From:
Daniel Sabba
Sent:
9/4/2015 2:31:55 PM
To:
'jeffrey E.'
[email protected]
CC:
Paul Morris
Vahe Stepanian
Ariane Dwyer
Subject:
FW: Faria: Brazil Daily Update ICI
Stewart Oldfield
Richard Kahn'
Classification: Confidential
Relevant Brazil update.
Sy on the run CDS at 384.
USDBRL 3.8485.
My impression is that there is still time to short more, if you are up to it Jeffrey.
original message
subject: Faria: Brazil Daily update
Brazil's economic outlook deteriorates further
According to newspaper Folha de S.Paulo, Finance minister Joaquim Levy told President Dilma Rousseff on
Wednesday that he was becoming increasingly isolated in the federal administration and losing support to
implement his fiscal adjustment plan, and concluded that, under these circumstances, it would be
difficult for him to stay in the government. shortly afterward, Rousseff publicly defended Levy, claiming
that he was not isolated in the government. As speculation about Levy's possible resignation continued on
Thursday, the beleaguered Finance minister cancelled a trip to Turkey (for the G-20 meetings) in order to
have a meeting with Rousseff, Planning Minister Nelson Barbosa, and Chief of Staff Aloizio Mercadante.
We expect Rousseff to repeat that Levy has her total support, and also to send to Congress an addendum to
the 2016 federal budget reducing the projected deficit. Nevertheless, the reality is that Levy has lost a
sequence of important fights in the government (especially the watering down of the fiscal measures, the
change in the fiscal targets, and more recently the 2016 budget forecasting a federal primary deficit of
0.5% of GDP), and his position is becoming increasingly difficult day by day, as he remains under intense
friendly fire (especially from the President's own party, the PT) and Rousseff seems to be having second
thoughts about his fiscal austerity plan. As a matter of fact, we believe Levy has not left yet because
the government fears that his departure could speed up Brazil's downgrade below investment grade, and
because Levy himself knows that his departure would aggravate the crisis.
The impression that we have at this point is that the federal government has indeed abandoned Levy's
fiscal adjustment plan. According to newspaper valor Econ6mico, the government is no longer willing to
cut fiscal spending, believing that it is necessary to use expansionary fiscal policy (including
subsidized loans) to rekindle growth. The authorities believe that, as economic growth picks up, tax
revenues will improve, alleviating the fiscal situation. It seems that the farthest the government is
willing to go to cut the primary fiscal deficit is to raise taxes, "especially on those sectors that
gained the most during the Lula years," preserving its welfare programs. According to newspaper Estado de
Sio Paulo, Rousseff has not given up on the CPMF tax idea, and allegedly wants to convince Congress to
propose reinstating the tax on financial transactions. According to the same source, some congressmen of
the ruling coalition are warming up to the idea, in light of the aggravation of the economic crisis.
However, resistance against the tax remains quite strong in the private sector and opposition, so it
remains to be seen whether Rousseff will manage to muster enough political support to pass it in
congress.
when the Rousseff administration announced Levy's appointment and its fiscal adjustment plans at the end
of last year, we warned that the president began her first mandate in 2011 by tightening fiscal and
monetary policies as well, but eventually gave up on those as growth faltered, promoting a combination of
rapid fiscal and monetary easing that was dubbed the "new macroeconomic matrix." Thus, we warned that
there was a significant risk that history could be repeated in Rousseff's second term. It seems, however,
that the austerity-based strategy is unraveling much faster than we could have expected, probably because
of the convoluted political environment and repercussions of the Petrobras bribery scandal (the "car
Wash" investigation). Under these circumstances, it is hard to believe that the economy will recover if
the government returns to the same populist policies that were mainly responsible for the crisis in the
first place. In the absence of a comprehensive fiscal adjustment and without a significant economic
recovery, the risk is that Brazil might have to generate increasing inflation rates to cope with its
ballooning public debt, a perverse process that we all remember very well from the1980s.
In light of the latest developments, we are updating our macroeconomic forecasts to take into
consideration the higher risks. while our scenario is not one of uncontrolled inflation, it envisages a
much slower economic recovery, weaker exchange rate, and higher inflation. We are optimistically assuming
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