in the US and EU, Brazil’s other main commercial partners,” says Salgado.

Hanke adds that while the Brazilian economy will take a Covid hit, and it will not be as hot as it would have been, “it’s bouncing back”.

“Real GDP growth could reach almost 6% this year [after last year’s 4.1% contraction],” he says. “This will help to stabilize the labour market, as well as the Brazilian real.”

Other positives include continued improvement to Brazil’s terms of trade and a current-account surplus – the first one since 2007.

Hanke also attaches an extremely low risk to huge capital outflows recurring, similar to 2020.

Interest rate increases “will drive the carry trade and fuel capital inflows”, he says.

“The rate increases are baked-in-the-cake and will be needed to anchor Brazil’s inflation expectations.”

There is also some opportunity to proceed with reforms until the elections are held next year, with a second tax bill now making its way through Congress.

The elections themselves are eagerly anticipated.

Salgado believes they are an opportunity for change, “first as a way out of the economic crisis that is currently being experienced due to Covid-19, and second to focus on the process of reconstruction and development of the post-pandemic economy”.

Both contributors see Brazil gradually improving and, given its enormous opportunities, that may well make the country a much more acceptable risk.