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Analysis: Brazil economy facing stimulus drought as monetary, fiscal taps run dry

BRASILIA (Reuters) - Brazil’s economy goes into next year continuing its rebound from this year’s pandemic-fueled slump, but risks losing steam because the window for further fiscal and monetary support is closing fast.

FILE PHOTO: Brazil's Economy Minister Paulo Guedes delivers a statement at the Itamaraty Palace in Brasilia, Brazil, October 20, 2020. REUTERS/Adriano Machado

Economy Minister Paulo Guedes insists this year’s emergency measures will end on Dec. 31 and give way to a huge wave of fiscal consolidation, and economists say the prospects of another interest rate cut are dimming, even though the central bank on Wednesday left the door ajar.

With emergency aid to millions of Brazilian families expiring, unemployment at a record high and rising, and confidence indicators starting to wobble, many are wondering where the stimulus, should it be needed, will come from.

“People and businesses are going to need continued support to maintain activity. Even the IMF is saying more fiscal support is needed, yet policymakers are still very wary,” said Emily Weis, emerging market strategist at State Street in Boston.

“It’s a very delicate balance, but more spending is needed,” she said.

On the monetary policy side, the central bank has made clear its reluctance to use “quantitative easing” bond buying to bring down long-term market interest rates, relying on a record low Selic rate of 2.00% and a “forward guidance” pledge not to raise it any time soon.

The bank’s statement on Wednesday after leaving the Selic on hold left the door open to another “small” cut. But with inflation picking up and fiscal stability concerns growing, analysts and traders reckon the next move on rates will be up.

“The central bank is unlikely to compromise its inflation targeting agenda to encourage economic activity, particularly now given the uncertainty on fiscal policy,” said Thomaz Favaro, director at Control Risk, a political risk consultancy in Sao Paulo.

However unlikely it may appear given the highly uncertain economic outlook, traders are currently roughly pricing in a 25-basis-point interest rate hike by May, and 100 basis points of tightening by December.

It is questionable whether an economy with tens of millions of people unemployed or underemployed, weak investment and huge spare productive capacity is strong enough to cope with higher interest rates.

The economy is on course to shrink by a record 5% this year, and rebound 3% or more next, according to consensus forecasts.

LOST DECADE

Brazil’s debt and deficit are among the highest of any emerging nation, and are on a par with many developed economies that are better equipped to carry such a heavy financial burden.

The government’s primary deficit before interest payments is on course to exceed 12% of gross domestic product this year, and the national debt will approach 100% of GDP.

According to Credit Suisse, the Brazilian government’s fiscal support for the economy this year exceeds 8% of GDP, again one of the highest in the emerging world and more than many developed nations.

For a graphic on Global fiscal policy, 2020:

The orthodox view is there is simply no room for further largesse without Brazil breaking its self-imposed fiscal rules, most notably the “spending cap,” and triggering a spiral of soaring debt, currency weakness and growth-crushing rate hikes.

The government wants to introduce a new welfare program “Renda Cidada” next year, which will replace this year’s emergency off-budget aid and merge with the current “Bolsa Familia” program that costs around 35 billion reais a year.

But it is not clear how it will be funded without breaking the government’s spending cap fiscal rule limiting growth in public expenditure to the annual rate of inflation.

Financial markets are concerned, with the real sinking to a five-month low of 5.80 per dollar BRBY and the yield curve steepening <0#DIJ:>.

But from an economic perspective, persistent exchange rate depreciation, a steeper yield curve and surging long-term interest rates are bad news because they reduce the chances of further stimulus from monetary easing or government spending.

And that’s before public fears over the COVID-19 pandemic are taken into account. The latest consumer and business sentiment indicators from the Getulio Vargas Foundation show pandemic fears are affecting the outlook for next year.

“From Q3 this year I think you will see a strong deceleration in the recovery. We will have GDP growth next year due to statistical effects, but the pace of recovery will be slow,” said Guilherme Mello, economics professor at the University of Campinas in Sao Paulo state.

“The economy doesn’t have the engines to drive it forward. GDP per capita is back where it was in 2010, meaning we have literally had a lost decade. The level of GDP will only get back to pre-crisis levels in 2023,” he said.

Reporting by Jamie McGeever; editing by Jonathan Oatis

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