Friday, 21 April 2017

Micro Level Trends – Brazil's Automotive Sector – “Brazil 66”...Sixty Six Years of Economic Power Lifting (Part 5.1.4)

This section relates to the observations of the OECD (Organisation for Economic Cooperation and Development) - complimented by those of the IMF (International Monetary Fund) - regards the current issues faced by President Michel Temer and his administration.

The most recent Economic Forecast by the OECD released in November 2016 is recounted here; an update expected soon.

OECD Report Summary -

- Emerging from a severe and protracted (4 year) recession
- Political uncertainty diminished
- Business confidence rising
- Consumer confidence rising
- Investment sentiment and cases strengthening
- Unemployment a mid-term challenge
- Inflation expected to gradually return to target range

- Fiscal conditions still fragile
- Need to to re-balance the Fiscal and Monetary by:
- 1. Consolidate public finances
- 2. Underpin macro-economic stability
- 3. Loosen monetary policy
- 4. To create the investment climate

- Raise productivity by:
- A. Strengthen competition
- B. Reduce administrative 'red tape'
- C. Continue infrastructure improvements

- Need to manage expected rising inequality

Pulling Out of Recession -

By November 2016 Brazil had experienced 6 quarters of technical recession, with accordant rising unemployment, business bankruptcies likewise and corporate debt higher.

But after heavy falls of business and consumer confidence sentiment appears to be increasing, albeit from lowly bases. Whilst industrial production figures have been mixed, tending to negative, investment growth has become positive. The replacement of Rousseff by Temer has tempered the previous political uncertainty, with next elections in October 2018 and the next government installed on new year's day 2019.

With that increased certainty the sovereign debt (bond) rate has fallen by a third back to 10%, but the period since 2013 has seen the fiscal balance decline to -11% by early 2016, now sitting at -9%, so showing improvement. Although down dramatically since its 2015 EoY high of nearly 11%, inflation now sits at 8%, so well above the 4.5% target and the 6.5%-2.5% 'tolerance band'.

Rebalancing Fragile Fiscal Conditions via Monetary Policy -

- 1. Consolidate public finances
- 2. Underpin macro-economic stability
- 3. Loosen monetary policy

A New Fiscal Rule imposed to reduce the fiscal deficit from its 9% of GDP, whilst the primary deficit of 3% hampers the need to create primary surpluses to keep public debt on a firm and sustainable declining path. Weakness obviously lies with the cyclical nature of reduced revenues during a recession, but critics cite poor taxation policy regards exemptions which are yet to be discontinued. This 'slack' backdrop means that the fiscal stance is expected to be only mildly contractionary; yet still part of necessary process to correct past excesses and strengthen the fiscal future; in essence the avenue chosen to try and strike an appropriate balance.

But rising current expenditures, plus projected increases in pensions costs, is an argument that undermines fiscal health over the mid/long-term. The reaction has been a new expenditure rule, which matches the recommendations of previous OECD economic surveys. This new rule limits real increases in expenditures whilst simultaneously lessening the rigidity of the budgeting process; except for pensions and benefits which amounts to almost half of government spending.

Separate pensions reform is noted as required to ensure the created fiscal adjustment is able to be successful. That reform though necessarily seeking ensure adequate continued decline in inequality and poverty by improving the targeted social benefits. Better spending efficiency is believed to exist across many areas, and it is believed that the new fiscal rule provides sufficient room to attain a balance of objectives regards overall spending and social cohesion.

The commitment regards public expenditure will provide for further monetary easing going forward, which should in-turn give rise to stronger investment (as public investment projects are followed by private investment interest).

A raft of structural reforms have the potential to boost growth significantly and make it more inclusive.

Reducing what are viewed as high compliance costs which relate to a complex state-based and fragmented indirect taxation regime is viewed as immediately advantageous to firms, an effort to consolidate the varied 'mini-taxes' into a singular VAT that encompasses import and export measures so as to strengthen international trade. The idea is that a full deductibility for imports would provide greater (price-based) competition for domestic producers/providers, so enhancing overall productivity.

Improved infrastructure would reduce transport costs, especially so for exporters, (so providing an effective efficiency boost regards price and speed to markets.

Stronger trade integration would benefit low-income earners specifically as the export sector would have a larger impact on the demand for unskilled and low-skilled workers.

Further educational attainment would raise productivity and allow more low-income households to join Brazil's middle-class.

These very broad policy avenues enabling the country...

- 4. To create the investment climate

Expected Slow and Gradual Recovery -

2017 should see progressive growth thanks to rising investment sentiment, but the pace of this recovery will inevitably be impacted by the size of corporate debt and the over-capacity/spare-capacity in various sectors.

Speedy implementation of structural reforms should see greater immediate momentum compared to historic re-growth periods....but....the measures highlighted are not adequate compared to the ambitious agenda needed.

Slow earnings growth and continuing contraction in private credit will initially limit consumption, this environment much assisted by the achievement of lower interest rates, which if attainable and properly entrenched would provide for improved recovery.

But critically, the background of low international trade growth and ongoing competitiveness challenges, the external sector will not be able to provide as much support as in past years. Inflation will continue to ease because of this weaker activity and reduced administrative costs, expected to return to the tolerance band by end 2017. Unemployment expected to rise until mid 2017 before falling as the economy gains new stride in 2018.

'Upside Risks' could be seen with a stronger momentum from Brasilia regards structural reforms could create better conditions and so more sooner, domestic demand boosted by lower spreads (regards government bond prices), less currency devaluation, and lower real interest rates.

'Downside Risks' could arrive from the corporate sector if a protracted recession results in rising corporate defaults as a consequence of high debt levels, which would weaken various parts of the financial sector.

And lastly, although political risk appears much diminished, it still remains under the surface with respect to the final implementation of the New Fiscal Rule.

Summary -

The OECD's remarks effectively parallel those of the IMF (International Monetary Fund) in as much that (to quote the IMF's November 2018 report)...

“Whilst capital markets have responded positively to the new political stability introduced, so bolstering asset prices and confidence, and helping the country ride a positive wave of sentiment regards emerging economies – and some high frequency indicators suggest the recession may be nearing its end – the implementation of much needed reforms to durably restore policy credibility is subject to risks”

This presently appears 'all to true' with the likelihood that such reforms – especially pensions and benefits - will be harder to implement than academically perceived given the social tensions that exist amongst the lower middle and poor regards the aftermath effects of the public indebtedness created by World Cup and Olympics projects (such as rising public transport costs) and now the fear of impacted state-provided incomes for OAPs and the increased number of marginalised people.

It is for these reasons – and especially the fragility of the inter-connected EM economies, much reliant on China - that investment-auto-motives previously implicitly and explicitly highlighted the need for Brazil (and the Latin American region en mass) to encourage greater trade with the USA , Europe and the UK.