Brazil – Policy Challenges and Very Negative Outlook

The economy has declined by 2.5 to 3 % of GDP according to most estimates.  Next year will also see a decline of over 1% of GDP.

The slowdown in China has impacted Brazil and this will continue into the future.  Tax revenues are under more pressure as the economy continues to contract, thus impacting the fiscal side.

In short, expect a deeper and more prolonged recession in Brazil.  This combined with an unhealthy fiscal situation could lead to a higher growth in inflation.  This is a difficult environment for the Banco de Brazil (Brazilian Central Bank) to operate and make policy.

Business confidence will fall further and the unemployment rate of around 7.5% should increase, possibly to over 10% in 2016.  On top of this there is political risk – corruption charges to deal with.

Potential Policy Surprise:  the central may have to implement a large one-time rate hike to stop inflation. This would be similar to what Turkey and Russia undertook in their policy.

Investment Thesis:  depreciating currency – expect BRL to go over 4 versus the USD

Short-term stay away, until fiscal measures are implemented and on track.