Brazil Budget Worries Too Much to Take for Foreign Investors

  • Pensions, payrolls pressure spending while tax income withers
  • Foreigners’ public debt share seen continuing downward trend

QuickTake: Brazil's Economic Instability

A president ousted, another charged, and growth as well as budget numbers in the doldrums -- Brazil hasn’t been easy to stomach for many foreign investors.

The share of public debt that foreigners hold has hit a five-year low as investors prefer not to renew expiring bonds. Non-Brazilians participate less in Brazil’s equity market than they did five months ago and added to bets the real will weaken against the US dollar.

Behind their reticence is an economy still stuttering after two years of recession and public deficits that are widening on disappointing tax revenues, ballooning pension and payroll costs, as well as headwinds in cutting expenses. The government is being forced to abandon its budget deficit targets for this year and next and faces an uphill battle after this month’s graft trial vote to gather legislative support for a bill to slash pension outlays.

"Markets were pricing in some fiscal measures getting passed but the recession has led budget numbers to get even worse," said Win Thin, senior vice-president of emerging markets at Brown Brothers Harriman & Co in New York. "So much can happen between now and then," he wrote in a message to Bloomberg News when asked about the 2018 election, adding that Brazilian assets look rich without sufficient reward for the risk.

Indeed, Brazil’s outlook looks equally muddy. Even among policy makers who met with a Standard & Poor’s delegation, yet another credit rating downgrade looks entirely possible, according to two people who participated in the meeting. Efforts to reduce spending and raise income have run head-on into a rigid budget structure. This year’s obligatory spending has soared 7.3 billion reais ($2.3 billion) above the level initially requested by the government, as civil servant salaries accounting for 27.3 percent of those expenditures leave little wiggle room to cut.

Many foreigners liquidated their position following Brazil’s loss of investment grade, and consequently missed later gains reaped by local investors, according to Edwin Gutierrez, head of emerging market sovereign debt at Aberdeen Asset Management. "Foreign investors need to do a better job of reading the tea leaves," he said in an email.

Still, after billions of dollars in pork-barrel spending unleashed by Temer ahead of a congressional vote that prevented him from facing a corruption trial, the government says it will have to ease its 2017 and 2018 fiscal targets in an announcement scheduled for Monday. The finance ministry wasn’t immediately able to comment for this story.

"We’re currently cautious on Brazilian assets and think that valuations do not reflect the risks of fiscal deterioration," Steve Drew, the head of emerging-market credit at Janus Henderson, said in an email. "With an election looming next year, many investors may just choose to wait for more stability and certainty before any meaningful investments are made."

— With assistance by Mario Sergio Lima, and Rafael Mendes

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