Brazil: political turmoil, tax reform and rate hike

Markets summary

Brazil - Latin America’s largest economy, following a turbulent period brought about by the coronavirus pandemic, is seemingly on track to recovery.

A long-awaited vaccination programme, whose success is to-date unknown as millions have missed their second doses of Covid-19 vaccine, further complicating a campaign already flawed by supply shortages, is under-way. Albeit the latter mishaps and the incessant decline in infection rate, business activity – previously dragged by services, is recouping.

The latest composite PMI reading - an indicator of economic health for manufacturing and service sectors, pointed to an almost stabilisation, amid the fifth straight month of contraction, underpinned by growth in the manufacturing sub-sector and a softer drop in service activities.  

Notwithstanding the recent economic optimism and Bolsonaro’s efforts to deliver on his electoral promises, political turmoil remains.

Political pressure on Bolsonaro mounts as inquiry continues

A congressional inquiry into the government’s response to the pandemic is heightening political pressure on President Jair Bolsonaro.

At the end of April, the Senate initiated an investigation into Jair Bolsonaro’s controversial handling of the pandemic - often prioritising the economy at the expense of health, which is hurting his approval ratings for the upcoming general elections, scheduled to be held in October 2022. The inquiry could pave the way to Bolsonaro’s impeachment, which, although plausible, remains highly unlikely.

The official senate committee’s attention now turned to a contract worth R$1.6 billion, equivalent to $320 million, to purchase 20 million doses of Indian-made Covaxin, which is turning into a major political headache for Bolsonaro. A point of scrutiny is the price agreed for the Covaxin shots, which at $15 per dose is considered to be more expensive than others bought by Brazil. Questions are also being raised on the role a company, acting as a middleman, played in such contracts, and why contracts with Covaxin were signed ahead of deals with other manufacturers, although the shot had not yet completed late stage trials.

In opinion polls, Jair Bolsonaro trails former president Luiz Inácio Lula da Silva, expected to run in the 2022 election. Former leftist president Lula da Silva was set aside after having criminal convictions for corruption.

A less ambitious tax reform proposal

Amid intense political pressure as the presidential election looms large, President Jair Bolsonaro is seeking to introduce reforms that were promised in his presidential campaign.

Albeit less ambitious than originally planned amid changes ordered by Jair Bolsonaro, a long-awaited proposal to overhaul Brazil’s income tax system was made. The proposal, which was delivered by Economy Minister Paulo Guedes to Congress in recent days is part of a broader plan to simplify a system deemed as one of the world’s most complex.

While the reform pledges to not increase the overall tax burden, it is expected to bring in 1.8 billion reais, equivalent to $365 million, to government reserves over the next three years. Amongst the changes proposed, Bolsonaro proposed; a 20 per cent tax on dividends (but exempted small enterprises), a tax deduction for expenses related to healthcare and education, and a reduction in corporate taxes to 10 per cent from 15 percent.

Paulo Guedes – Minister of the Economy in the Bolsonaro administration stated that the proposed tax overhaul shall reduce taxes for more than 30 million Brazilians.

Inflation figures points higher

Brazil’s annual inflation rate climbed to 8.06 per cent in May of 2021, the highest since September of 2016, and beating market expectations of 7.93 per cent mostly due to the base effect as prices remained subdued last year due to coronavirus-inflicted movement restrictions. Upward price pressures mainly came from food and beverage, transport, household items, and housing.

On a monthly basis, consumer prices increased by 0.83 per cent – faster than forecasts of a 0.71 per cent increase. 

Inflation fears prompt Brazil to lift rates

In response to inflationary pressures, Brazil’s central bank raised its benchmark interest rate by a further 75 basis points, to 4.25 per cent. The third interest rate hike in 2021.

The Monetary Policy Committee (Copom) - the body of the Central Bank, which defines the basic interest rate of the economy, anticipates a similar rise in August to mitigate the spread of current temporary shocks to inflation.

The Copom noted that despite the intensity of the second wave of the pandemic, recent economic indicators showed a stronger-than-expected development.  The Committee also emphasized that its view for its next policy meeting will continue to depend on the evolution of economic activity, the balance of risks, and inflation projections and expectations.


Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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