According to Cristiano Romero from Valor Economico, the possibility of Brazil suffering the effects of a “perfect storm” in the coming months has significantly increased in recent weeks.
“This storm would be the result from the US starting to ease its monetary-stimulus policy and the downgrade of Brazil’s sovereign credit rating.”
Here’s a summary of his opinion:
In the first case, there is nothing to do. In September, the Federal Reserve signaled it could start tapering stimuli in the first quarter of 2014. The decision was always conditional on the unemployment rate performance.
… data have led the market to believe the Fed may anticipate the tapering of its monthly purchase of assets. That expectation has shaken the markets, causing another round of dollar appreciation.
The effect of this process on economies like Brazil is not entirely predictable, but it’s already known that the real would fall against the dollar, as it has been happening since May, when the Fed started talking about tapering. Unlike other turmoil periods, when the real fell sharply to then recover all its losses, this time it’s unlikely that the Brazilian currency will return to previous levels. One reason is that terms of trade – the difference between export and import prices – which benefited the country between 2004 and 2010, thanks to the Chinese economy’s boom, are not so favorable.
There are already bets the greenback will rise again to R$2.45, the record high in 2013, before the year’s end.
The increase in US interest rates is likely to redirect capital flows. Investors tend to have higher risk aversion and, therefore, to focus on investing in US bonds. Countries that don’t have their fundamentals in good standing will suffer a larger outflow of funds.
There is a risk of Brazil having its sovereign credit rating downgraded as the tapering starts. It would be an explosive combination. The downgrade is already embedded in price assets; the loss of investment rating is not. But if an agency downgrades the country and sets a negative outlook for it, the market will be sure of this investment downgrade, which will be reflected on prices.
The worsening of perception on Brazil is clear.
The main reason for this worsening perception is Brazil’s fiscal policy. It is important to say that the country is not on the brink of insolvency. The problem is that, in addition to strong growth in gross debt and nominal deficit in the last three years and credibility loss of fiscal management, the government has taken steps that lead to future imbalances.
Two examples on this ground are conclusive: a retroactive change in the index of states and municipalities’ debts, to allow new borrowing, and the measure that frees the Union to cover the primary surplus of federal entities when they don’t meet their targets.
The behavior of CDS clearly shows the market is discounting to present values the medium-term fiscal deterioration.