Macro scenario - Brazil

August 12, 2021

Inflation and fiscal risk outline a more challenging scenario

 Vaccination is advancing and will likely allow a return to economic normality before year-end. The main risk to
consider is the emergence of COVID-19 variants that impact the effectiveness of the vaccines distributed in the
country.
 We expect primary deficits of 1.4% of GDP in 2021 (vs. 1.8% previously) and 0.7% of GDP in 2022, and gross
debt at 80.9% in 2021 and 81.1% in 2022, from 88.8% in 2020. Notwithstanding the quantitative improvement
in the primary deficit estimate, we see rising risks around fiscal discipline – due to waived revenues under the
proposed changes to income and profit taxes, the mounting challenge of reconciling the constitutional
spending ceiling with higher inflation, unexpected increases in expenses related to court-ordered debts
(precatórios), and pressure to expand the Bolsa Familia aid program.
 We forecast inflation rates of 6.9% in 2021 and 3.9% in 2022. The high current inflation indicates a stronger
pass-through to prices that are more inertial in the economy, notably in the service sector.
 With higher inflationary risks, we expect a Selic rate of 7.5% p.a. at year-end.
 We have revised our 2021 GDP growth estimate to 5.7% from 5.8% due to supply restrictions. We now expect
a sharper slowdown to 1.5% in 2022 (vs. 2.0% previously), as the factors that are currently driving the
expansion will likely be less significant next year.
 We have maintained our year-end exchange-rate forecasts at BRL 4.75 per dollar in 2021 and BRL 5.10 per
dollar in 2022. We recognize, however, that the risks to this FX appreciation scenario have increased in light of
the higher fiscal concerns.

Coronavirus: advancing vaccination, falling
death numbers
Progress on vaccination will likely allow for a return
to economic normality in 4Q21. More specifically, we
expect that the entire population aged 18 and over will
have gotten at least a first dose by September.
The main risk going forward is the potential
emergence of virus variants that impact the
effectiveness of the vaccines distributed in the
country. In particular, the Delta variant, originally from
India, has recently been detected in Brazil and is
showing signs that it will outcompete the Gamma
variant, which drove the second wave of COVID-19 in
the country. Scientific studies indicate that vaccines
remain effective against this variant but also that
protection is more robust after the full two-dose
immunization schedule.
In the short term, the immunization campaign is
producing benefits: hospitalization and death
numbers continue to decline. We estimate that for
each new case, the risk of death is currently about 75%
lower than it was before the start of the vaccination
campaign (see graph), considering that: i) among
Brazilians aged 60+ (which accounted for about 75% of
all deaths before vaccines), 99% have had at least the
first dose and about 85% have had their second shot;
and ii) the average effectiveness against death of the
vaccines already distributed stands at 55% for the first
dose and 87% for the second.

Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do
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Macro scenario - Brazil | August 12, 2021
For each new case, we estimate that the risk of
death is now 75% lower
80%
Probability, for every new case
(considering total population), that
70%
deployed vaccines are able to
prevent death
60%
50%
40%
30%
20%
10%
0%
Jan-21 Feb-21Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21
Source: Itaú
Smaller fiscal deficit, but greater risks
The fiscal outlook points to a quantitative
improvement mixed with a potentially relevant
qualitative deterioration. We have revised our 2021
primary deficit estimate to 1.4% of GDP (BRL 124
billion) from 1.8% of GDP (BRL 152 billion) while
maintaining our 2022 call for a deficit of 0.7% of
GDP (BRL 70 billion). The revision in our 2021
number mainly reflects better primary results for states
and municipalities – we now expect a surplus of 0.5%
of GDP (BRL 43 billion), up from 0.3% of GDP (BRL
25 billion) previously – and higher non-tax revenues,
such as dividends paid by state-owned enterprises
and repayments related to last year’s Pronampe loan
program.
According to our estimates, public debt will reach
80.9% of GDP in 2021 and 81.1% of GDP in 2022,
from 88.8% of GDP in 2020. The debt dynamics this
year and the next will likely be favored by temporary
factors, such as an implicit GDP deflator above the
IPCA consumer price index and additional amounts
that BNDES (Brazil’s development bank) will return to
the National Treasury.
Notwithstanding the improvement in fiscal
forecasts, we believe that the risks to fiscal
discipline are increasing, with potential negative
effects on the economy. There is a plausible
scenario where public debt is higher than expected,
increasing the risk of higher interest rates and lower
growth.
2
On the revenue side, the proposed changes in
income and profit taxes (PL 2337/21) could lead to a
reduction in revenue of about BRL 25 billion (0.25%
of GDP) in 2023, according to the latest version of
the assessment presented by the bill’s rapporteur in
the Lower House, Representative Celso Sabino
(PSDB-Pará). On the one hand, Brazil’s tax burden is
already high for its per-capita income level. On the other
hand, the fiscal imbalance, even with the recent
improvement, is still significant, and it is not advisable for
an emerging economy with high public debt to reduce
revenues without compensatory reductions on the
spending side. (See Macro Vision: 10 FAQs about the
reform on income and profit taxes)
Because of the spending situation, accelerating
inflation, the budget’s indexation and unexpected
growth in expenses related to court-ordered debts
(precatórios), sustaining the constitutional spending
ceiling is likely to become more challenging,
hindering plans to reconcile the expansion of the
Bolsa Familia aid program with the credibility of the
fiscal adjustment. In particular, expenditures related to
precatórios (which will be submitted as part of the
budget bill later in August) are likely to total BRL 89
billion, compared with the original expectation of BRL 56
billion. This higher-than-expected amount is significantly
larger than the BRL 25 billion space in the spending
ceiling in 2022, which was planned to be used to expand
the coverage and average benefit paid by Bolsa Familia.
The government is discussing annual limits on precatório
payments or even excluding this expenditure from the
spending ceiling, but in both cases, the fiscal adjustment
would become even more gradual.
Inflation remains high, with signs of pass-
through to inertial prices
We expect the IPCA consumer price index to climb
by 6.9% in 2021, with service inflation picking up in
4Q21. Inflation remains under upward pressure from
widespread price increases. We expect the year-over-
year IPCA reading to peak at around 9.3% in August.
The more noticeable price hikes involve items linked to
commodities (such as food consumed at home and
auto fuels) and production bottlenecks (such as for
automobiles and electronics). At the margin, items
linked to the economic reopening, such as restaurant
meals and travel-related goods and services, are also
showing signs of accelerating price growth. Underlying
inflation measures remain above the level that would be
compatible with the inflation target. This is the case
both for goods inflation, which has not yet shown any
Macro scenario - Brazil | August 12, 2021
signs of receding, and for service inflation, which is
pointing to accelerated growth in prices that are subject
to greater inertia.
For market-set prices in the IPCA, we expect
increases of around 4.0% for services, 8.0% for
industrial goods and 7.0% for food consumed at
home this year. In the food category, grain prices in
U.S. dollars have stabilized, albeit at high levels,
suggesting that the pressure on the group will at least
cool down going forward. As for industrial inflation, we
see metal commodity prices peaking at their current
levels, which should bring some disinflation to
wholesale prices. However, this cost relief may take a
while to reach final consumers, given the tight gap in
the industrial sector and production bottlenecks.
Service inflation is showing signs that the current
inflationary shock is being passed through and is thus
expected to remain high in 3Q21 and 4Q21. Moreover,
nominal wage adjustments suggest that high current
inflation is being passed through as well, suggesting
that the current shock could be prolonged. For
regulated prices, we project an increase of
approximately 9.5% this year. Our call assumes that
the tariff flag system for electricity bills will be in Red
Mode Level 1 in December. A move to Red Mode
Level 2 in December would have an additional impact
of 0.40-0.50 pp on the IPCA in 2021, depending on the
new value approved by regulator ANEEL (between
BRL 9.492/100 kWh and BRL 11.500/100 kWh).
Given higher current inflation and the impact on
prices subject to greater inertia, we estimate that
the IPCA will rise by 3.9% in 2022. Regarding the
risk balance for next year, we see upside for market-
set prices, especially services. It should be noted that
a more intense mode in the tariff flag system this year
and the assumed normalization of rainfall patterns next
year mean that inflation in this item could be partially
reversed in 2022. In any case, the risk balance tilts
toward a less favorable inflation composition, with
more pressure on market-set prices and potentially
lower pressure on regulated prices.
Inflation is more widespread and under
greater pressure, requiring a faster
adjustment in the Selic rate
At its August meeting, the Central Bank’s
monetary policy committee (Copom) raised the
benchmark Selic rate by 100 bps, to 5.25% p.a., in
line with market consensus, despite some uncertainty
on the eve of the decision. According to the
3
committee, the acceleration in the pace of adjustment
was based on its assessment that recent pressure on
inertial components could cause a deterioration in
inflation expectations, especially while the service
sector is reopening. In this context, the committee
decided that it is appropriate to adopt a more timely
monetary tightening strategy to ensure that inflation
expectations are anchored. The Copom foresees
another adjustment of the same magnitude at its next
meeting.
In a major change, the committee signaled that
interest rates will climb above the neutral level. At
the previous meeting, in June, the signal was that
interest rates would rise to the neutral level. At the
May meeting, the Copom still understood the baseline
scenario and risk balance as consistent with only a
partial normalization of the level of monetary stimulus.
Given the higher inflationary risks, especially the
abovementioned pressure on service costs, we
expect another 100-bp hike at the next Copom
meeting, with the Selic climbing to 7.5% by year-
end.
Activity: factors that boosted growth in 2021
will be exhausted in 2022
We have marginally lowered our 2021 GDP growth
projection to 5.7% from 5.8%. We still expect
significant GDP growth in 3Q21 but have reduced our
estimate for this quarter to +0.9% from +1.2% (vs.
+0.2% qoq/sa in 2Q21). The biggest positive
contribution in 3Q21 will likely come from service
segments that are highly sensitive to social mobility,
which is recovering. On the other hand, the expansion
in industrial production has been slower than
anticipated due to input shortages that are generating
supply-side constraints, especially in the automotive
industry.
We now expect a sharper slowdown in GDP
growth in 2022, to 1.5% (vs. our previous estimate
of 2.0%), because the factors that are driving the
expansion this year will likely be exhausted. The
revision is based on our expectation of higher interest
rates, which would make monetary policy restrictive on
economic activity next year. In addition, we believe
that fiscal policy will also be contractionary, even
considering the new income transfer program,
because total primary public spending in real terms is
expected to fall back to 2019 levels. We foresee a
slowdown in the global industrial sector and declining
commodity prices next year. Finally, in 2022, economic
Macro scenario - Brazil | August 12, 2021

activity will no longer benefit from the momentum benchmark rate and higher commodity prices, which
coming from the reopening of the service sector. In our are likely to result in more favorable trade and financial
view, this beneficial momentum will be limited to the flows.
second half of this year. The graph below illustrates
two of these points: a substantial slowdown in the However, we recognize that the risks to our
global industrial sector and significantly higher stronger FX outlook have become more intense.
domestic real interest rates than those seen this year. The first such risk is related to the evolution of public
accounts in the coming years. If significant fiscal
Global industrial slowdown and higher real deterioration results in heftier capital outflows (with the
interest rates in 2022 possible flight of Brazilian capital), the Brazilian real
10% will likely depreciate. A second risk concerns one-off
Recession Strong flows, such as those related to the changes that Law
9% Low Growth
Growth 14031/20201 have brought to the taxation of
8%
investments abroad (which could lead to net
7% purchases of about USD 15 billion in 4Q21) or the
6% potential for early dividend payments in response to
5%
the tax reform (the exact amount of which is difficult to
estimate).
4%
3% The currency is expected to weaken to BRL 5.10 per
2% dollar in 2022. Globally, quantitative stimulus
Global GDP QoQ/SAAR withdrawal, higher interest rates and a stronger dollar
1%
(estimated by global will tend to put pressure on the Brazilian real and other
0% manufacturing PMI) emerging-market currencies.
Ex-ante real interest rate
-1%
Mar-15
Jul-15
Nov-15
Mar-16
Jul-16
Nov-16
Mar-17
Jul-17
Nov-17
Mar-18
Jul-18
Nov-18
Mar-19
Jul-19
Nov-19
Mar-20
Jul-20
Nov-20
Mar-21
Jul-21
Nov-21
Mar-22
Jul-22
Nov-22

We have revised our estimates for the external

accounts and now expect small current account
Source: Bloomberg, Itaú deficits in 2021 and 2022. Our call for this year is for a
deficit of USD 8 billion (compared with a zero balance
previously), incorporating the annual ordinary review of
We have maintained our 2021 year-end
the balance-of-payments data carried out by the Central
unemployment rate estimate at 12.0% and lifted our
Bank, which increased the deficit related to profits and
2022 estimate to 12.0% from 11.9%. The GDP growth
dividends by USD 3 billion in the January-May period,
we expect for 2022 would be close to potential and
as well as higher imports under the Repetro customs
therefore insufficient to generate significant declines in
regime. For 2022 we now forecast a deficit of USD 12
the unemployment rate.
billion (compared with a deficit of USD 8 billion in our
previous forecast). On the financing side, we note the
BRL: fundamentals still point to appreciation, return of foreign investments to Brazil (especially to the
but risks have increased stock and fixed income markets), offset by more intense
outflows of Brazilian investments to other countries.
Notwithstanding some recent volatility, we are
maintaining our year-end exchange rate forecast at
BRL 4.75 per dollar. After the greenback fell below
BRL 5.00 in June, the local currency weakened during
July amid fiscal noise and uncertainties related to the
Delta variant of COVID-19. Still, we still believe that
the key fundamentals justify an appreciation from
current levels; these factors include a rising Selic

1 Due to divergences in tax treatment, FX hedging should be

higher than the value of the investment abroad to neutralize
the effects of FX volatility on returns. This additional
component is usually referred to as over-hedge. Law 14031,
signed on July 28, 2020, eliminated these divergences; the
law goes into effect in two stages, in early 2021 and early
2022.

4
Macro scenario - Brazil | August 12, 2021

Brazil | Forecasts and Data

2016 2017 2018 2019 2020 2021F 2022F
Current Previous Current Previous
Economic Activity
Real GDP growth - % -3.3 1.3 1.8 1.4 -4.1 5.7 5.8 1.5 2.0
Nominal GDP - BRL bn 6,269 6585.5 7,004 7,407 7,448 8,666 8,677 9,391 9,427
Nominal GDP - USD bn 1,798 2063.3 1,916 1,877 1,443 1,676 1,694 1,901 1,908
Population (millions) 205.2 206.8 208.5 210.1 211.8 213.3 213.3 214.8 214.8
Per Capita GDP - USD 8,764 9977 9,189 8,932 6,816 7,858 7,941 8,850 8,883
Nation-wide Unemployment Rate - year avg (*) 11.5 12.7 12.3 11.9 13.3 13.0 13.0 12.0 11.9
Nation-wide Unemployment Rate - year end (*) 12.7 12.4 12.2 11.6 14.3 12.0 12.0 12.0 11.9
Inflation
IPCA - % 6.3 2.9 3.7 4.3 4.5 6.9 6.9 3.9 3.9
IGP–M - % 7.2 -0.5 7.5 7.3 23.1 18.5 18.5 4.0 4.0
Interest Rate
Selic - eop - % 13.75 7.00 6.50 4.50 2.00 7.50 7.50 7.50 7.50
Balance of Payments
BRL / USD - eop 3.26 3.31 3.88 4.03 5.19 4.75 4.75 5.10 5.10
Trade Balance - USD bn 40 56 47 35 50 77 77 77 77
Current Account - % GDP -1.4 -1.1 -2.7 -3.5 -1.7 -0.5 0.0 -0.6 -0.4
Direct Investment (liabilities) - % GDP 4.1 3.3 4.1 3.7 3.1 3.0 3.0 3.2 3.1
International Reserves - USD bn 372 382 387 367 356 356 356 356 356
Public Finances
Primary Balance - % GDP -2.5 -1.7 -1.5 -0.8 -9.4 -1.4 -1.8 -0.7 -0.7
Nominal Balance - % GDP -9.0 -7.8 -7.0 -5.8 -13.6 -6.3 -6.3 -6.6 -5.8
Gross Public Debt - % GDP 69.9 73.7 75.3 74.3 88.8 80.9 81.0 81.1 80.2
Net Public Debt - % GDP 46.2 51.4 52.8 54.6 62.7 61.4 61.5 62.3 61.4
Source: IBGE, FGV, BCB and Itaú
(*) Nation-wide Unemployment Rate measured by
PNADC

Macro Research – Itaú

Mario Mesquita – Chief Economist

To access our reports and forecast visit our website:

https://www.itau.com.br/itaubba-en/economic-analysis/publications

5
Macro scenario - Brazil | August 12, 2021

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