OECD Economic Outlook, Volume 2020 Issue 1

Brazil

The economy was finally recovering from a long recession when the COVID‑19 outbreak hit, and is now projected to suffer a further deep recession. GDP is expected to fall by 9.1% in 2020 in the double‑hit scenario, which assumes that a second wave of the pandemic will take place in the last quarter of 2020, and 7.4% in the single-hit scenario, which assumes there are no further outbreaks. As lockdown measures are eased and activity resumes, the economy is projected to recover slowly and partially, but some jobs and firms will not be able to survive. Unemployment will reach historic highs before receding gradually.

The economic policy response was timely and decisive, making a real difference for millions of vulnerable households, including those without formal employment and social protection. This support should continue for as long as the pandemic restricts earning opportunities. At the same time, the limited fiscal space, exacerbated by the COVID19-related increase in public debt, calls for keeping the fiscal response temporary, and resuming efforts toward improving fiscal sustainability and public spending efficiency afterwards. An exception to this should be the welcome funding increase for conditional cash transfers, which can be the pillar of a more effective social safety network, including for those not covered by unemployment insurance in the formal sector.

Local lockdown measures are in place, but the pandemic is still spreading rapidly

Brazil recorded the first COVID-19 case in late February. Reported infections surpassed 500 thousand in late May. Deaths are increasing rapidly, with daily fatalities still trending upward. While the city of São Paulo was the initial epicentre of the outbreak, the virus has now spread around the country. Capacities in intensive care units (ICU) are estimated at 15.6 ICU beds per 100 thousand inhabitants, but there are serious shortages in some regions, including the northern and north‑eastern regions. The public healthcare system, on which two‑thirds of Brazilians depend, is under particular strain. Intensive care capacities have been almost fully occupied in some states since early May, and waiting lists have formed.

Brazil: Two scenarios of real GDP and confidence

Source: FGV; CEIC; CNI; OECD Economic Outlook 107 database; and Refinitiv.

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Brazil: Demand, output and prices (double-hit scenario)

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Brazil: Prices and exchange rate

1. The ex-ante real interest rate is calculated as SELIC rate minus inflation expectations one year ahead.

Source: CEIC; Central Bank of Brazil; and OECD Economic Outlook 107 database.

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Brazil: Demand, output and prices (single-hit scenario)

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The central government has not taken any coercive lockdown measures. By contrast, state and municipal governments have introduced them since 20 March, including closing shops, schools and beaches, in addition to cancelling public events. Distancing measures are currently in place in all of Brazil’s 27 federative units. Land borders have been closed and entry by air from many countries has been restricted to returning nationals and residents.

Economic activity is declining amid deteriorating external financing conditions

Early indicators of activity and demand point to a sharp contraction since the beginning of the lockdown measures. Confidence and purchasing manager expectations have fallen sharply, while an early indicator of retail sales based on payment card transactions suggests average declines of 30% between 1 March and 30 May. Particularly pronounced drops in activity have affected air transportation, tourism and hospitality, but many informal activities also shut down as public life has come to a halt in large parts of the country. OECD benchmark estimates suggest a decline in activity of around 20% during the lockdown. Turbulence in international capital markets affected Brazil before economic activity started to decline, as international investors sought safe haven assets and portfolio outflows soared. This put significant pressure on the exchange rate, equity prices and sovereign spreads. Prices of exported commodities have seen a minor decline since the beginning of the year, driven by sharp declines in oil prices, but largely compensated by rising agriculture and mineral prices.

A sizeable policy reaction supports the most vulnerable

Fiscal policy responses to the pandemic have been bold and sizeable, with a total fiscal impact exceeding 6% of GDP and a strong focus on the most vulnerable groups, including informal workers. Monetary policy support has taken the form of two rate cuts of a joint 125 basis points, combined with prudential and regulatory measures that would allow additional credit extension of up to 17% of GDP.

Income support measures for low‑income workers (2.9% of GDP) have included a new temporary emergency benefit of USD 120 per month for informal or unemployed workers earning less than half the minimum wage. The benefit is doubled for single parents and, as a side‑effect, it has led to significant progress in expanding access to basic banking services. Over 50 million benefit claims have been paid out. Conditional cash transfer programmes have received resources to enrol 1.2 million of additional beneficiaries. A new short-time work scheme with public income support from unemployment insurance will compensate income losses of formal workers and alleviate wage costs for employers in exchange for job guarantees. Temporary exemptions from certain labour regulations, the possibility to advance annual leave and other measures will create further flexibility in working hours for firms.

Policy support for SMEs (1.4% of GDP) includes a low-interest credit line to cover wages for employees earning up to two-times minimum wages, with 85% of the credit risk borne by the federal government. Additional new corporate credit lines will be created by the national development bank. Tax liabilities and other charges on firms are being postponed, with a particular focus on SMEs. The government has pledged to cover the first 15 days of sick leave for infected workers. Finally, direct spending on health and transfers to states and municipalities, who bear the primary responsibility for financing public healthcare services, has been increased by 2% of GDP.

The economy is entering a deep recession

Economic projections assume a gradual easing of most local lockdown measures in the first half of June. GDP is estimated to have declined sharply in the second quarter, with an only gradual and partial recovery by end‑2021. The economy is projected to contract by more than 9.1% during 2020 in the double‑hit scenario, which assumes a second lockdown in Brazil at the end of the year. The recovery in 2021 would be moderate in this scenario, with projected growth of 2.4%. The unemployment rate will rise to a historic peak of 15.4% during 2021 in this scenario. A higher fiscal deficit will add at least 10 percentage points of GDP to gross public debt, which will exceed 90% of GDP at the end of 2020. In the single‑hit scenario, the economy is projected to contract by 7.4% during 2020, followed by an expansion of 4.2% in 2021. Public debt will rise to almost 90% of GDP by end-2020. Against the background of job losses, lower hours worked and significantly reduced earning possibilities for self-employed workers, private consumption and investment are projected to drive the downturn, albeit mitigated by the policy response. Estimates suggest that the hit to private consumption could have been some 2‑3 percentage points higher, on an annual basis, in the absence of emergency income support measures.

The market reaction to deteriorating fiscal accounts entails significant risks. Interest rates have recently declined on the back of improving fiscal prospects, but this could reverse if confidence about a resumption of this trend after the crisis were to fade. Strong portfolio outflows from Brazil and other emerging markets have foreshadowed possible adverse events in global financial markets. With almost 90% of gross public debt held by domestic residents and 95% denominated in domestic currency, risks are lower than in the past for sovereign debt, but Brazilian corporates have accumulated significant foreign‑currency liabilities over recent years. To what extent these are hedged is hard to ascertain. Currency reserves of 18% of GDP and a dollar swap‑line with the US Federal Reserve provide significant dollar liquidity, and act as a cushion against external risks.

The fiscal response should be temporary to preserve recent progress

The COVID‑19 policy response has helped to limit the permanent scars inflicted by the pandemic, and should be continued as long as the effects of lockdowns weigh on economic activity. However, the additional spending measures should be kept temporary and attempts to slip in additional expenses that are not related to COVID‑19 should be resisted. Potential negative confidence effects and higher interest rates could be avoided by combining needed extra spending in 2020 with structural measures that strengthen spending efficiency and the credibility of the medium‑term fiscal consolidation planned prior to the COVID‑19 outbreak. This could be achieved by legislating measures, such as a public administration reform comprising civil servant pay, or an ambitious reduction of ineffective subsidies and tax exemptions, while implementing them only as of 2021. With inflation declining and firmly below target, monetary policy has some limited room left to support the economic recovery with lower policy rates and continuous liquidity support.