“Potential twist of fate casts doubt on Brazilian outlook,” writes Citibank economist Leonardo Porto:
“New political instability has the potential to derail ensuing recovery. From an economic point of view, this event can be considered a serious threat for our outlook of Brazilian economy bringing back to the virtuous circle.
“As we have been stressing for a long period, the plummet on inflation since 4Q16 opened the room for the Brazilian Central Bank to initiate a long/deep monetary easing cycle. Given the lack of other policy instruments (fiscal and credit policies largely unavailable at this point) this monetary stimulus is the cornerstone backing our activity outlook of gradual recovery in 2017/2018.
“However, a crucial assumption regarding the adjustment of fiscal accounts was being made in our base case scenario, as we incorporated President Temer’s strategy of approving an ambitious social security reform in Congress. The accusations revealed yesterday by O Globo newspaper, if proved true, removes any governability in the Congress coalition, making the approval of social security reform an unlikely outcome in the near/medium term.
“Therefore, easing the assumption of fiscal consolidation, we should expect a significantly weaker domestic currency, eliminating/reducing the room of interest rate cuts, consequently the virtuous circle scenario currently envisaged for Brazilian economy. At this point, despite being extremely hard to assess not only the magnitude of this shock on macroeconomic variables but also its temporal dimension, it definitely has the potential power of being a game change.”