BBVA Research – Brazil Economic Outlook 3Q18 / 1

Brazil Economic
Outlook
4Q18
October 2018
Key messages

The Brazilian economy will continue to recover slowly in the

coming years. We expect GDP to grow 1.2% in 2018, 2.4% in 2019
and around 2.0% afterwards

The gradual strengthening of domestic demand and the normalization of food prices, among
other factors, will help to drive both inflation and interest rates upwards. Inflation should
converge to 4.9% in 2019, above the 4.25% target for the period, after closing 2018 at
4.5%. In an environment of greater pressures on prices, interest rates would be adjusted
upwards, from 6.5% to 10.0%, throughout 2019

The exchange rate is expected be around 3.8 in the remainder of the year and during 2019,
partly due to the reduction of political uncertainty after the October presidential elections

The next government will likely take measures to reduce fiscal vulnerability, although it will
hardly manage to approve an ambitious social security reform

A more positive macroeconomic scenario, mainly in terms of growth, requires a more

aggressive fiscal adjustment than expected and a series of reforms to increase productivity,
something that now seems unlikely
 BBVA Research – Brazil Economic Outlook 4Q18 / 3

Índice

01 Global environment: Positive global inertia continues,

although the risks are intensifying

02 Brasil: A slow recovery ahead

03 Brazil: Forecast table

 BBVA Research – Brazil Economic Outlook 4Q18 / 4

01
Global environment:
Positive global inertia continues,
although risks are intensifying
 BBVA Research – Brazil Economic Outlook 4Q18 / 5

More moderate global growth

World GDP growth

(Forecasts based on BBVA-GAIN, % QoQ
Slight moderation of global growth
1.2
towards rates slightly below 1% QoQ
in 2H18
1.0
Activity data remains strong, but has
lost momentum as protectionism
0.8
weighs down on confidence, trade and
investment
0.6
Apart from this volatility, world trade
0.4 has improved and stabilized after the
Dec-17

Dec-18
Dec-13

Dec-14

Dec-15

Dec-16

Jun-17

Jun-18
Jun-14

Jun-15

Jun-16

slowdown at the beginning of the year

CI 20% CI 40% CI 60%

Point estimates Period average

Source: BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 6

Monetary policy continues to normalize; the Fed and the ECB will take
divergent paths from 2019 onwards

Assessment Interest rates

3.25 3.00
0.25
Balance sheet reduction More rate hikes in 2019,
1.50 2.25
continues (US$450 billion but the cycle is ending
in 2018) (natural interest rate) 0.75

2016 2017 2018 2019 2020

0.75
End of QE in Dec-2018 Anchored expectations of
low rates for an extended 0.25

Total reinvestment at least

period of time. No interest
until Dec-2020
rate increases expected 0% 0% 0%

Repayment of TLTROs as before September 2019 2016 2017 2018 2019 2020
from June 2020
Forecast (eop) Interest rate (eop)

Source: BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 7

Financial tensions have rebounded in emerging markets, but have been

less synchronized than in previous tension episodes

BBVA index of financial tensions for emerging Emerging markets are under greater
economies stress which translates into a currency
(Index) depreciation and an increase in their
risk premium
6 Argentina
There is differentiation: tensions have
5 been concentrated in particular in the
4 most vulnerable economies. We are
3 Turkey not looking at a systemic crisis in
emerging markets
2
1 The adoption of economic policy
Brazil
0 measures (monetary and fiscal) is
allowing for some stabilization
-1
-2
Dec-07

Dec-09

Dec-17
Dec-08

Dec-10
Dec-11

Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Jun-14

Jun-16
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13

Jun-15

Jun-17
Jun-18

Source: BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 8

Persistent capital outflows from emerging economies, but far away

from a typical sudden-stop episode

Portfolio flows to emerging economies Cumulative flows in the last 5 quarters

(% of total assets under management, monthly data) (% of cumulative amount since January 2017)

Tapper US Current
tantrum China elections episode EM total 16.7%

5%
4% Outflows 2.1%
3%
2%
1%
0%
-1% Inflows 14.6%
-2%
-3%
-4%
-5%
Dec-15
Dec-13

Dec-14

Sep-15

Dec-16

Dec-17

Dec-18
Jun-15

Mar-16
Jun-16
Sep-13

Sep-14

Sep-16

Sep-17

Sep-18
Mar-13
Jun-13

Mar-14
Jun-14

Mar-15

Mar-17
Jun-17

Mar-18
Jun-18

Mar-19
Jun-19

Mar-17 / Jun-19

Source: BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 9

Trade loses momentum after the strength exhibited in 2017, but will
continue to support global growth

World export of goods

(QoQ, constant prices)
The trade war has so far had a limited
8% impact but it may be reflecting the
7% advancement of international
6%
exchanges

5%
Increased volatility of trade flows as a
4% result of uncertainty in some countries..
3%
2% ...especially because of trade tensions,
the political situation and the
1%
depreciation of currencies in emerging
0% economies
1Q13

3Q13

1Q14

3Q14

1Q15

3Q15

1Q16

3Q16

1Q17

3Q17

1Q18

3Q18

BBVA-Goods Exports CPB-Goods Exports

Source: CPB World Trade Monitor and BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 10

U.S. and China have announced higher tariffs, but with an estimated
limited effect on global GDP

Effect on GDP growth of US tariff increases and the The impact on the growth of the
response by other countries measures adopted so far through the
(2018-20, pp) trade channel could be limited but the
indirect effects could be considerable
0.0 especially for China and emerging
-0.2 economies
-0.4
-0.6 The signing of the USMCA trade
-0.8 agreement reduces uncertainty with
Mexico and Canada, pending its
-1.0
approval
-1.2
World China US Europe
In Europe the increase in tariffs on
Approved, confidence / financial channel automobiles is currently frozen
Approved, trade channel although it will be renegotiated from
Tariffs 25% All Chinese imports November onwards

Approved increase of tariffs: US (25% on steel, 10% on aluminium, 25% on Chinese imports for the value of
US$50 billion and 10% on imports for the value of US$200 billion); China (25% on US imports for the value of
US$50 billion and 10% on imports for the value of US$60 billion)
Source: BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 11

The downward revision of growth in emerging economies explains

the expected moderation of global growth in 2019

US
  Eurozone
2018 2019
 
2.8 2.8 2018 2019 China
2.0 1.7  
2018 2019

Mexico 6.5 6.0

 
2018 2019

1.9 2.0 South

Latam
America
 
2018 2019
World
0.6
0.9 1.8
 
2018 2019

Sube
Se mantiene
3.7 3.6
Baja

Fuente: BBVA Research

 BBVA Research – Brazil Economic Outlook 4Q18 / 12

Global risks: protectionism and the Fed’s exit strategy remain the most
relevant risks but political uncertainty is increasing in Europe

CHINA
Protectionism: on the upside (new tariffs and reprisals) with an impact
on domestic policies (financial stability, reforms)
High indebtedness: more contained in the short-term but higher in the
medium-term (private debt continues to rise)

US CHINA USA
The Fed’s exit strategy: high. Higher-than-expected rate hikes
EZ • Differential impact on emerging markets
Short-term probability

Protectionism: on the rise and concentrated on China

Economic recession: low probability but rising
Signs of financial instability in some assets

EURO ZONE
Political risk: on the rise, led by tensions in Italy and Brexit
Protectionism: more contained. Focus on the automotive sector
Severity
The ECB’s exit strategy: low

Tensions in Emerging Economies may amplify the impacts

of the global risks mentioned above
(“second round” effects on world growth)
Source: BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 13

02 Brasil:
A slow recovery ahead
 BBVA Research – Brazil Economic Outlook 4Q18 / 14

Jair Bolsonaro, the favorite to be the president

of Brazil between 2019 and 2022

Elections: result of the 1st round, 2nd round

poll and Google searches (*)
(%) The conservative J. Bolsonaro and the
leftist F. Haddad will compete for the
70%
presidency of Brazil in the second round
62%
59% of the elections on October 28, with the
60%
first being the clear favorite
50% 46% A new Congress emerged from October
41% 7th elections. It will continue exhibiting a
40% 38% very high degree of fragmentation, with
a somewhat more conservative profile in
29%
30% comparison to the previous one.

20%
The fragmentation of the Congress will
be a challenge for governance. The next
10%
president will have to build a coalition of
many parties to pass important
measures and reforms
0%
1st round (results) 2nd round (polls) Google Searches

J. Bolsonaro F. Haddad

(*) Results of the 1st round and polls: proportion of valid votes. In the 1st round the other
candidates together got 25% of the valid votes. The DATAFOLHA poll was conducted on
October 17 and 18. Google searches refer to searches related to the topic "government" made
between October 15 and 22.
Source:TSE, IDATAFOLHA, GoogleTrends, BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 15

The fragmentation of the Congress, political polarization and market

pressure will reduce the room for maneuver of the next government

Base scenario: the most likely is that a not very ambitious fiscal adjustment is implemented
Markets will leave little space for a less pragmatic economic policy. Thus, whoever is the next president, will be forced to
present a plan to stop the deterioration of public accounts and maintain macroeconomic stability. As the political
environment will remain polarized, and taking into account that Congress will be very fragmented, it will be difficult to
approve an ambitious reform of the pension system (which is key to guarantee the sustainability of the public debt). Most
likely, a decaffeinated reform will be implemented, as well as other measures to increase revenue and reduce public
spending. Building on these assumptions about the policies of the next government, we detail in the next slides our
macroeconomic scenario for Brazil in the coming years.

Positive alternative scenario: A more aggressive reform of the pension system would create the
conditions for greater economic growth
An ambitious pension system reform, i.e. one that ensures the solvency of public debt in the medium and long term, would
generate a significant appreciation of the exchange rate and allow the country to grow above 3% in the coming years,
mainly if other policies and reforms that stimulate the increase of productivity are adopted .

Negative alternative scenario: Not addressing the fiscal problem could generate a new crisis
The lack of concrete measures to curb the fiscal deterioration would have a negative impact on confidence. Also, the
exchange rate would depreciate, increasing the pressure on domestic prices and on interest rates. In such an environment,
a crisis like 2015-16 could not be ruled out.
 BBVA Research – Brazil Economic Outlook 4Q18 / 16

GDP growth moderated and financial volatility increased amidst

increasing political uncertainty

GDP: quarterly evolution since 1Q14 BBVA index of financial tensions

(Index = 100 in 1Q14; seasonally-adjusted series) (average since Jan-06 = 0)

102 3,5 Rousseff's News of recording in

impeachment which Temer allegedly
process endorses bribes
3,0
100
2,5 Recent
turbulence
98 2,0

1,5
96
1,0

94 0,5

0,0
92
-0,5

90 -1,0
Mar-15
Mar-14

Mar-16

Mar-17

Mar-18
Dec-14

Dec-15

Dec-16

Dec-17
Jun-17
Jun-14
Sep-14

Jun-15
Sep-15

Jun-16
Sep-16

Sep-17

Jun-18

-1,5

Jul-14

Jul-15

Jul-16

Jul-17

Jul-18
Apr-14

Oct-14

Apr-15

Oct-15

Apr-16

Apr-17

Apr-18
Oct-16

Oct-17

Oct-18
Jan-14

Jan-15

Jan-16

Jan-17

Jan-18
Source: IBGE, BBVA Research Source: BBVA Research

GDP growth moderated in the last three quarters (when Financial tensions have increased once again over
average growth was of 0.1% QoQ) after a stronger the last few months . However, in the last few weeks,
expansion in the first three quarters of 2017 (when the tone has been (excessively) positive because of
average growth was of 0.7% QoQ). GDP is currently 6% markets’ increased optimism regarding the political
below the pre-crisis level scenario after the elections
 BBVA Research – Brazil Economic Outlook 4Q18 / 17

We revised down our growth forecast: the recovery of the activity will
be even more gradual than expected

2.4 % 2.4 %
(before) (now)
1.6 %
(before) 1.2 %
(now)
1.0 %

2017 2018 2019

The recent moderation of economic activity and
the increase of volatility in financial markets,
amidst increasing political uncertainty, have led
us to a further downward revision of GDP growth
in 2018
We maintain the forecast of 2.4% for 2019, with a
downward bias. From 2020 onwards GDP growth
would be around 2.0%. A stronger expansion
would require the approval of economic reforms,
which now seem unlikely
 BBVA Research – Brazil Economic Outlook 4Q18 / 18

The greater dynamism of private consumption and, especially,

of investment will be the main drivers of the recovery

Growth of GDP and its components(*)

(%)
7,5

5,0

2,5

0,0

-2,5
GDP Investment Private consumption Public consumption Exports Imports

2017 2018 (f) 2019 (f)

(*) (f) = Forecasts.

Source: BBVA Research

We have revised downwards our forecasts for
investment, but we still think that it will lead the
process of gradual recovery of the economy in the
coming quarters. The main driver would be the likely
rebound of confidence after the elections
In the coming quarters, GDP growth should
accelerate somewhat. Specifically, we expect a
GDP expansion of around 0.6% QoQ during the
second half of 2018 and also during the next
year
 BBVA Research – Brazil Economic Outlook 4Q18 / 19

Inflation should reach 4.5% this year and converge

to 4.9% in 2019, somewhat above the target

Inflation: IPCA(*) Inflation: IPCA(*)

(% YoY) (% YoY; end of period)
12 7
11
10 6
9
5
8
7
4
6
5 3
4
3 2
2
1
Apr-14
Jul-14

Apr-15
Jul-15
Oct-15

Apr-16
Jul-16

Apr-17
Jul-17

Apr-18
Jul-18
Oct-14

Oct-16

Oct-17
Jan-15
Jan-14

Jan-16

Jan-17

Jan-18

0
Observed (with observed food inflation) 2016 2017 2018 (f) 2019 (f)
Simulated (with food inflation equal to its 2009-16 average) Current forecasts Previous forecasts (Jul/18)

(*) For the simulation of inflation from January 2017 on, observed food
inflation is replaced by the average food inflation in 2009-16 (8.75%).
(*) (f) = Forecasts.
Source: BBVA Research
Source: BBVA Research

Inflation had been at very low levels until recently,
basically due to short-term factors (weak demand,
positive effects of weather conditions on food
supply, low energy prices...) In recent months these
factors have stopped contributing so benignly ...
... something that will continue to happen as we
move forward. We foresee, thus, an increase of the
upward pressures on domestic prices in 2019, so
that inflation must be above the 4.25% target for the
period
 BBVA Research – Brazil Economic Outlook 4Q18 / 20

The Central Bank will soon begin to tighten

monetary conditions

Interest rates: SELIC Interest rates: SELIC(*)

(% YoY) (% YoY; end of period)

16 16

14 14

12
12
10
10
8
8
6
6
4
4
2

0 2
Apr-14
Jul-14

Apr-15
Jul-15

Apr-16
Jul-16

Apr-17
Jul-17

Apr-18
Jul-18
Oct-14

Oct-15

Oct-16

Oct-17
Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

0
2016 2017 2018 (f) 2019 (f)

Nominal interest rates Real interest rates Current forecasts Previous forecasts (Jul/18)

(*) (f) = Forecasts.

Source: BBVA Research
Source: BBVA Research

We expect a first rise in SELIC interest rate at the
first monetary policy meeting of 2019 (in
February). Additional adjustments will make the
SELIC interest rate to converge to 10% over the
next year
The next government will have the power to change
the members of the board of the Central Bank of Brazil,
since the institution is not legally independent. Despite
the risks, in principle no negative surprises are
expected
 BBVA Research – Brazil Economic Outlook 4Q18 / 21

Fiscal adjustment measures and greater GDP growth would allow the
primary deficit to fall, but interest payments would remain high

Fiscal results(*) There is still a lot of uncertainty about

(% of GDP) how the next government will address the
fiscal problem
0
Under the pressure of markets, the next
-2 government is likely to take measures to
reduce fiscal vulnerability
-4
In any case, the fragmentation of the
Congress and political polarization make
-6 an ambitious reform of social security
unlikely
-8
We foresee a gradual reduction of the
-10
primary deficit in the coming years;
however, interest payments could
increase as a consequence of an
-12
increase of the SELIC interest rate
2017
2014

2015

2016

2018 (f)

2019 (f)

2020 (f)

2021 (f)

2022 (f)

Public debt, currently 77% of GDP, will

continue to rise
Primary result Interest payments
Total fiscal result

(*) (f) = Forecasts.

Source: BCB, BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 22

External accounts: there are no signs of vulnerability

Current account deficit and foreign direct

investment in Brazil(*)
(% of GDP)
The situation of external accounts is
relatively positive:
5,0
• International reserves are high (20% of GDP)
4,5
• The total external debt is close to 15% of
4,0 GDP, lower than the level of international
3,5
reserves

3,0 • 82% of external debt is long term

2,5 • More than 90% of public debt is denominated

in local currency
2,0
• The current account deficit is limited (0.8% of
1,5
GDP in August)
1,0
• Foreign direct investment in Brazil remains
0,5 relatively robust (3.6% of GDP in August)
0,0
However, the greater dynamism of
2014

2015

2016

2017

2018 (f)

2019 (f)

2020 (f)

2021 (f)

2022 (f)

domestic demand will cause an increase

in the current account deficit in the
coming years
Current account deficit Foreign direct investment

(*) (f) Forecasts.

Source: BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 23

Calm after the storm in foreign exchange markets

Nominal exchange rate Nominal exchange rate(*)

(USD / BRL) (USD / BRL; end of period)

4,5 3,90

3,80
4,0 3,70

3,60
3,5
3,50

3,40
3,0
3,30

2,5 3,20

3,10

2,0 3,00
Apr-14
Jul-14

Apr-15
Jul-15

Apr-16
Jul-16

Apr-17
Jul-17

Apr-18
Jul-18
Oct-14

Oct-15

Oct-16

Oct-17

Oct-18
Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

2016 2017 2018 (f) 2019 (f)

Current forecasts Previous forecasts (Jul/18)

(*) (f) = Forecasts.

Source: BBVA Research Source: BBVA Research

In the last few weeks, the exchange rate
appreciated significantly, from around 4.15 to about
3.7, largely due to an (excessively?) positive
perception of the scenario after the elections by
the markets
Volatility may return, mainly after the elections, when
the economic policy for the next four years will
begins to be unveiled. We expect the Brazilian real
(BRL) to float around 3.8 over the forthcoming
quarters
 BBVA Research – Brazil Economic Outlook 4Q18 / 24

All in all, Brazil will hardly be able to recover in the coming years the lost
growth

GDP growth: 2003 – 2017 average Even if the expected recovery of activity
(%) materializes, Brazil’s growth will remain
7,0
relatively modest, around 2%

6,0 Therefore, the country will continue to

6,0
grow less than most Latin American and
5,4
emerging economies, and even less than
5,0 4,6 some developed economies (at least in
4,4
4,0
4,2 per capita terms)
3,9
4,0
This will not be a novelty: between 2003
3,0 and 2017 Brazil’s average growth was of
2,5
2,4 2.4%, while most of the other economies
2,0 1,7
of the region grew at least 4% and
emerging economies grew around 6%
1,0 Recover lost growth in the coming
decades would require, among other
0,0 things, structural reforms that increase
Argentina

Paraguay
Uruguay

Peru
Brazil

Chile

Developed

Emerging
Mexico

Colombia

productivity

Source: BBVA Research, FMI

 BBVA Research – Brazil Economic Outlook 4Q18 / 25

03Brasil:
Forecast table
 BBVA Research – Brazil Economic Outlook 4Q18 / 26

Brazil forecasts

2016 2017 2018 (f) 2019 (f)

GDP -3.4 1.0 1.2 2.4

Private consumption (%) -4.3 0.9 1.6 1.8

Public consumption (%) -0.1 -0.6 -0.2 -0.5

Investment in fixed capital (%) -10.3 -1.9 2.0 4.5

Exports (%) 1.9 5.7 0.1 5.3

Imports (%) -10.2 5.5 2.9 3.2

Unemployment rate (average) 11.3 12.7 12.3 11.0

Inflation (end of period. YoY %) 6.3 2.9 4.5 4.9

SELIC rate (end of period. YoY %) 13.75 7.00 6.50 10.00

Exchange rate (end of period) 3.35 3.30 3.80 3.70

Current account (% of GDP) -1.3 -0.5 -0.2 -1.2

Public sector fiscal balance (% of GDP) -9.0 -7.8 -7.9 -5.8

(p) Forecast.
Source: BBVA Research
 BBVA Research – Brazil Economic Outlook 4Q18 / 27

This report has been produced by the Latin America Unit:

Enestor Dos Santos

enestor.dossantos@bbva.com

With the collaboration of:

Global Macroeconomic Scenarios
Miguel Jiménez
mjimenezg@bbva.com

BBVA-Research
Jorge Sicilia Serrano

Macroeconomic Analysis Financial Systems and Regulation Spain and Portugal South America
Rafael Doménech Santiago Fernández de Lis Miguel Cardoso Juan Manuel Ruiz
r.domenech@bbva.com sfernandezdelis@bbva.com miguel.cardoso@bbva.com juan.ruiz@bbva.com
Digital Economy Digital Regulation and Trends United States Argentina
Alejandro Neut Álvaro Martín Nathaniel Karp Gloria Sorensen
robertoalejandro.neut@bbva.com alvaro.martin@bbva.com Nathaniel.karp@bbva.com gsorensen@bbva.com
Global Macroeconomic Scenarios Regulation Mexico Colombia
Miguel Jiménez Ana Rubio Carlos Serrano Juana Téllez
mjimenezg@bbva.com arubiog@bbva.com carlos.serranoh@bbva.com juana.tellez@bbva.com
Global Financial Markets Financial Systems Turkey, China and Big Data Economic Outlook
Sonsoles Castillo Olga Cerqueira Álvaro Ortiz Hugo Perea
s.castillo@bbva.com olga.gouveia@bbva.com alvaro.ortiz@bbva.com hperea@bbva.com
Long-Term Global Modelling and Analysis Turkey Venezuela
Julián Cubero Álvaro Ortiz Julio Pineda
juan.cubero@bbva.com alvaro.ortiz@bbva.com juliocesar.pineda@bbva.com
Innovation and Processes Asia
Oscar de las Peñas Le Xia
oscar.delaspena@bbva.com Le.xia@bbva.com

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