As the manufacturing cycle – a vital thread in the economic and social fabric of Brazil seemed to be heading for a U-turn in the first half of 2020, and necessary economic reforms were being enacted, the country undeniably proved to be a very attractive play for 2020.

Following Jair Bolsonaro’s 2018 presidential victory, social and pro-business reforms were enacted. Amongst other initiatives, lowering borrowing costs, back then, to its lowest on record and the well-needed pension reform, set to reduce the government’s expenditure by $250bn over the next decade, roused investor optimism.

Fresh investor optimism on Brazil’s political and economic prospects was however short-lived, as the COVID-19 outbreak in the Hubei province, China struck, renewing political uncertainty and fears of a deterioration in economic conditions. 

The economic repercussions brought about by country-wide closures, augmented pressure on governments to intervene. Albeit strained from a fiscal perspective, Bolsonaro’s Government and policymakers stepped-in to soften the economic blow. While cutting its benchmark interest rate by 50 bp, lowering borrowing costs to 3.75 per cent, Bolsonaro’s government introduced a multi-billion support package, bringing forward social assistance payments and deferrals in tax collections – a sizeable emergency policy response. 

Albeit softening the impact COVID-19 posed, as the number of infected cases mounted, the possibility of a v-shaped economic recovery diminished, making Bolsonaro’s challenge way tougher than initially expected. 

Due to rising external challenges, including China’s significant slowdown – a key trading partner and consumer of Brazil’s manufacturing industry, lower commodity prices, and tightening external financing conditions, the economic outlook deteriorated. Social distancing and lockdown measures instated to mitigate the spread lead to a sharp contraction in domestic economic activity and higher unemployment rates. 

Contrasting pre-coronavirus estimates, signalling economic growth and gradual recovery from Brazil 2016 recession, the World Bank is now forecasting an eight per cent economic shrink for 2020. Such a slump in Brazil’s GDP and thus prospective economic growth will further increase public indebtedness, erode fiscal flexibility, and increase vulnerability to shocks. 

In a bid to alleviate the economic environment, and thus try to create a ripple effect of increased spending throughout the economy, the Central Bank of Brazil on June 17 once more unanimously decided to slash its benchmark interest rate, better known as the Selic rate, by a further 75 bps to a new all-time low of 2.25 per cent, leaving the door open for further rate cuts, which although limited, are indeed possible.

In the committee meeting, policymakers added that fiscal policy responses to the outbreak that permanently worsen the fiscal trajectory are at this stage necessary for a sustainable economic recovery.

More than ever Brazil’s vast and diverse economy, high per capita income relative to its peers and a capacity to absorb external shocks supported by its; flexible exchange rate, external imbalances, robust international reserves, and deep domestic government debt market are detrimental to the future of Brazil’s economy. 

Should normality be re-instated and recovery within the manufacturing industry, on both a local and global scale, transpire, the Latin America’s largest economy shall indeed reap. Conversely, should the spread of the deadly coronavirus fail to be contained and political turbulence fails to weaken, the recovery forecasted for 2021 may indeed be off the table. 

Without undermining Brazil’s ability to recover from such unprecedented scenario and thus prove that COVID-19 was just a hiccup rather than a detriment to the future of Brazil’s economy, we reiterate that as uncertainties remain, a bottom-up approach is indeed imperative. This, to determine corporates with good fundamentals and robust liquidity, thus capable of servicing its debt, albeit facing plenty of headwinds.

This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information, visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.