Economy to decelerate somewhat in 2023
Brazil´s GDP climbed by 4% YOY (from 1.9% YOY in Q4 2022) and by 1.9% QOQ (from -0.1% QOQ in Q4 2022) in Q1 2023. Nonetheless, the figure breakdown reveals a weaker and uneven economic momentum. On the demand side, the positive external sector contribution was driven by a deeper drop in imports (-7.1% QOQ) than in exports (-0.4% QOQ), thereby highlighting the weakness of domestic demand. Regarding the latter, household consumption growth actually decelerated to a mild +0.2% QOQ (from 0.4% QOQ in Q4 2022) and gross fixed investments fell for a second quarter in a row (-3.4% QOQ vs -1.3% in Q4 2022). On the supply side, activity was strongly underpinned by agriculture (+ 21.6% QOQ), as a result notably of a record soybean crop (after adverse weather conditions in 2022). Looking ahead, GDP is expected to decelerate in the coming quarters as the positive agriculture contribution gradually fades and lending conditions remain tight. The latter led to a sharp deterioration in payment experience, with the number of companies that filed for Chapter XI protection rising by 51% YOY during the first five months of 2023 (the highest since 2018). While the central bank should start to cut the policy rate from Q3 2023 onwards (on hold at 13.75% per annum since August 2022), the easing cycle should be very gradual. Importantly, household consumption (61% of GDP) should somewhat be supported by a still resilient job market, social policies (such as the rise of the real minimum wage and the expansion of the Bolsa Família welfare program), debt renegotiation programs and as inflation appeases. Meanwhile, gross fixed investments are expected to contract slightly as global credit conditions remains tight. Despite relatively lower average commodity prices in 2023 (accounting for 60% of foreign sales), the bright 2022-2023 crop outlook and relatively higher growth in China (the main export destination), along with the easing of Covid-19 lockdowns will allow exports to grow even as the global economy loses traction.
Fiscal deficit to widen, while the external shortfall will narrow
Brazil will maintain an adequate external position in 2023, with the current account deficit expected to narrow somewhat. The trade balance surplus should increase (2.1% of GDP in 2022) since the deceleration in import growth (reflecting weaker domestic activity) should exceed that of exports. In addition, the primary income deficit (3.1% of GDP) should be curtailed by the drop in repatriated foreign investment income (albeit still high during the first five months of the year). Meanwhile, the services deficit (1.9% of GDP) is likely to also slightly narrow driven by the reduction of average freight cost, which should offset higher foreign travel. On the financing side, foreign direct investment (4.8% of GDP) will continue to comfortably cover the external shortfall. FDI recovered the 2019 pre-pandemic level in 2022, but should marginally weaken in 2023, reflecting higher financing costs and a weaker activity outlook. Meanwhile, foreign currency reserves will remain robust (ensuring an import coverage of 15 months as at May 2023). Last, total gross external debt (including intercompany loans and domestic fixed income securities held by non-residents) stood at 35% of GDP in May 2023, with its public share representing 5% of GDP.
Regarding the fiscal accounts, the budgetary deficit is set to climb in 2023, owing to a current rise in public expenditure (including higher expenses with the Bolsa Família social welfare program, a real increase in the minimum wage, education, court sentences and court-ordered debt payments), lower average commodity prices and higher interest payments. Moreover, the government was able to approve a new fiscal framework in Congress in late June 2023 (as of early July 2023 the bill returned to the Lower House for the final vote). The new rule replaces the spending cap created in 2016, limiting the growth of expenditure to inflation, and which worked with several exceptions. Generally, the new framework defines that the real growth rate of primary spending may vary between 0.6% and 2.5% per year, or correspond to 70% of revenue growth. It also re-established annual targets for the primary result (before interest payments). While the approved bill does not guarantee a downward trajectory for public debt (its effectiveness relies on the capacity to increase public revenues), it will prevent an explosive trajectory of the index. Overall, the already elevated gross public debt (95% is domestically owed) is set to further increase in 2023.
Brazil switches back to left
Luiz Inácio Lula da Silva (better known as Lula), from the leftist Labour Party and formerly twice president (2003-2010), took office again in January 2023 after a defeating by a tight margin the incumbent leader Jair Bolsonaro from the right-wing Liberal party in the presidential election runoff. Shortly after his inauguration on 8 January, the new government faced its first challenge when supporters of Mr. Bolsonaro invaded and wilfully damaged the presidential palace, Congress and Supreme Court in the capital Brasília, demanding intervention by the Armed Forces. The prompt and unified response of the three arms of government (executive, judicial and legislative) meant that the movement was contained without causing major disruption. While the political environment is still somewhat polarised, tensions have eased significantly since January. However, challenges persist on another spectrum. The incumbent power depends on a coalition with centrist parties in order to pass constitutional amendments. This is because in the Lower House the left-leaning members hold 25% of the seats, while centrists and centre-right wing members have 24% and 51% of the seats, respectively. The framework is no better in the Senate, with the leftists holding 16% of the seats, the centrists 40% and centre-right wing members 44%. Lula favours a more active role for the state in the economy, including raising the participation of state banks, halting new privatisations (and shifting the emphasis to public-private partnerships) and reversing the state-owned oil company Petrobras´ divestment policy towards more investments to increase domestic energy autonomy. A tax reform is also among the top priorities. The government will initially seek to approve the unification of five consumption taxes that will be replaced by a federal tax and another shared by states and municipalities (approved by the Lower House in July 2023 and now before the Senate). The change is due to begin in 2026, but there will be a phase-in transition period until 2033. Income tax reform will be part of a second stage of the reform which is expected to gain momentum in the second half of 2023. In foreign policy, relations with neighbouring countries (many of which have also leaned to the left in recent years) have been strengthened, including with Venezuela, with which relations had been severed since 2019. Last, the new government is also poised to sign the Mercosur trade agreement with the European Union, which has been stalled due to environmental concerns raised by the EU member states. However, consensus is still lacking on two major topics: Lula has criticised an addendum which imposes penalties for nations failing to comply with climate goals and a procurement clause allowing European companies to sell to Brazil's public sector.