Hello, hello, how low?

In spite of the deteriorating fiscal situation, interest rates in Brazil continue to go down. Is the impending “consumption based recovery” set to change it?

Warnings on the poor quality of the Brazilian fiscal adjustment never stop coming. Reforms are losing momentum; fiscal targets that once seemed pessimistic become unrealistic (and need to be lowered). In the foreseeable future, there will be no primary surpluses (the most likely scenario is that only after two presidential elections will Brazilian fiscal accounts be positive again; this is not foreseeable future).

Brazil is one of the few big economies in the world that still remunerates the effort of resisting the temptation of immediate pleasures. For the wrong reasons, it must be said.

All that in a context of unusually high political uncertainty, which Bluming Thoughts does not believe will be resolved after the 2018 elections. There is a non-negligible risk that one of the most competitive contenders lose its right of being elected after winning the elections, to start with. Still, money keeps pouring in: financial investors are aware of all the confusion, but the attractive interest rates in Brazil still “forces” them to look the other way.

If global interest rates are set as zero, or very close to that, time has lost its price. In other words, money holders have been given the sign that waiting is worth nothing. Money wants return, and it wants it now. If borrowing has no cost, why worry about something that may only happen in the future? Money goes wherever there is immediate return. If risk shows up, everyone can always try to be the first one to sell (knowing that Central Banks will be willing to buy, ultimately).

Brazil is one of the few big economies in the world that still remunerates the effort of resisting the temptation of immediate pleasures. For the wrong reasons, it must be said. The country simply cannot save. In spite of the hiccup in 1Q17, domestic savings still stand as low as 14.4% of GDP. The few people willing to put some money aside for the future end up benefitting from the existence of a large government that not only cannot invest but also needs to borrow for its own consumption. Brazilian society chose the State as the main performer of income transfers in all kinds of way (from entitlement programs, as the Bolsa Família, to subsided loans from the BNDES). The flipside is that whoever is not benefitted has to face the high price of the remaining (and scarce) pool of savings. Interest rates are thus so high in Brazil.

Let’s for now just assume that interest rates will not normalize on a global basis in the next two years (two long of a financial investment horizon for Brazil). As long as foreigners keep buying Brazilian assets, the BRL will continue to appreciate, providing some kind of anchor to inflation, so it is said. Provided that inflation stays low, the BCB will see no constraints for keeping up with the Selic cuts. And as long as real interest rates remain positive and falling, fiscal threats may be temporarily tolerated (supported by the delusive speech of “at least now things are going in the right direction”). One could wonder if Brazil is finally embarking on the global low inflation trend and becoming as “normal” as those countries that do not need to remunerate savings.

The issue is that, unlike the US, Europe or Japan, Brazil has not gone through a major credit cycle yet. In that first group of countries, low interest rates – and the expansion of Central Banks’ balance sheets – have been a form of bailing out banks that overstretched their lending capacities. True: Brazilian public sector banks were abused as countercyclical tools. But the process has been much smoother. Luckily enough, no banks had to be officially bailed out. So much so that, after only two years, the deleveraging process already gives signs of stalling: credit/GDP has fallen from a peak of 53% in late 2015 to be now hovering around 48% since the beginning of this year.

However, the rebound in credit is coming exactly from credit to consumption. Some may hail it as the beginning of a consumption driven recovery. Although an investment boom would be preferable, it is going to be a recovery anyway, right? Yes, but there are reasons to curb the enthusiasm. The government has not been able to restrain its own expenses and investments are not picking up. More household consumption should not come free of trouble. In this scenario of consumption coming from all the sides, domestic savings should fall, not rise. And all time low domestic savings rates disagree with all time low interest rates. One of them will have to change. Any guesses to which one it is going to be?

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