Country Report Brazil October 2008

Outlook for 2009-10

• Lula will face a much more challenging environment as a deterioration in the economy will expose more starkly weaknesses in his government such as legislative inertia and corruption.
• It is early to make a firm prediction for the October 2010 presidential election, but more difficult economic times seem likely to favour the candidacy of Jose Serra, the opposition governor of Sao Paulo state.
• Policymakers will be focused in the short term on restoring stability in the domestic financial markets. We expect further intervention in the foreign exchange market but the BCB is unlikely to draw down reserves heavily.
• Despite concerns over the pass-through effects on inflation of the sharp currency weakening, we now expect Copom to keep rates on hold in the remainder of 2008 and an easing cycle to start before mid-2009.
• We now project a sharper slowdown in GDP growth next year to 2.7% (previously 3.4%) with a recovery in 2010 to 3.9% (with downside risks, depending on the length and depth of the OECD downturn).
• We now expect the Real to end 2008 at R2.33:US$1 and 2009 at R2.30:US$1 (previously R1.78:US$1 and R1.89:US$1 respectively) before an improvement in economic conditions in 2010 allows a renewed moderate appreciation.
• The current-account deficit will now widen from 1.8% of GDP in 2008 to 2% in 2009, narrowing to 1.8% in 2010. Exports will now contract in 2009.

Monthly review

• The outcome of the October 5th municipal elections brought mixed results for Lula's allies but seems likely to favour Mr Serra's 2010 presidential candidacy.
• The escalation of global financial turmoil has exposed the Brazilian economy's vulnerability to the accelerating process of deleveraging on the part of international investors.
• Volatility not seen since the 2002 Brazilian financial market crisis has thrown the currency and equity markets into turmoil, many credit lines have vanished overnight, and the BCB has been forced to take steps to boost liquidity.
• Many investors scrambled to cover their Real exposure following the disclosure in early October that several Brazilian companies had incurred very large losses in foreign-exchange derivatives.
• The deterioration of the external environment has yet to be felt starkly in the trade accounts, but some signs are emerging.