Goldman Sachs’ Alberto Ramos said in a note to clients recently:
“The ongoing economic recession/depression has now lasted an extraordinarily long period of time and has been unusually deep: leading to a 9.7% cumulative decline in per-capita real GDP. By 2Q2016, real GDP was at the same level of 3Q2010. Final private sector domestic demand has declined a very large 12.4% cumulatively since 2Q2014.”
Essentially, Brazil’s economy has traveled back six years in the past. The country’s systemic problems won’t be solved overnight, either. In fact, it’ll take many years to get debt under control and restore Brazil to some form of growth:
A deep, permanent, large structural fiscal adjustment remains front-and-center on the policy agenda to restore both domestic and external balance. In our assessment, fiscal consolidation in Brazil will be a multi-year endeavor. Most likely, returning to primary fiscal surpluses will take no less than 2-3 years, and returning to a primary surplus level that stabilizes the debt dynamics (around 2.5% of GDP) likely 4-5 years, or perhaps longer.
Brazil’s finances are such a mess that its central bankers are unable to use fiscal policy to help restore growth, either. The tight lending controls in place with relatively high rates will likely stick around for quite some time.
At the end of the fiscal consolidation process we estimate that Brazil needs to end up with a primary surplus of 3.0% to 3.5% of GDP. This would be the level of primary surplus that would put gross public debt on a clear declining trajectory, something that is required for Brazil to rebuild fiscal buffers and regain room to use fiscal policy counter-cyclically, whenever needed and appropriate. Furthermore, we believe a deep fiscal adjustment that would elevate public sector savings is needed to facilitate a permanent structural current account adjustment (rather than just a cyclical adjustment driven by the sharp contraction of domestic demand), and also to endow the central bank with extra degrees of freedom to set monetary policy at a less restrictive level.
Despite ongoing economic turmoil, Brazil’s stock market has exploded this year. The largest Brazil-focused ETF, the iShares MSCI Brazil Index ETF (NYSE:EWZ), is up 62% since the start of 2016, making it the best-performing country-focused ETF year-to-date.
It’s difficult to imagine a larger disconnect between a country’s stock market and its underlying economy like we are seeing right now with Brazil. Investor beware, because the inevitable correction will likely be sharp and dramatic.