Brazilian Real Outlook (1-3 Month) – Fiscal uncertainty

On May 22, Planning Minister Nelson Barbosa announced a round of BRL 69.9bn in contingent cuts across most of the main portfolios. According to RBC Capital Markets, the announcement is an important sign that all is not going well with regards to 2015 fiscal targets. Even after the cuts, total spending will reach trl, which is BRL100bn higher than in 2014. This is 2pp above the 8.26% inflation estimate that the budget assumes. 

Moreover, the "new" budget estimate of a primary surplus of BRL 66.3bn assumes a highly unlikely 18.4% revenue growth over last year. This 10pp real revenue growth seems highly unlikely due to the -1.2% growth assumption in the budget itself. Issuance growth of BRL214bn so far this year and a total of BRL 357bn in the past twelve months indicate that the fiscal gap continues to widen in real terms. Roughly 65% of the spending cuts will be on city budgets, health, education, and transport. 

"These spending cuts do not address Brazil's main macro issues, the policy mix that may improve the macro outlook should combine: 1) lower real wages; 2) lower real interest rates in the private sector; 3) weaker exchange rate; and 4) opening the tradable sector", added RBC Capital Markets. 

However, legislation to get these four approved in Congress and Senate makes it nearly impossible. A more realistic approach may combine 1 and 2, through changes in social security payments and interest rate adjustments. These two could eventually trigger 3 and 4.

Lower interest rates in the private sector may be achieved by lowering the reference Selic rate and raising the much lower TJLP rate charged by government-led financial institutions such as BNDES, Banco do Brasil, and Caixa Economica Federal, currently at 6%. Therefore, BCB may cut the Selic rate in H2. USD/BRL will trade above 3.30 and higher from June to the end of 2015, assumes RBC Capital Markets.