Central Bank expected to weigh in on Brazil’s enhanced fiscal risk

central bank brazil fiscal risk Central Bank building (right), next to the headquarters of federal bank Caixa. Photo: Muffato/Shutterstock

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Today, we cover markets’ expectations around the latest meeting of Brazil’s Central Bank Monetary Policy Committee. How airlines are managing to survive without a government bailout. And the broken promises of 2020 IPOs. 

Market awaits a sign from the Central Bank

Later today, the Brazilian Central Bank will announce its decision on the country’s Selic benchmark interest rate.

The consensus among analysts is that the pandemic and sluggish economy will hold the rate at its current level of 2 percent a year, which is already an all-time low. Beyond the decision about the rate itself, markets want to see what the Monetary Policy Committee will say about the country&#8217;s fiscal risk and the outlook for potential future interest rate changes.</p> <p><strong>What is happening.</strong> Unease about Brazil&#8217;s fiscal situation is growing, as the country&#8217;s debt levels shoot up due to the massive spending required to offset the effects of the pandemic. Relief programs have topped USD 107 billion, or 8.4 percent of GDP. Bloomberg <a href="https://www.bnnbloomberg.ca/investors-rebel-against-brazil-s-rich-nation-approach-to-crisis-1.1513614">reckons</a> it as &#8220;more like the massive stimulus packages engineered by the world’s wealthiest nations than those cobbled together by Brazil’s junk-rated peers in emerging markets.&#8221;</p> <ul><li>Investors demand higher premiums to keep public bonds, which has pressured the local fixed-income market.</li><li>Recently, Central Bank authorities said fiscal risk could drive interest rates up.&nbsp;</li></ul> <p><strong>Give me a sign.</strong> According to economist Camila Abdelmalack, of Veedha Investimentos, neither investors nor the Central Bank expect a quick debt reduction, &#8220;but rather a concrete plan to tackle the issue in 2021.&#8221;</p> <ul><li>As things stand, Brazil&#8217;s interest rates are not expected to rise before H2 2021. But that outlook could change depending on what the Central Bank says in the minutes of its latest policy meeting.</li></ul> <p><strong>Well-behaved inflation?</strong> Central Bank analyses use the IPCA consumer price index as its <a href="https://brazilian.report/business/2020/08/10/interest-rate-two-brazilian-inflation-rates-during-the-pandemic/">inflation</a> bellwether. The IPCA has consistently remained below the government&#8217;s 4-percent target in all readings. However, the index does not tell the full story.</p> <ul><li>Food prices have <a href="https://brazilian.report/business/2020/09/09/food-inflation-triggers-warning-for-brazil-bolsonaro/">skyrocketed</a>, something especially detrimental to Iow-income families. The INPC index — which measures inflation for households earning up to five times the minimum wage — peaked at 0.87 percent in September, the highest for the month since 1995.</li><li>IGP-M — used to adjust energy and telephony tariffs, health insurance premiums, and property rental prices —&nbsp;has spiked nearly 18 percent in the past 12 months.</li><li>IPP — inflation on producers — is up 13 percent over the past 12 months.</li></ul> <div class="flourish-embed flourish-chart" data-src="visualisation/4159474"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <p><strong>A problem for tomorrow.</strong> Ms. Abdelmalack explains that food inflation is being driven by a shock in supply — as producers are cashing in on surging exports, which are even more profitable as the Brazilian Real has lost ground against the U.S. Dollar. That is not something the Central Bank can act upon. She believes it is unlikely that producers or landlords will jack up prices in the current state of the economy. However, “if activity picks up, a stagnant inflation could shoot up. That is something to keep an eye on.”</p> <hr class="wp-block-separator"/> <h2>Without stimulus, Brazilian carriers find solutions on their own</h2> <p>Trying to improve its cash flow, Azul Airlines (Brazil&#8217;s third-largest carrier) issued BRL 1.6 billion (USD 280 million) in convertible bonds this week, becoming the latest Brazilian airline to go to the market for funds instead of accepting a bailout package proposed over 6 months ago by the government-controlled National Development Bank (BNDES).</p> <p><strong>What is happening.</strong> The airline sector was among the worst-hit by the pandemic, with nearly all passenger planes grounded at one point of the year. Still, the BNDES and airlines do not see eye to eye when it comes to the conditions for the aid package. By issuing convertible bonds, Azul reportedly managed to avoid a more significant equity dilution — and will have more freedom to use its newfound money as it pleases.</p> <ul><li><strong>Azul.</strong> In August, the company sold a 6-percent stake in carrier TAP Portugal for EUR 10.5 million. Azul, however, still holds TAP bonds amounting to EUR 101 million, giving it a more comfortable situation than its peers.</li><li><strong>Latam.</strong> The company is under Chapter 11 bankruptcy protection in the U.S., and managed to get a USD 2.45-billion refinancing program <a href="https://www.barrons.com/news/latam-wins-approval-for-2-4-bn-financing-01600467908">approved by courts</a>.</li><li><strong>Gol.</strong> Brazil&#8217;s largest airline reached a deal with frequent flyer program operator Smiles to get BRL 1.2 billion (USD 210 million) through advance ticket purchases. However, the deal will end up in the courts. Smiles is controlled by Gol, and minority shareholders believe the controller failed to meet its fiduciary obligations in advancing purchases.</li></ul> <p><strong>Ballooning debts.</strong> Fuel and other core expenses for airlines are traded in U.S. Dollars. But with the Brazilian Real continuing its rout in 2020 — losing 40 percent against the greenback — this adds pressure to an already challenging situation.</p> <p><strong>What lies ahead.</strong> Hope for a recovery of the air travel sector fades by the day, as Europe struggles with a second coronavirus wave, and new lockdowns become more probable.</p> <ul><li>According to their Q2 earnings reports, Gol and Azul have BRL 2.8 and 2.3 billion in cash, respectively. However, they are incurring daily losses of BRL 12 and 3 million.</li></ul> <p><strong>Interest rates.</strong> Low interest rates increase companies’ appetite for raising money in the market, either through initial or follow-on public offerings, or debt issuance. Right now, Azul bonds are paying investors a 7-percent premium, way above the 2-percent Selic rate. If (or when) the Selic rate goes up, “companies will have to pay higher premiums,” says Pedro Galdi, an analyst at Mirae Asset.</p> <hr class="wp-block-separator"/> <h2>IP-Oh My God!</h2> <p>2020 has certainly been <em>the</em> year for companies to go public: from the biggest IPO in history —&nbsp;by <a href="https://www.morningbrew.com/daily/stories/2020/10/25/jack-ma-talks-ant-group-ipo">Chinese fintech Ant</a>, valued at USD 300 billion-plus — to Brazil&#8217;s very own IPO frenzy. This year, 19 homegrown companies went public, more than any other year in history. Figures could have been bigger if it weren&#8217;t for the pandemic, which forced many players to postpone their plans.&nbsp;</p> <ul><li>New data compiled by fintech C6 Bank shows that quantity is, by no means, quality. Of the 19 new companies in the <a href="https://brazilian.report/business/2020/08/07/economy-pandemic-wealth-stock-markets-wealth-nations/">stock market</a>, only four outperformed the Ibovespa benchmark stock index.</li></ul> <p><strong>Why it matters.</strong> Poor performance, according to experts, suggests that companies were not mature enough at the time of their IPOs.&nbsp;</p> <p><strong>Investor behavior.</strong> Moreover, the unwillingness of Brazilian investors to put their money in new players is testament to how conservative the local market remains.&nbsp;</p> <ul><li>Main street investors are just now discovering the ups and downs of high-risk assets — and tend to opt for more consolidated players when selecting their portfolio. &#8220;In moments of pessimism, investors tend to demand higher return margins due to an enhanced perception of risk. [Stock] prices are always pegged to perceptions,&#8221; says advisor Lucas Taxweiler, <a href="https://6minutos.uol.com.br/mercado-e-dolar/saldo-dos-ipos-por-que-somente-4-das-19-novatas-tiveram-desempenho-melhor-que-o-do-ibovespa/">quoted</a> by 6 Minutos.</li></ul> <hr class="wp-block-separator"/> <h2>What else you need to know today</h2> <ul><li><strong>Vaccine. </strong>House Speaker Rodrigo Maia called upon Congress to debate whether a Covid-19 vaccine should be made mandatory once available. &#8220;We can leave room for the Supreme Court to once again decide,&#8221; he told reporters. With the <a href="https://brazilian.report/podcast/2020/10/21/podcast-electoral-calculations-around-covid-19-vaccine/">exclusion of the Chinese CoronaVac</a> (which is being tested in São Paulo) from the National Immunization Program, there is no guarantee that the most-advanced vaccine so far will be made available outside of São Paulo — which worries local administrators about the possibility of social unrest.</li><li><strong>Credit.</strong> Brazilians&#8217; use of savings to pay for mortgages jumped by 10 percent in September, reaching an all-time record of BRL 12.9 billion. In the first nine months of the year, loans for buying and building properties in Brazil jumped by 44 percent, to BRL 78.8 billion — overcoming 2019 results. During the pandemic, Brazilians started saving more.</li><li><strong>Elections.</strong> Nationwide, at least 20 <a href="https://brazilian.report/podcast/2020/06/18/covid-19-pandemic-brazilian-elections-more-exposed-fake-news/">candidates for municipal office</a> have died of Covid-19. However, without specific norms banning candidates from promoting public events with voters that may cause crowds, many candidates are disregarding health recommendations and packing their political events. That is particularly the case in small cities, where meet-and-greet campaigning continues to be crucial.</li><li><strong>Financial aid. </strong>One of President Jair Bolsonaro&#8217;s marquee campaign promises in 2018 — a 13th annual installment of the <a href="https://brazilian.report/power/2018/10/26/bolsa-familia-brazilian-elections/">cash-transfer program Bolsa Família</a> — could be short-lived. Paid out by the administration last year, it risks disappearing in 2020, as the Economy Minister says it has not been included in the budget. To ensure the payment, the president would have to sign a provisional decree or propose a new law.</li><li><strong>Violence.</strong> The Superior Electoral Court will send federal troops to seven states in the North, Northeast, and Center-West regions. They will help ensure the safety of the municipal elections in 345 cities. The court mentioned that these areas have a history of political violence and feeble police forces. We showed in <a href="https://brazilian.report/newsletters/brazil-daily/2020/10/27/vale-mining-giant-makes-last-step-to-becoming-a-true-corporation/">yesterday&#8217;s Daily Briefing</a> that authorities are increasingly worried about the influence of organized criminal groups on this year&#8217;s election.</li><li><strong>Human Rights.</strong> The Inter-American Court of Human Rights convicted Brazil for not protecting the rights of 64 victims (including 22 children) and six survivors of the explosion of a fireworks factory in Bahia which occurred in December 1998. The court established that the Brazilian state must pay USD 60,000 in reparations to each of 100 family members of the victims. The trial happened in July, but the decision was published this week.

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