Brazil's economy takes the good with the bad

Demonstrators protest against Brazilian President Dilma Rousseff, calling for her impeachment, in Sao Paulo.
Paulo Whitaker | Reuters
Demonstrators protest against Brazilian President Dilma Rousseff, calling for her impeachment, in Sao Paulo.

Brazil's president is battling scandal and low poll numbers, inflation and unemployment are soaring, and ratings agencies are taking the knife to its credit rating. Is there any good news investors can count on from Latin America's largest economy?

There are some bright spots, analysts say. Yet for now, the immediate term outlook is overwhelmingly grim for the country that put the 'B' in the acronym BRICS — shorthand for the most attractive emerging market economies investors once considered a sure bet.

As Brazilian president Dilma Rousseff combats a slumping economy and corruption accusations, the country's inflation surged above 10 percent while unemployment jumped to 7.9 percent, according to the latest official data. The dour state of affairs has Barclays forecasting a 4 percent economic contraction this year, followed by 3.3 percent shrinkage next year, the investment bank said in a research note last week.

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The political and economic turmoil has recently driven the real, Brazil's currency, to multiyear lows, a factor helping to stoke price pressures.

According to Carlos A. Primo Braga, a professor of international political economy at Switzerland's IMD Business School, the sinking real may be a blessing in disguise for tourists and foreign investors. Braga estimates that a steak lunch in a top Brazilian restaurant in Brazil that would have easily cost roughly $120 per capita last year now costs almost half that much. At the same time, Brazilian real estate prices have plummeted, leading some big investors to take advantage of rock bottom prices. That may eventually help lift sentiment and improve growth prospects.

The Brazilian real "has experienced one of the most dramatic depreciations among currencies from emerging economies over the last 12 months," Braga explained to CNBC. On the upside, however, the extreme adjustment will "help the tradable sector of the economy improve its international competitiveness," he said, as it makes Brazil's exports cheaper abroad.

Don't expect an FX crisis--yet

The real's depreciation, combined with the slow-down of the economy, has translated into a substantial decrease in the Brazilian trade deficit by roughly 30 percent compared with last year, Braga stated.

At the same time, economic uncertainty is leading to speculation the Federal Reserve may stay its hand on interest rates. That would be a boost to risk assets and battered emerging markets. Last week, the real and Brazilian stocks jumped as markets bet the Fed would take a slower approach to tightening policy.

"Brazilian assets are becoming increasingly attractive to foreign investors. In sum, no foreign exchange crisis is expected in the near future," he said. "But the economic crisis and the fate of the real will continue to be driven by the political imbroglio."

Still, fiscal issues continue to drag on the country, defying Rousseff's push to engineer a turnaround with a plan to hike taxes. The primary deficit of more than 7 billion reals has been better than some estimates, but is far from the government's early goal of having a 2015 surplus. Analysts are skeptical that Brazil can shift the dynamic in the near term.

Sao Paulo skyline
Getty Images
Sao Paulo skyline

"We do not see how Brazil's fiscal position can improve in the short term given the lack of political consensus, which has kept the current administration from delivering primary surpluses large enough to arrest rising government debt ratios," Mauro Leos, Moody's senior credit officer wrote in a note published October 2015.

"We do not believe Brazil can achieve real growth of 2 percent, and primary surpluses of at least 2 percent of GDP until 2017-18, which are required to stabilize the debt-to-GDP ratio," Leos added.

Meanwhile, an economic crisis is being exacerbated by a political one. Rousseff's popularity has dwindled at a rate even quicker than the price of commodities prices — a big reason behind the country's current struggles.

The global landscape, where big economies are struggling and developing economies find it hard to lavish spending on their populations, is casting doubt on Brazil's "interventionist economic model," Bruno Rovai, a Barclays strategist told CNBC. "The country's political turmoil prevent[s] deeper structural reforms and hamper policy adjustments."

With that in mind, policy accommodation will become increasingly difficult for the government, Brazil watchers say. That will curb growth prospects, keep pressure on the real and prop up interest rates, they add.