Brazil’s fiscal deficits remain large and are expected to decline only gradually.
Talk of the Day
Fitch Ratings has downgraded Brazil’s Long-Term Foreign Currency Issuer Default Rating (IDR) to BB- from BB and revised the rating outlook to stable from negative. The downgrade reflects Fitch’s perspective that Brazil’s persistent and large fiscal deficits, a high and growing government debt burden and the failure to legislate reforms that would improve the structural performance of public finances. Also, the rating agency points out the decision of the government not to put the social security reform to a congressional vote represents an important setback in the reform agenda that undermines confidence in the medium-term trajectory of public finances and the political commitment to address the issue. Finally, the October Presidential and Congressional elections mean that the social security reform will be delayed until after the elections and there is uncertainty whether the next administration will be able to secure its approval in a timely manner.
Brazil’s fiscal deficits remain large and are expected to decline only gradually. The government overperformed its primary deficit target for 2017. However, the general government deficit reached over 8% of GDP in 2017 (compared with 3% for the ‘BB’ median), and Fitch forecasts the deficit to average just over 7% of GDP during 2018-2019. The challenging political environment has hampered the ability of the government to secure congressional approval and enact revenue and spending measures intended to consolidate fiscal accounts in 2018. For example, the government was not able to secure approval for imposing a tax on certain investment funds and increase the civil servants’ pension contributions, while a court injunction has suspended the postponement of salary adjustments for federal public sector workers. While a cyclical economic recovery and one-off revenue receipts can contribute towards meeting the 2018 primary deficit target, the inability to pass structural measures highlights the continuing political malaise and its adverse impact on fiscal policy.
The IPCA-15 result in February (0.38%) printed in line with our estimate (0.37%) and the median of market expectations (0.38%). The index rose 0.39% in the previous month and 0.54% in February 2017. The year-over-year change slid to 2.86% from 3.02% in January. Market-set prices advanced 0.38% in February and the year-over-year change slowed down to 1.4% from 1.5% in January. Regulated prices climbed 0.37% during the month and the year-over-year change slid to 7.4% from 7.8%. The underlying indicator for service inflation – which excludes tourism items, household services, courses and communication – advanced 0.25% in February and the year-over-year change slipped to 3.4% from 3.6% in the previous month. Breaking down by product groups, the largest upward contributions during the month came from transportation (0.20 p.p.) and education (0.20 p.p.). On the opposite direction, housing (-0.08 p.p.) and apparel (-0.04 p.p.) posted negative contributions. Core inflation measures receded vs. the previous month and remain well-behaved. The average of the three most used core measures (smoothed trimmed means, double weight core and core inflation by exclusion) reached 0.25% vs. 0.31% in January, while the year-over-year change slipped to 3.3% from 3.6%. The diffusion index (which measures the share of products with positive price changes) narrowed to 51.2% in February from 61.9% in January. Seasonally-adjusted total diffusion fell to 48% from 56%.
Our preliminary forecast for the headline IPCA in February is a 0.35% increase. As in the IPCA-15, the biggest upward contributions will come from education and transportation costs. On the other hand, food and apparel are set to post negative changes. For the full year, our estimate for the IPCA remains around 3.5%. ** Full Story here.
FGV has released its monthly survey related to consumer confidence and a preview of the industry sector survey. Business confidence in the industrial sector (FGV) rose slightly (0.2%) in January to 99.6. The preview of the capacity utilization (NUCI) rose 0.6 pp to 75.3. The index is 1.6 pp above the low levels seen in 4Q16, yet well below the neutral level (81.5, according to our estimates). Consumer confidence fell 1.6% mom/sa in February, interrupting a sequence of five consecutive increases. The breakdown shows the decline was widespread.
Week Ahead: 4Q17 GDP (to be released on Thursday) will be next week’s highlight. Our forecast points to a 0.1% qoq/sa gain, which is below what fundamentals and confidence surveys suggest due to two factors: i) agricultural GDP is still providing a negative contribution after a strong reading in 1Q17; and ii) persistent weakness in some service components. This result will lead Brazil’s annual GDP to rise 1.0% in 2017. The national unemployment rate for January will come in on Wednesday – we expect it to increase 0.3 p.p. to 12.1% (remaining stable in seasonally adjusted terms) – and January’s CAGED formal job creation will probably come through as well (release date not specified yet), for which we forecast a net creation of 105k jobs – 66k in seasonally adjusted terms, improving the 3-month s.a. moving average to 51k from 48k. January’s tax collection will be released during the week (without an official release date), for which we forecast BRL 149 billion, or a 6.3% y/y increase in real terms. The central government (on Tuesday) should post a BRL 20.5 billion primary surplus in the month and the consolidated public sector (on Wednesday) will likely show a BRL 38 billion surplus, with regional governments contributing with a BRL 11 billion surplus. We expect the trade balance (on Thursday) to post a USD 4.9 billion surplus in February, slightly above the USD 4.6 billion seen in the same month of last year. For the current account (on Monday), we forecast a USD 4.5 billion deficit in January. Foreign direct investment will likely amount to USD 3.5 billion in January. Also, the Central Bank announced another FX swap rollover auction on Monday, tendering up to 9,500 contracts (USD 475 million). ** Read our full week ahead note below.
Mexico’s GDP growth slowed down in 2017 – in the midst of an uncertainty context (with NAFTA renegotiation and the forthcoming presidential elections standing out as key risks), plunging oil output, and the doubling of inflation (which ate through real wages) – but recovered momentum in 4Q17 (after suffering the effects of natural hazards in 3Q17). The monthly GDP proxy (IGAE) grew 1.1% year-over-year in December, with growth for 4Q17 posting 1.5% (below our forecast of 1.8%, which matched Bloomberg’s median market expectations and the flash estimate published by INEGI last month). According to calendar-adjusted data reported by the Statistics institute (INEGI), the IGAE expanded 2% year-over-year in December and also 1.5% year-over-year in 4Q17 (from 1.6% in 3Q17). Looking at the full-year figures, we note that in 2017 GDP growth slowed down to 2% (from 2.9% in 2016) with slower expansions across all the main sectors: services (3%, from 3.9%), with retail sales weakening substantially; industries (-0.6%, from 0.4%), with manufacturing outperforming mining and construction; and the small and volatile primary sectors (3.3%, from 3.8%), which basically represent agriculture. In December, the seasonally-adjusted monthly GDP proxy gained 0.7% from the previous month and quarter-over-quarter annualized growth jumped to 3.2% (from -0.7% qoq/saar in 3Q17). Importantly, this rebound is not only about the normalization of oil output (which bore the brunt of the hurricanes and earthquakes in 3Q17) but also visible in GDP growth excluding mining and the volatile primary sectors (3.4% qoq/saar in 4Q17, from 0.1% in 3Q17).
We expect GDP growth of 2.1% in 2018, slightly above that recorded in the previous year. The factors playing against economic growth in the short-term are tight macro policies (fiscal and monetary) and the uncertainties associated to NAFTA and elections (which put investment decisions on hold). On the positive side, we note that the fiscal drag will be smaller in 2018 relative to 2017. Moreover, a dynamic U.S. industry, coupled with a competitive real exchange rate, will likely sustain Mexico’s manufacturing exports. Finally, lower inflation and a robust labor market (supported by stronger US activity which is highly correlated to the Mexican business cycle) will stimulate consumption in 2018.
** Full Story here.
Mexico’s current account deficit (CAD) narrowed significantly in 2017, given a record-high non-energy trade surplus (driven by the pick-up of the US economy), a smaller net income deficit (reflecting lower profit remittances from foreign firms operating in Mexico), and solid transfers (supported by stronger U.S. economy). In the fourth quarter of 2018, the CAD came in at USD 3.2 billion – in line with median market expectations (as per Bloomberg) and larger than our forecast (USD 1.4 billion) – which brought the annual deficit to USD 18.8 billion (1.6% of GDP), from USD 22.8 billion (2.1% of GDP) in 2016. At the margin, the seasonally-adjusted CAD narrowed to 1.6% of GDP in 4Q17 (from 1.8% of GDP in 3Q17) according to our estimations. Looking at the breakdown, we note that the 0.5pp of GDP narrowing of the CAD between 2016 and 2017 was accounted by a smaller trade deficit (0.3pp) and lower net income payments (0.3pp) while the services deficit remained unchanged and transfers surplus decreased by 0.1pp (albeit still pretty big, at 2.4% of GDP). The trade deficit narrowed to 0.9% of GDP in 2017 from 1.2% of GDP in 2016, with a growing non-energy surplus (0.7% of GDP, from nil) offset by a deterioration of the energy deficit (1.6% of GDP, from 1.2% of GDP) during the same period. Meanwhile, the net income deficit narrowed to 2.4% of GDP (from 2.7% of GDP in 2016).
We have revised our current account deficit forecast for 2018 (to 1.3% of GDP, from 1.6% of GDP). The CAD will likely narrow a bit more, as manufacturing exports continue accelerating, while internal demand expands at a more moderate pace. Also, it is worth pointing out that the narrowing of the current account deficit also reflects a lower fiscal deficit, so Mexico’s fundamentals are improving. ** Full Story here.
Week Ahead: The statistics institute (INEGI) will announce December’s retail sales on Monday. We estimate that retail sales fell 1.6% year-over-year. INEGI will announce January’s trade balance on Tuesday. We expect the trade deficit to narrow. At the same time, INEGI will announce January’s unemployment rate. We expect the unemployment rate to post 3.4%. Banxico will publish February’s Expectations Survey on Thursday. We believe inflation expectations for 2018 will likely move down a bit, considering the more benign inflationary conditions observed in January and the first half of February. GDP growth and exchange rate expectations are unlikely to show meaningful changes. On Friday, the Ministry of Finance (Hacienda) will announce January’s fiscal balance. We expect the fiscal deficit indicators to continue narrowing, as the fiscal consolidation plan enters its final year (aiming at an ambitious 0.9% of GDP primary surplus). ** Read our full week ahead note below.
Peru’s GDP growth weakened in 2017, battered by idiosyncratic shocks such as El Niño (which not only affected natural resource sectors, but also caused negative wealth effects) and corruption scandals. According to the Central Bank (BCRP), GDP growth posted 2.2% year-over-year in 4Q17 (from 2.9% in 3Q17), with annual growth for 2017 at 2.5% (from 4% in 2016). At the margin, quarter-over-quarter annualized growth slowed down to 1% in 4Q17 (from 3% qoq/saar in 3Q17). We note that exports of goods & services grew 8.5% in 2017 (from 9.5% in 2016) outstripping the growth of imports of goods & services (4%, from -2.2%). Also, after 14 consecutive quarters of contraction, private investment grew in 2H17 in line with the rise of the terms of trade (7.3% in 2017, following 5 years of decline, mainly because of higher copper and zinc prices). We expect an acceleration of GDP growth, to 4%, in 2018. Even though the political crisis will probably linger, putting a risk on investment decisions, this will be more than offset by the positive effects of higher terms of trade (largely determined by metal prices), expansionary macroeconomic policies (mostly fiscal, but also monetary), and – to lesser extent – some rebound in infrastructure investment.
Given robust export volumes and higher metal prices, Peru’s current account deficit (CAD) narrowed between 2016 (2.7% of GDP) and 2017 (1.3% of GDP). However, according to our calculations, the quarterly seasonally adjusted CAD increased in 4Q17 (to 3.2% of GDP, from 0.9% of GDP in 3Q17) mainly due to softer exports (affected by a one-off postponement of the fishing season and a decline in copper export volumes) and stronger imports (led by imports of capital goods, reflecting the strengthening of investment). We believe that the weakening of exports in 4Q17 was temporary, considering that copper export volumes (down by 9.7% year-over-year in 4Q17) are usually highly correlated to copper output (up by 3.5% in 4Q17) while the postponement of the fishing season added 0.3% of GDP to the quarterly CAD (equivalent to the fall of fishing exports in 4Q17).
The nominal fiscal deficit widened to 3.2% of GDP in 2017 (from 2.6% of GDP in 2016) which implies that the fiscal deficit cap for last year (3% of GDP) was breached for the first time since the inception of the fiscal rule in 2013. Currently, the targets are 3.5% of GDP in 2018 (accommodating the fiscal stimulus), 2.9% of GDP in 2019, 2.1% of GDP in 2020, and 1% of GDP in 2021 (long-term target). To be sure, Peru’s fiscal rule is toothless as there are no consequences for breaching it (other than the erosion of credibility in the face of investors and rating agencies, if this lack of compliance is recurrent). Turning to public debt, both gross (24.8% of GDP in 2017, from 23.8% of GDP in 2016) and net (9.5% of GDP in 2017, from 6.9% of GDP in 2016) measures increased, although the latter increased more than the former because the government shed financial assets from the fiscal stabilization fund (to cover its funding gap). ** Full Story here.
Week Ahead: The statistics institute (INEI) will announce February’s CPI inflation on Thursday. We forecast a 0.35% month-over-month inflation rate. Assuming our forecast is correct, annual inflation would increase to 1.28% year-over-year in January (from 1.25% in January). On the same day, INEI will publish the full set of coincident indicators for January’s economic activity, which we expect to remain subdued. ** Read our full week ahead note below.
Moody’s announced it retains Colombia’s sovereign debt rating at Baa2 (one notch above investment grade), but downgraded the outlook to negative from stable. The agency highlighted economic and institutional strength and relatively low external vulnerability as key points supporting the current rating. Meanwhile, the downgrade in outlook responds to the expectation of a slower pace of fiscal consolidation and the risk that the new government arising from this year’s elections, will not have an effective mandate to pass additional fiscal measures to preserve Colombia’s fiscal strength. We expect the nominal deficit to narrow to 3.1% of GDP this year (3.6% in 2017), however the with no additional fiscal measures, further narrowing towards Colombia’s 1% of GDP long-term target for the deficit would be challenging.
Week Ahead: On Wednesday, the institute of statistics (DANE) will release the unemployment rate for January. We expect the urban unemployment rate to inch up to 13.5% in January from 13.4% recorded in the same month of 2017, resulting in the national unemployment rate coming in at 11.5% (11.7% one year prior). On Friday, DANE will publish exports for the month of January. We expect exports to come in at USD 3.290 million, a 18.1% annual expansion, boosted by oil exports. ** Read our full week ahead note below.
Week Ahead: On Tuesday, the central bank will hold its biweekly monetary policy meeting to decide on the reference rate. The central bank left its benchmark interest rate (7-day repo rate) unchanged at 27.25% in the previous meeting, following a 150-bp cut in January (75 bps at each of the two monthly meetings). We do not expect changes in the next meeting, as inflation expectations are rising and the February CPI reading will likely be unfavorable, even though short-term Lebac’s rates are trading 50-bps below the policy rate. On the activity front, the INDEC will publish several indicators on Wednesday. The most relevant is the EMAE (official monthly GDP proxy) for December 2017. We expect activity to grow 2.2% year-over-year (0.4% mom/sa) after gaining 3.9% in November (0.4% adjusted by seasonality). Also, manufacturing and construction data for January will see the light. Tax collection for February will see the light on Thursday. Argentina’s tax revenue totaled ARS 262 billion in January, marking a 23.9% year-over-year nominal expansion. We expect tax collection to increase 28.0% yoy to ARS 220.5 billion in February. On Friday, the central bank will release its monthly expectations survey. In the latest publication, analysts raised their inflation forecasts for 2018 (to 19.4% from 17.4%) and for 2019 (to 13.5% from 11.6%). Further increases are possible given the recent CPI prints. ** Read our full week ahead note below.
Week Ahead: On Wednesday, the national statistics agency (INE) will publish the industrial activity indicators for the first month of 2018. We expect manufacturing production to recover to 3.5% year over year. Also on Wednesday, INE will release the national unemployment rate for the quarter ending in January. We see the unemployment rate reaching 6.4% in the quarter, with unfavorable dynamics likely to still persist. On Friday, the national statistics agency (INE) will publish the private consumption activity indicators for January. We expect the commercial activity index to have increased 5.0% from last year, with retail sales growing 5.5% (4.8% previously). ** Read our full week ahead note below.