By John Baur
With the Olympics finally underway in Rio, investors are looking for signs that Brazil can turn the corner on a struggling economy. The country has been hurt by years of lower commodity prices, massive government spending, and political corruption and infighting, culminating in the impeachment of President Dilma Rousseff last April.
The market reflects some bullishness, as the yield on Brazil’s debt has declined in 2016 by almost five percentage points to 16.8%. However, we believe that the larger structural issues plaguing the economy are more severe than the market perceives. Brazil’s credit spread trades in line with its BB rating, but the country has yet to address pressing structural problems. For example, government debt has been steadily climbing, from about 60% of GDP at the end of 2013 to a projected 75% for 2016, one of the highest levels among big emerging markets, according to the International Monetary Fund (IMF). Central government spending remains largely locked in, with Social Security, payroll and other mandatory outlays accounting for 78% of expenditures.
The picture, though, leaves some room for optimism. Brazil’s current account has come into balance, after falling to a 5% deficit in March 2015, indicating that external trade has adjusted to lower oil prices. Brazil’s fiscal deficit, after several years of worsening, has shown signs of improvement. Such trends have not been significantly reflected in the Brazilian real, which still trades well below the average level of the last 10 years, even adjusted for inflation differentials.
Rousseff’s impeachment trial at the end of August may help Brazil end its political paralysis, and the new administration will likely pass some fiscal improvements. However, polls show that public dissatisfaction with government corruption is at an all-time high, which will impede sustained support for reform of popular social programmes.
Bottom line: After the Olympic glow fades, the road to a sound Brazilian economy will still be a long one.
John Baur is a portfolio manager at Eaton Vance.
