Brazilian economy scenarios and prospects

Gustavo Arruda - BNP Paribas

“Brazil needs to get closer to the global economy”

Gustavo Arruda is Director of Research for Latin America at BNP Paribas and holds a PhD in Economics, a Masters in Macroeconomics from São Paulo School of Economics (EESP-FGV) and a degree in Economics from the University of São Paulo (FEA-USP).

Arruda is located in Sao Paulo, Brazil, and coordinates a team of economists and strategists in Latin American countries that provides forecasts, analysis and insights into the region’s economies and markets, supporting the trading desks and interacting with investors and international press.

BNP Paribas S.A. is a French international banking group, the largest bank in Europe and rancked seventh largest bank in the world by total assets; was formed through the merger of Banque Nationale de Paris (BNP) and Paribas in 2000.

AgriBrasilis – What is the role of BNP Paribas in Brazil and Latin America?
Gustavo Arruda – We believe in Latin America where we have a local presence in several of its countries. As a matter of fact, Brazil headquarter is celebrating 25 years as a full banking license. The Latin American hub is here.

We are in countries such as Argentina, Colombia and Mexico. In Mexico, we recently opened up as a full licensed bank.
We focus on helping foreign investors to invest locally, being their eyes in Brazil. We also concentrate in European companies that wish to or already invest here.

Two examples of the group’s confidence in Latin America: last year’s capital increase in Brazil to guarantee assistance to clients during the crisis, and Mexico´s bank opening.

AgriBrasilis – How does the bank operate in agribusiness and what is the importance of this sector for the bank?
Gustavo Arruda – Regarding agribusiness, we are very concerned with exporting companies that work with commodities, especially in regards to ESG.

The sustainability agenda is an important innovation that the bank has brought in. We work closely with commodity goods customers to help transition towards sustainability.

It is often difficult for the company to understand where to go. Many talk about ESG, sustainability, but how to make this transition? That’s why our research area also works in sustainability, not only in the environmental area, but also in the socioeconomic one.

BNP came from Europe aiming to be recognized for its concern with sustainability both in power generation, in the production of goods and commodities.

AgriBrasilis – In the short term, what economic scenarios would you describe in view of Covid-19, inflation, exchange rate devaluation, unemployment …?
Gustavo Arruda – We will have to live with Covid. The expectation that it would end, that the variants would stabilize, did not materialize. But global vaccination is proving effective, which makes the economy more confident to reopen.

There will still have volatility, regions with punctual increases in infection or countries with delayed vaccination status. These can hinder growth. But we are clearly went through the worst moments. The global economy is strong.

Recent numbers published by us were positive. Growth comes with help from governments: support similar to Brazilian emergential aid; credit guarantees for companies in an attempt to eliminate the problem of bank lending; loan percentage guarantee; lower interest rates in the world, particularly in developed countries, which did not have much pressure to act.

In developed countries, there will be measures if there are signs that the economy is slowing down. If Europe slows down earlier, we will see the German government spending, announcing projects to maintain growth. In the United States, the same pattern: The Federal Reserve only takes away incentives if the economy remains stable.

Even in China you can see the government supporting, stabilizing and maintaining growth.

Another issue is inflation. Brazil is not alone, but the difference is the level which has reached 10%. In some countries there is accelerated inflation, but not like ours.

Commodity prices fell during the crisis and are now accelerating again, so there were inflation here and around the world.

Several companies partially closed during the crisis, delaying an entire production chain in progress. In this case, it was thought to be quick to solve, but it is still far from resolution. We estimate that it will not normalize until the second half of next year. There is still time until prices rise up.

The global economy recovery was faster than imagined when governments were still creating its policies. This put pressure on inflation. We have seen emerging countries, such as Brazil, that are not comfortable leaving interest rates at a standstill.

We have “less anchored expectations”. People abroad have the perception that inflation will return down to 2%, they adjust prices and contracts taking in consideration this percentage.
In emerging countries, we have a recent history of inflation. It is different from the United States, Europe and other countries, asking for incentives and low interest rates, with increased inflation.

In Europe, the result was positive because they were seeking for that 2% inflation rate in which they were not able to reach earlier. While in Brazil, Chile, Mexico, Russia, South Africa, Colombia, everyone is raising interest rates thinking “We did what we could. It’s time to revert”.

AgriBrasilis – Can a double digit inflation bring back uncontrolled increasing prices and rising interest rates?
Gustavo Arruda – We don’t believe in lack of control, but in delaying the fall.

Brazilian government is trying to bring inflation closer to that of other countries. We’re looking for 3%. Inflation hitting 10% this month generates a chain effect of delayed inflation slowdown.

In similar cases, we’ve seen an aggressive Brazilian Central Bank, rising interest rates often and fast. Central Bank is trying, but should be swift to increase the same level of interest rate, but at a higher speed.

People get used to it. They don’t look at the Central Bank’s inflation target but look back: “I know the government is talking about 3%, but last year it was 4.5%, the previous year it was 4.3%, this year it will be 9%. Hard to go to 3% next year. And my costs are increasing”.

We will likely see a slow downturn. This is not what the Central Bank wishes, because the longer it takes to bring inflation down, the greater the risk.

We saw breakdowns this year and nothing assures next year will be different. But we don’t see lack of control. The government, among challenges with regard to tax, has reduced incentives. We have discussed the price ceiling often. It is an indication that the law is working. Unemployment is still high, so it’s hard to imagine an inflation spiral that keeps growing.

AgriBrasilis – What actions or measures do you consider important for a consistent economy recovery?
Gustavo Arruda – We entered the election period, that hinders reforms. Some we debated for decades without consensus. It won’t happen for the next 12 to 18 months.
Tax reform would be important, it implifies processes. Brazil needs to get closer to the global economy. Foreigners have difficulty in understanding how taxes work in Brazil.
Additionally: balance between fiscal policies, assistance for low-income people, health education policy, the size of the civil servants, and the amount of tax that the population is willing to pay.

We have a high tax burden. But if we are going to cut taxes, we must cut government spending.
There is a lot of discussion today about administrative reform to define what civil servants can do and their earnings. It is a difficult task, but it would be fundamental for Brazil.
Critical issues of success: we carried out a robust pension reform. Pensions have high costs. But the process took almost 3 years of discussion.

AgriBrasilis – The US-China dispute did not cool down with the Biden government. What advantages and opportunities appear for Brazil?
Gustavo Arruda – It’s a challenge and an opportunity. Trump-era clashes between China and the United States were aggressive and open. Even with Biden, it is a dispute for hegemony between powers with huge GDPs, that at the same time depend on each other.

In the Trump government, Brazil benefited from the commodity goods with high prices. And with the Chicago award, that kind of tension eases.

Regardless, Brazil consolidated itself in the global commodity markets and will continue to be a focal point for exports, production and technology.

Brazilian agribusiness crossed several barriers that we see in other sectors of the economy. It is the sector with highest productivity growth. It develops not only the end-activity, but the whole related sector.

We must pay attention to the effects of our hegemonic position in the commodity market. There are side effects that can be exploited, rather than focusing on developing where we are not competitive.

AgriBrasilis – What led the bank to suspend credit for companies related to deforestation? How important is ESG to the bank?
Gustavo Arruda – It’s a decision to do more for the world. We want customers to see us as a starting point in the transition the world needs to go through, be renewable energy or agricultural production.

BNP has ceased some businesses, and have been helping other sectors interested in transitioning. It will not always be profitable in the short term, but this is the way to go. Some will make this decision sooner, others later. BNP decided to do this much earlier than most banks.

AgriBrasilis -What about the future of exchange rate?
Gustavo Arruda – In the economy, the exchange rate worries people. The rate was R$ 1.50, set to R$ 3, to R$ 4, and to R$ 5 … Commodities have come a long way. Usually, when commodity prices increased, our currency appreciation would also increase, but it didn’t happen.

There is a challenge we see with our clients, in particular long-term investors, which is to know how to perform, if they hedge their position or protect themselves in general. We have a team that looks at exchange rates here and they think that in Brazil it should be more valued.

Regarding the dollar, it was around R$ 5.30, but it should be closer to R$ 5, R$ 4.90, because we have higher interest rates, and this helps in the composition of the currency. When investors think about where to allocate the money they have from savings, they think about interest versus exchange. If the interest rate in Brazil is similar to the United States, client will probably prefer it in dollars. With higher interest rates, it is different.

Another aspect is the price of commodities (terms of trade), which is the price of what is exported against what is imported. It’s also high and that should cause our currency to move.
Turbulent political environment raises investor doubts, impacting the currency, generating volatility and depreciation. To the exporter, it’s satisfactory. To the importer, it is a challenge to make the business viable.

We imagine the exchange rate will converge to R$ 5 at the end of next year, but there is still pressure for a while. The risk of this scenario is what leads to a bigger change, such as a potential slowdown in China, when iron ore prices dropped from 220 to 100 and now slowly returns.

We are less concerned about that. Our team believes that should the Chinese economy significantly slow down, for example, the Chinese government will act to stabilize. It is always a controlled drop, which limits this risk on the downside for the Brazilian currency and even for the brazillian growth.

AgriBrasilis – What is the perception of foreign investors in relation to Brazil in the long run?
Gustavo Arruda – Investors have difficulty in understanding our domestic policy, but stay in Brazil. It is an important country for the portfolio, but we need to settle down institutions.
Global liquidity is high. The investor has money, looks for opportunities and is not difficult to find. Brazil has everything to do: privatization, concessions of ports, roads, railways, airports, 5G, and so on. Money is interested in getting here.

Investors compare Brazil with other emerging countries that also have volatility and political noise, high exchange rates and inflation.

For example, Chile was thought to be a stable country in Latin America, but a year ago people were seen in the streets, and they are rewriting the Constitution. In other words, volatility is part of it. Brazil needs to be more predictable to develop further.

In other words, volatility is part of it. Brazil needs to be more predictable to develop further.