Macro scenario - Brazil

December 17, 2021

New year, same challenges

 The pandemic in Brazil still shows no signs of a spike in hospitalizations and deaths. However, the
effectiveness of vaccines against the new Omicron variant is still uncertain and carries risks. At the very least,
the new strain places greater importance on booster shots.
 Notwithstanding the improvement in current data, the main challenge is related to fiscal sustainability going
forward. We expect a primary budget surplus of 0.3% of GDP in 2021 (we previously estimated a deficit of 0.6%
of GDP), a deficit of 0.8% of GDP in 2022 (previously a deficit of 1.5% of GDP), and a deficit of 1.1% of GDP in
2023, with gross debt reaching 81%, 84% and 87% of GDP in each of these years, respectively.
 The dynamics driven by a recovery in mobility-related services and weakness in the goods sector should be
repeated in the 4Q21 releases. We revised our call for GDP growth in 2021 to 4.4% from 4.7%. For 2022 and
2023, we forecast -0.5% and 1.0%, respectively.
 We maintained our year-end exchange rate forecasts at BRL 5.50 per U.S. dollar in 2021 and 2022. For 2023,
we forecast BRL 5.75, amid persisting high uncertainty and a decline in the Selic rate.
 For the consumer price index IPCA, we anticipate a 5.0% increase in 2022, after climbing around 10.0% this
year. The shock in industrial goods tied to supply bottlenecks is still showing great persistence, with secondary
effects on other prices, mainly services. Due to lagged effects of the interest rate hike and a still-open output
gap, we expect a 3.3% increase in the IPCA in 2023.
 We believe the Selic rate will reach 11.75% p.a. by the end of 1Q22, the level at which the current tightening
cycle will finish (with increases of 150 bps in February and 100 bps in March). In 2023, we expect the Selic to
fall toward less restrictive levels.

Fiscal: current data continue to improve, but
uncertain framework puts debt sustainability at
risk going forward
The consolidated public sector should deliver a
primary surplus of 0.3% of GDP (BRL 25 billion) in
2021, marking the first positive reading since 2013,
when the surplus reached 1.6% of GDP. The revision
in our scenario – previously anticipating a deficit of
0.6% of GDP (BRL 55 billion) – is partly due to an
even better-than-expected result by states and
municipalities, which should achieve a surplus of 1.1%
of GDP (BRL 95 billion), compared with 0.7% of GDP
(BRL 60 billion) previously. In addition, central
government revenues – especially those related to
corporate profits – continue to deliver positive
surprises, while expenses from measures related to
the pandemic will likely be lower than anticipated.
In 2022, the primary result will reach a deficit of
0.8% of GDP (BRL 75 billion), a negative result that
would be milder than we expected before (deficit
of 1.5% of GDP or BRL 140 billion). States and
municipalities should attain a surplus of 0.5% of GDP
(BRL 45 billion vs. 0.1% of GDP or BRL 6 billion in our
previous estimate), with still-high revenues and just-
partial use of available fiscal space for expenditures.
For the central government, despite the help provided
by good revenue performance in 2021, increased
spending made possible by the approval of
constitutional amendment proposal PEC 23/21,
disinflation and the deterioration in growth prospects
will cause spending to advance faster than revenues.
In 2023, we expect a deficit of 1.1% of GDP (BRL
110 billion). The public budget to be approved after
the elections should still follow the rules of the
modified spending ceiling, but the elected
government must define throughout the year the
fiscal framework that will be valid from 2024
onward.

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Macro scenario - Brazil | December 17, 2021
Public debt is expected to decline from 89% of
GDP in 2020 to 81% of GDP in 2021 and to rebound
to 84% of GDP in 2022 and 87% of GDP in 2023.
Rising indebtedness amid high interest rates, low
growth and an uncertain fiscal framework suggests
greater risks of a return to an unsustainable fiscal path
going forward.
Activity: signs of weakness to continue in
4Q21
In 3Q21, GDP dropped slightly (-0.1% qoq/sa),
despite the recovery in sectors that involve social
interaction1 and have a large share of GDP. Poor
performances in the agricultural sector, heavily
impacted by weather problems (water crisis and frost),
and sectors linked to the consumption of goods (such
as retail and manufacturing) explain the quarterly
contraction (see table).
We expect stability in GDP in 4Q21, with a
continuation of the same dynamics: a recovery in
mobility-related services and contraction in
segments related to the goods sector. Industrial
production has been declining since 2Q21 due to
supply constraints caused in part by input shortages,
but also because some segments reached their
production capacity. In recent months, demand for
goods has started to slow down as well, as shown by
consecutive declines in retail sales from August to
October (we expect the slide to continue in November
and December). Both credit-sensitive and income-
sensitive retail sales have contracted in recent months.
In our view, this movement is a consequence of rising
inflation, as well as the first signs of a slowdown in
credit – a trend that should consolidate in the near
future amid higher interest rates.
Recovery in services, but the goods sector
(manufacturing + retail) is slowing down
GDP growth (QoQ/sa)
Breakdown Weight 2Q21 3Q21
GDP 100% -0.4% -0.1%
Services ex-retail sales 51% 0.5% 1.8%
Industry + retail sales 29% -0.7% -0.2%
Agriculture and livestock 6% -2.9% -8.0%
1 Private and public healthcare and education, bars,
restaurants, hotels, beauty parlors etc.
2
We revised our 2021 GDP growth forecast to 4.4%
from 4.7%, incorporating weaker economic-activity
readings in 3Q21 and 4Q21.
For 2022, we maintain our expectation that GDP will
drop 0.5%, dragged by the expected contraction in
aggregate demand due to higher interest rates. The
1Q22 reading will benefit from strong and one-off growth
in agricultural GDP, but we expect headline GDP to
contract in subsequent quarters. For 2023, we forecast
1.0% growth as interest rates move to a less restrictive
level than in 2022.
BRL: historically weak level in the coming
years
We maintained our year-end exchange-rate forecasts
at BRL 5.50 per U.S. dollar in 2021 and 2022.
Domestic uncertainties (especially those related to the
evolution of public accounts in the coming years)
combined with a global scenario which has been
challenging for risky assets (increased global inflationary
pressures and anticipation of higher interest rates in the
U.S.) put pressure on the currency, even in a context of
a rising Selic rate.
For 2023, we forecast the exchange rate at BRL 5.75
per dollar. Uncertainties related to the fiscal regime
from 2024 onwards, the normalization of monetary policy
in the United States and a falling Selic rate should
pressure the Brazilian currency.
We revised our estimates for external accounts. For
2021, we see a trade surplus of USD 64 billion (vs. USD
72 billion previously) and a current account deficit of
USD 22 billion (vs. USD 14 billion), incorporating a
sharper-than-expected decline in the trade surplus in the
later months of the year (with falling commodity/export
prices and more significant fuel imports). For 2022 and
2023, we forecast current account deficits of USD 24
billion and USD 19 billion, respectively.
4Q21 (F)
0.0%
0.6%
-1.8%
3.4%
Macro scenario - Brazil | December 17, 2021
Inflation remains under pressure in the short
term; disinflation next year depends on
tradable goods
With just the December reading yet to be published,
we forecast the consumer price index IPCA at 10.0%
this year — with almost 7 pp resulting from pressure on
fuels (gasoline, ethanol, diesel oil and bottled cooking
gas), electricity (water scarcity mode in the tariff flag
system) and food. Core inflation measures also remain
under pressure. In the November reading, inflation in
underlying services was still hovering near 7.0% at the
margin (annualized and seasonally adjusted), while
goods inflation remained under pressure and with no
signs of deceleration, staying near 10% at the margin.
We maintain our forecast for the IPCA in 2022 at
5.0%. Inflation should remain at a significant level
throughout 1Q22, impacted by the usual price
adjustments of this time of the year, including urban
bus fares and school tuition fees. Industrial inflation
remains under pressure, and the effects of production
bottlenecks in some segments (notably the automotive
sector) show greater persistence. Additionally, there is
impact on items whose demand increased during the
pandemic, such as electronics and household items.
We see regulated prices rising just below 5.0%,
maintaining the forecast of red mode level 1 in the
tariff-flag system applied to electricity bills, in
December 2022 (implying a surcharge of BRL 3.971
per 100 kWh). For market-set prices in the IPCA in
2022, we forecast increases of approximately 5.0% in
services, 6.0% in industrial goods and 4.0% in food
consumed at home. We still see upside risk for
inflation next year, considering the component linked
to electoral uncertainty and the exchange rate. It
should be noted, however, that some downside factors
are also in place, notably commodity prices, signs of
inventory normalization, and the effects of monetary
policy, which tend to accumulate over time.
For 2023, in view of the lagged effect of the
tightening cycle in the benchmark interest rate and
the still-open output gap, we forecast inflation at
3.3%.
3
Copom vows persistence in the fight against
inflation
At its December meeting, the Brazilian Central
Bank’s Monetary Policy Committee (Copom) lifted
the Selic rate by 150 bps to 9.25% p.a. and signaled
an increase of the same magnitude at its next
meeting, in February. Authorities did not outline
changes in the balance of risks for inflation and stated
that it is appropriate for the tightening cycle to advance
significantly into contractionary territory, given the
increase in their forecasts and the threat of expectations
losing their anchor for longer periods.
The committee added that it will persevere in the
strategy of monetary tightening until consolidation
is achieved in the disinflation process and in
anchoring expectations to the targets. In our view,
this stance suggests that, if necessary, the interest-rate
tightening cycle could be longer than anticipated in
2022, especially because inflationary dynamics at the
beginning of the year can be challenging. For instance,
we expect the year-over-year increase in the IPCA to
oscillate around 10% until May, receding more
consistently only after the middle of the year. The
Copom minutes also indicated that the authorities plan
to increase the Selic rate to the 12% neighbourhood, if
not beyond, and to leave the base rate at a
contractionary level for a protracted period. This clearly
pushes back against expectations that the Copom might
begin an easing cycle as early as end 2022. Finally, in
the December quarterly inflation report, the authorities
presented forecasts that, in our view, are consistent with
the continuation of the monetary tightening cycle.
Thus, we maintain for now our forecast that the
cycle will end at 11.75% p.a., which is consistent
with projections presented in the committee’s recent
communication, with increases of 150 bps in
February and 100 bps in March. We believe that this
level will be maintained throughout 2022.
For 2023, we expect the Selic rate to fall toward less
restrictive levels. With the lagged effects of rising
interest rates and economic slack (especially in the labor
market), inflation tends to move closer to the target.
Therefore, we believe that there will be room for a
reduction in the benchmark rate in 2023. More precisely,
we believe that the Selic rate should drop towards 8.0%
p.a. during the year. However, room for this reduction
(and possible additional cuts) in interest rates will
depend on future economic policy choices, particularly in
terms of controlling public accounts.
Macro scenario - Brazil | December 17, 2021

Brazil | Forecasts and Data

2016 2017 2018 2019 2020 2021F 2022F 2023F
Current Previous Current Previous Current
Economic Activity
Real GDP growth - % -3.3 1.3 1.8 1.2 -3.9 4.4 4.7 -0.5 -0.5 1.0
Nominal GDP - BRL bn 6,269 6585.5 7,004 7,389 7,468 8,605 8,596 9,229 9,241 9,904
Nominal GDP - USD bn 1,798 2063.3 1,916 1,872 1,447 1,599 1,598 1,678 1,680 1,757
Population (millions) 205.2 206.8 208.5 210.1 211.8 213.3 213.3 214.8 214.8 216.3
Per Capita GDP - USD 8,764 9977 9,189 8,910 6,834 7,494 7,491 7,811 7,821 8,126
Nation-wide Unemployment Rate - year avg (*) 11.5 12.7 12.3 11.9 13.4 12.6 13.1 12.7 12.9 12.7
Nation-wide Unemployment Rate - year end (*) 12.8 12.5 12.4 11.7 14.6 12.2 12.2 13.3 13.3 13.5
Inflation
IPCA - % 6.3 2.9 3.7 4.3 4.5 10.0 10.1** 5.0 5.0 3.3
IGP–M - % 7.2 -0.5 7.5 7.3 23.1 17.0 18.7 5.5 5.5 3.5
Interest Rate
Selic - eop - % 13.75 7.00 6.50 4.50 2.00 9.25 9.25 11.75 11.75 8.00
Balance of Payments
BRL / USD - eop 3.26 3.31 3.88 4.03 5.19 5.50 5.50 5.50 5.50 5.75
Trade Balance - USD bn 40 56 47 35 50 64 72 62 67 67
Current Account - % GDP -1.4 -1.1 -2.7 -3.5 -1.7 -1.4 -0.9 -1.4 -1.4 -1.1
Direct Investment (liabilities) - % GDP 4.1 3.3 4.1 3.7 3.1 3.1 3.1 3.6 3.6 3.7
International Reserves - USD bn 372 382 387 367 356 366 356 366 356 366
Public Finances
Primary Balance - % GDP -2.5 -1.7 -1.5 -0.8 -9.4 0.3 -0.6 -0.8 -1.5 -1.1
Nominal Balance - % GDP -9.0 -7.8 -7.0 -5.8 -13.6 -5.0 -6.1 -9.0 -9.7 -8.7
Gross Public Debt - % GDP 69.9 73.7 75.3 74.3 88.8 81.0 82.1 84.0 85.6 87.1
Net Public Debt - % GDP 46.2 51.4 52.8 54.6 62.7 58.4 59.5 63.4 65.1 67.1
Source: IBGE, FGV, BCB and Itaú
(*) Nation-wide Unemployment Rate measured by
PNADC
(**) This was the figure published in our last macro scenario update (Nov.). Since then, we have revised this forecast to our current 10.0% call, following the release of
the November IPCA.

Macro Research – Itaú

Mario Mesquita – Chief Economist

To access our reports and forecast visit our website:

https://www.itau.com.br/itaubba-pt/macroeconomic-analysis

4
Macro scenario - Brazil | December 17, 2021

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