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 ISSN: 0969-5966

June 2018 Contents

Vol 35 Issue 6

Latin America Monitor

Import Boom Ending But Stronger
Consumers Will Keep Sales
Growing 3
Brazil Uncertain Presidential Field As
Lula's Imprisonment Looms 5

Weakening Sentiment Signals Rising Downside Minas-Rio Suspension Prompts

Risks Slight Downward Revision To Brazil
Iron Ore Growth  8
• Brazil is undergoing a cyclical recovery led by private consumption that will most likely
continue over the coming quarters.
• However, downside risks to our growth forecasts are growing as investor sentiment
is weakening ahead of the general election and the labour market is showing signs of
wavering.
• Given the economy's still-nascent recovery, a sudden, sharp reversal in investor
sentiment could severely undermine the recovery.

Our core view is that Brazil's economy recovery will accelerate in 2018. In March, we
upwardly revised our real GDP growth forecast for 2018 to 2.5%, from 2.0%, in response
to stronger than expected activity in Q417 and improving confidence indicators (see
'Buoyant Sentiment Supports Forecast Upgrade', March 5). Industrial production growth, Copy Deadline: 27 April 2018
supported by strong external demand, will bolster employment, while the beginning of a
Analyst: Jeffrey Lamoureux
new credit cycle, underpinned by low interest rates, will encourage spending.
Editor: Katherine Weber
Our core scenario assumes that fixed investment remains modest due to uncertainty
Sub-Editor: Mia Kilroy
over the October general election and that Brazilian assets see some downside over
the coming months.​​​​​ Nonetheless, Brazil's recovery is still nascent and downside risks Subscriptions Manager: Lyan Chan
to our core scenario are growing. Risks primarily stem from the potential for a more
Marketing Manager: Julia Consuegra

...continued on page 2 Production: Kavita Saini

Dovish Signaling Suggests Further Cuts  6

The Banco Central do Brasil will most likely enact one more 25 basis point rate cut in 2018
in light of below-target inflation. However, inflation will likely trend upward over the coming
months, leading to rate hikes in 2019.

REGIONAL INDICATORS
Latin America 2016 2017e 2018f 2019f Head Office
Nominal GDP, USDbn 6,145.3 4,956.6 5,484.2 5,702.4
30 North Colonnade, London
Population, mn 631.3 637.9 644.5 650.9
E14 5GN, UK
GDP per capita, USD 9,734.7 7,769.7 8,509.6 8,760.9
Real GDP growth, % 0.7 -0.2 1.5 2.7
Inflation, % 6.8 9.6 6.5 5.3 Company Locations
Goods Exports, USDbn 1,002.8 976.2 1,088.3 1,156.0 London | New York | Singapore
Goods Imports, USDbn 1,047.4 959.4 1,038.5 1,094.7 Hong Kong | Dubai | Pretoria
Notes: e/f = BMI estimate/forecast. Source: BMI.

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 Brazil | June 2018

LATIN AMERICA RISK INDEX

BMI's Country Risk Index scores countries on a 0-100 scale, evaluating short-term and long-term political stability, short-term economic
outlook, long-term economic potential and operational barriers to doing business. For a detailed methodology, visit bmiresearch.com or
contact us using the details on page 1.

RISK INDEX TABLE

Short Term Long Term Operational Country
Political Economic Political Economic Risk Risk
Chile 76.0 70.2 83.2 68.4 65.2 71.4
Uruguay 71.5 63.5 75.3 65.2 53.7 64.0
Mexico 56.0 68.8 62.7 65.6 51.6 59.4
Peru 57.1 69.2 62.5 66.5 50.5 59.4
Brazil 55.0 59.4 68.9 63.1 46.3 56.6
Colombia 61.5 63.8 60.4 63.3 49.0 57.9
Argentina 65.8 56.3 61.6 56.4 46.5 55.5
Ecuador 51.3 56.3 50.1 58.5 47.1 51.8
Venezuela 36.0 27.1 44.8 31.8 29.5 33.3
Regional Average 58.9 59.4 63.3 59.9 48.8 56.6
Global Average 63.3 53.1 62.2 53.7 49.8 55.3
Note: Scores out of 100; higher score = lower risk. Source: BMI

ECONOMIC OUTLOOK
...continued from front page

significant weakening of investor sentiment ahead of the October general election than Disappointing Data Shows Risks
Economic Activity Index (SA), % m-o-m
we currently anticipate. Sentiment has been buoyant over recent months, as markets
appear to believe that a centrist, reform-supportive candidate will prevail. However, the
real recently sold off even as former President Luiz Inácio Lula da Silva's candidacy was
dealt a significant blow by his imprisonment (see 'Quick View: Uncertain Presidential Field
As Lula's Imprisonment Looms', April 6). Previously, markets rallied on developments that
undermined his candidacy, given his anti-reform campaign platform.

While the sell-off comes in line with our view (see 'BRL: Election Risks Will Drive
Depreciation', March 8), its timing may be a sign that sentiment is turning earlier than
we expected. Other Brazilian asset classes, including equities, bonds and credit default
Source: BCB, BMI
swaps, have been unaffected thus far. However, if the real's weakening foreshadows
rising bond yields, the rising cost of capital will likely lead businesses and other fixed
asset investors to pull back on near-term investments. Weaker investment would in
turn undermine the labour market and private consumption, the key driver of the
recovery.

FX Weakness Shows Rising Investor Concern

Private consumption may already be faltering. Unemployment rose in the first two Exchange Rate, BRL/USD
months of the year, to 12.6% in February, and retail sales growth decelerated, to 1.3%
in February. Retail sales growth has historically moved in line with private consumption,
suggesting that private consumption in Q118 likely underperformed the 2.6% growth
seen in Q417. Consumer confidence held steady in Q118, but rising unemployment could
weaken sentiment over the coming months and discourage spending.​​​​​​

Brazil is unlikely to fall back into a recession in 2018, but growth could remain sluggish.
Historically low inflation and interest rates have created a supportive macro environment,
and, given the size of Brazil's market, some firms appear willing to downplay near-
term political volatility in order to make strategic investments. Nonetheless, a sharp Source: Bloomberg, BMI

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 Brazil | June 2018

deterioration in sentiment over the near-term could mean that Brazil, already the region's growth laggard, largely misses out on the
region's improving near-term growth prospects. It would also compound the risk of growth underperformance beyond 2018 should
an anti-reform candidate win the presidency in October.

INDUSTRY OUTLOOK

Import Boom Ending But Stronger Consumers Will Keep Sales Growing
BMI View: Brazil's passenger car market will continue to boom over 2018 despite our expectations for a slowdown in sales of im-
ported cars which have, up until now, been spurring growth in the car market. We expect the slowdown in imports will be outweighed
by a continued growth in consumer demand for new cars overall owing to the improving employment, borrowing and confidence
profiles of households in the country.

We forecast passenger vehicle (PV) sales in Brazil to outperform the broader new vehicle Inovar Auto's Expiry Only Raising Imports Temporarily
New Vehicle Sales Growth By Manufacturing Origin, %
market in 2018, growing by 17.2% to 2.17mn units in 2018 compared to a forecasted chg y-o-y
commercial vehicle (CV) sales expansion of 13.7%. Sales of new cars have expanded 15.2%
y-o-y in the first three months of 2018 helped in part by a sharp rise in sales of imported
models but we expect this trend to cease in the second half of 2018.

Nevertheless, we believe the upcoming slowdown in sales of imported vehicles will be

outweighed by ongoing improvements in consumer demand (outlined below) that will
keep accelerating growth in passenger car sales overall for the remainder of 2018 and
into 2019.

Import Boom Will Be Temporary Source: ANFAVEA, BMI

For the most part the Brazilian market looks set for an increase in sales over the year,
however, this quarter we highlight that one drag on sales in the latter half of 2018 will be a
slowdown in imported vehicle sales. As can be seen in the chart below, sales of imported
vehicles have skyrocketed in the first three months of 2018, rising 22.5% y-o-y compared to
the 14.7% y-o-y growth in domestically-made vehicles. This has largely been down to the
December 2017 expiry of Brazil's automotive industrial policy, known as 'Inovar Auto', which
had placed heavy taxes on imported vehicles.

However, after the policy expired, these import taxes have been drastically reduced,
providing importers with a window to import more vehicles at lower costs. We expect,
however, that this window of opportunity for importers will be temporary as the government
is set to announce its new automotive industrial policy, known as 'Ruta 2030', sometime Jobs Market Gains Still Improving
during Q218. This new policy will most likely re-impose some higher taxes on imported Brazil – Unemployment Rate, %

vehicles. The resulting slowdown in sales of imported vehicles that will follow will therefore
drag on total vehicle sales over the second half of 2018.

Passenger Car Market Seeing Healthy Mix Of Macroeconomic Drivers

Despite our expectations of slower imports from H218 onwards, we believe underlying
growth in demand from households will keep passenger car sales growth strong over
the remainder of the year to an extent that will outweigh the potential negative effects
of the import slowdown. The passenger car segment will benefit from a broader cyclical
uptrend in household spending. Our Country Risk team forecasts real GDP growth to
Source: BCB
accelerate to 2.5% in 2018 and 2019, up from an estimated 1.0% in 2017, with a view that

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 Brazil | June 2018

this uptick will be driven mostly by a recovery in household private consumption, which Real Earnings On The Rise Once Again
Real Average Earnings (excl. bonuses), BRL
will rise by 2.6% in 2018 and 3.0% the following year.

In line with this view, we highlight four main themes which outline how the prospects for a
consumer-driven recovery in vehicle sales are improving:

• Rise in employment.
• Low inflation and rising wages combining to boost disposable incomes of households.
• Falling costs of borrowing for households both in terms of nominal interest rates on auto
loans and in terms of household income.
• Rising consumer confidence. Source: BCB, BMI

A key signal for rising consumer spending strength in the future is the recovery in
employment across the country. Previously, we had highlighted that little progress had
been made in terms of stemming the rise in unemployment. However, since March 2017,
when unemployment reached 13.7%, the indicator has shown a steady decline. Although
unemployment has risen slightly since December 2017 this is simply a normal seasonal
upswing and it is important to remember that unemployment in February 2018 was still 0.6
percentage points lower than the same month a year ago and our Country Risk team still Falling Vehicle Financing Costs Should Entice Buyers
forecasts unemployment to fall to 10.0% by year end. As this improving employment trend Interest Rates On Auto Loans For Households & Leases
For Businesses
continues and more people move into work, this should have the strongest positive impact
on new passenger car demand as it greatly boosts household incomes and confidence.

We stress, however, that this view should still be tempered with the fact that unemployment
is still sitting at 12% compared with the 6-8% range it maintained during the 2012-2014
period, when passenger car sales peaked. Thus, the total pool of potential car buyers with
steady employment is unlikely to reach its 2012-2014 levels in 2018, which, in turn, will limit
total demand for new vehicles to lower volumes than previously seen in the 2012-2014
period.
Source: BCB
Rising real wages are also supporting new vehicle sales, with real wage growth having
remained positive for 15 straight months to January 2018. With inflation having slowed to
2.9% in January 2018, wages have been growing at a faster rate than prices which is helping
to lift consumer purchasing power after continuous real wage declines during 2016.

A third major support for the Brazilian new car market is the falling cost burden of borrowing
and leasing, which is lowering the overall costs of purchase and helping to make vehicles
more affordable for both businesses and consumers. Annual interest rates on auto loans Falling Debt Burden To Free Up More Spending
Power
to households averaged 22.5% in February 2018, compared to 25.7% in February 2017, Household Debt Servicing Ratio, %
while annual interest rate equivalent costs of vehicle leasing for businesses dropped to
their lowest point in eight years reaching 12.6% in February 2018, compared to 16.0% in
February 2017. At the same time, households have also been making strong headway into
lowering their overall debt burdens. Debt repayments of all kinds accounted for an average
of 19.9% of each household's income in January 2018, the lowest they have been since
February 2011 and lower compared to the 22.4% peak in 2016.

Evidence that these improving conditions are spurring new vehicle sales is now also being
reflected in the data. Together, the lower debt burdens of households and falling interest
rates on auto loans appear to be helping encourage households to reconsider new car Source: BCB

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 Brazil | June 2018

purchases on finance. In the first three months of 2018 sales of new light vehicles on Financed Sales Now In The Lead
New Light Vehicle Sales By Financing Type, Units *
credit or leasing have risen 18.8% y-o-y compared to the 10.0% y-o-y rise light vehicle % chg y-o-y
350,000 20
purchases purchased in cash. This is a sign that Brazil's recovery is shifting into the next 18
300,000
stage of growth, with both financed and non-financed sales channels now showing positive 16
250,000
expansions, paving the way for stronger market growth in 2018. 14
12
200,000
10
150,000
Adding to the positive signs of a recovery is the fact that falling unemployment, rising real 8

100,000 6
wages and falling borrowing costs are now also translating into rising consumer confidence. 4
50,000
Consumer confidence has been on a positive uptrend since September 2017 which is 2

0 0
likely to translate increased confidence in making big-ticket purchases such as new cars. Financed Sales Non-financed Sales

However, it is still important to qualify this with the fact that consumer confidence is still 3M18 3M17 % chg y-o-y

low relative to its pre-2014 levels and that there are still potential downside shocks to Source: CETIP

consumer confidence looming such as the upcoming October presidential elections and
the uncertainty in policy direction that this brings.

POLITICAL OUTLOOK

Uncertain Presidential Field As Lula's Imprisonment Looms

Editor's Note: On April 7, after this story was published, Lula turned himself in to police to Significant Undecided Population Leaves Race Open
Brazil – Voter Intentions For First Round Presidential
begin his prison sentence, ending a brief stand off. Election, % (March 2018)

The Latest: On April 5, Brazilian prosecutors ordered the arrest of former President Luiz
Inácio Lula da Silva, giving him until late April 6 to turn himself in after the Supreme Court
ruled against his habeas corpus petition. Lula has reportedly refused to turn himself in,
setting up a potential confrontation with the police over the coming hours.

Implications: The court's 6-to-5 decision upholds its 2016 ruling that convicted defendants
can be jailed after their initial appeal is rejected. Lula, whose initial appeal was rejected in
January, had hoped to remain free while pursuing his legal appeals to both overturn his
conviction on corruption charges and advance his presidential candidacy ahead of the Source: BNP Paribas Brasil

October election.

What's Next: While Lula's likely imprisonment does not necessarily end his candidacy, we
believe that the electoral court is highly likely to disqualify him when it makes its decision in
August. Under laws passed during Lula's tenure, candidates who have been convicted of a
crime and lost an appeal are disqualified from contesting elections.

Nonetheless, the campaign will be a highly competitive contest between anti-

establishment, leftist and reformist candidates that raises risks to policy continuity. Recent
polling suggests that in Lula's absence, anti-establishment and leftist candidates, including
populist Jair Bolsonaro, environmentalist Marina Silva and leftist Ciro Gomes, poll ahead of
leading centre-right, reform-supportive candidate Geraldo Alckmin.

Lula will attempt to use his imprisonment to rally support for his leftist Partido dos
Trabalhadores (PT) and his most likely replacement, Fernando Haddad. Additionally, former
Supreme Court President Joaquim Barbosa is reportedly considering a campaign, which
would leverage his popularity as a leader of previous anti-corruption efforts.

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 Brazil | June 2018

Related Research:

• Election Season Likely To Weaken Investor Sentiment, March 5

• Quick View: Lula Not Yet Out, January 24
• 2018 Election Initial Thoughts: Corruption Critical To Outlook, August 22 2017.

ECONOMIC OUTLOOK

Dovish Signaling Suggests Further Cuts

BMI View: The Banco Central do Brasil will most likely enact one more 25 basis point rate cut in 2018 in light of below-target
inflation. However, inflation will likely trend upward over the coming months, leading to rate hikes in 2019.

• The Banco Central do Brasil (BCB) will extend its rate cutting cycle longer than we Benign Inflation Supports Lower Rates
Interest Rates & Inflation
previously expected in light of tepid inflation.
• We expect one additional 25 basis point rate cut will bring the Selic target to 6.25% by
end-2018, a downward revision of our previous 6.75% forecast. We have also revised our
end-2019 forecast to 7.25%, from 7.50%.
• We have downwardly revised our inflation forecasts to an average of 3.2% y-o-y in 2018,
from 3.5% previously, and 4.0% in 2019.

The BCB will pursue more dovish monetary policy over the coming months than we
previously expected. On March 21, the bank reduced the Selic rate by 25 basis points
(bps) to 6.50% and made clear that it would likely cut rates further at its next meeting, Source: IBGE, BCB, BMI
scheduled for May 15-16 (see 'Quick View: BCB's Dovish Tone Could Spell Further Easing',
March 22). Altering its previous stance (see 'Rate Cuts Finished As Pension Reform
Appears Unlikely', February 8), the BCB cited below-target inflation expectations in
light of benign external conditions and a still-nascent domestic economic recovery as
justifying continued accommodation. Markets appear to judge the bank's shift in posture
as credible, as interest rate futures now imply an additional cut this year and lower interest
rates over the foreseeable future.

Inflation will remain moderate over the coming months. With unemployment at 12.2%
and industrial capacity utilisation at 78.1% in January, the economy is still below capacity,
mitigating risks of a sudden uptick in inflation as economic activity rebounds (see 'Buoyant
Sentiment Supports Forecast Upgrade', March 5). At 2.9% y-o-y in mid-March, inflation
remains well below the 4.5% mid-point of the bank's target range and price pressures have
been weaker than expected, driving the downward revisions to our forecasts.

Nonetheless, we maintain that rebounding domestic demand, supported by lower interest

rates and credit expansion, rising oil prices and a weaker exchange rate will underpin an
uptick in inflation in the latter half of the year. We forecast inflation of 3.4% at end-2018 and
4.7% at end-2019.

The BCB will most likely begin hiking rates again in 2019, although there are risks of an
earlier commencement in Q418. Low real interest rates will risk fueling inflation and weigh
on Brazilian assets over the coming quarters. Moreover, as the BCB has long cautioned, a
lack of progress on fiscal reforms has left a key structural driver of inflation in place and

www.bmiresearch.com Page 6
 Brazil | June 2018

is likely to increase risk premiums on Brazilian assets (see 'Pension Reform Defeat Signals Shift Lower Suggests BCB Credibility
One-Day Interbank Deposit Futures Contracts, %
Rising Risks', February 22).

We do not expect rate hikes before the October election, as interest rate hikes and
uncertainty over policy direction would pose significant downside risks to Brazilian assets
and investment activity. In our base case scenario, which assumes that current economic
policy direction remains broadly unchanged following the election, rate hikes will begin as
inflation converges on the 4.25% mid-point target for 2019 early in the year. However, if a
candidate such as former President Luiz Inácio Lula da Silva, who opposes fiscal reforms,
wins the election (see 'Election Season To Weaken Investor Sentiment', March 9), rate
hikes could come sooner in order to mitigate risks of capital outflows and ensure the bank Source: Bloomberg, BMI
remains ahead of the curve as inflation expectations rise.

DATA & FORECASTS

2014 2015 2016e 2017e 2018f 2019f 2020f
Nominal GDP, USDbn 2,454.9 1,799.9 1,794.8 2,055.0 2,068.7 2,088.7 2,185.8
Real GDP growth, % y-o-y 0.5 -3.5 -3.5 1.0 2.5 2.5 2.4
GDP per capita, USD 12,021 8,738 8,643 9,819 9,810 9,834 10,220
Industrial production, % y-o-y, ave -2.9 -8.2 -6.4 2.4 2.8 3.0 3.1
Population, mn 204.21 205.96 207.65 209.29 210.87 212.39 213.86
Consumer price inflation, % y-o-y, eop 6.4 10.7 6.3 2.9 3.4 4.7 4.9
Consumer price inflation, % y-o-y, ave 6.3 9.0 8.8 3.5 3.2 4.4 4.8
Central bank policy rate, % eop 11.75 14.25 13.75 7.00 6.25 7.25 8.00
Exchange rate BRL/USD, ave 2.35 3.33 3.49 3.19 3.36 3.56 3.65
Exchange rate BRL/USD, eop 2.66 3.96 3.26 3.31 3.52 3.60 3.70
Budget balance, BRLbn -343.9 -613.0 -562.8 -511.4 -524.6 -517.9 -473.1
Budget balance, % of GDP -6.0 -10.2 -9.0 -7.8 -7.5 -7.0 -5.9
Goods and services exports, USDbn 264.1 223.9 217.8 251.7 273.3 278.8 284.3
Goods and services imports, USDbn 318.8 243.1 203.2 221.5 248.6 259.9 269.3
Current account balance, USDbn -104.2 -59.4 -23.5 -9.8 -26.3 -33.5 -37.8
Current account balance, % of GDP -4.2 -3.3 -1.3 -0.5 -1.3 -1.6 -1.7
Foreign reserves ex gold, USDbn 363.6 356.5 365.0 374.0 385.2 396.7 404.7
Import cover, months 13.7 17.6 21.6 20.3 18.6 18.3 18.0
Total external debt stock, USDbn 556.9 543.4 543.3 499.3 471.9 452.0 435.8
Total external debt stock, % of GDP 22.7 30.2 30.3 24.3 22.8 21.6 19.9
Crude, NGPL & other liquids prod, 000b/d 2,346.3 2,527.0 2,614.1 2,732.7 2,912.1 3,142.9 3,304.6
Total net oil exports (crude & products), 000b/d 146.8 459.2 599.8 694.0 837.6 1,023.2 1,149.9
Dry natural gas production, bcm 20.4 20.4 20.6 24.0 25.0 25.8 26.4
Dry natural gas consumption, bcm 41.6 43.7 41.5 42.2 43.1 44.5 45.6
e/f = BMI estimate/forecast. Source: National Sources/BMI

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 Brazil | June 2018

INDUSTRY OUTLOOK

Minas-Rio Suspension Prompts Slight Downward Revision To Brazil Iron

Ore Growth
BMI View: Anglo American's suspension of mining at Minas-Rio will have a relatively limited impact on Brazil's iron ore production
growth and Anglo American's revenues; however, iron ore prices will see a near-term boost.

In late March, Anglo American announced a 90 day suspension of operations at the Minas- Exports To Take A Hit
Iron Ore Exports (mnt)
Rio iron ore mine in Brazil due to a pipeline leak. Based on the firm's 2018 production guidance
for the mine as of February, between 13-15mnt, we estimate the suspension will result in the
loss of approximately 3.5mnt and have subsequently revised down Brazil's iron ore production
growth forecast, albeit marginally, to 3.0% from 4.0%. Anglo American already anticipated
lower production in 2018 compared with 16.8mnt produced in 2017, due to weaker ore grades.

More notably, the firm's decision to implement a months-long suspension to conduct a full
inspection of the pipeline in question reflects a more proactive approach from the industry,
in the wake of the 2015 Samarco dam burst that led to several fatalities and significant
environmental damage. The Brazilian environmental regulatory body reportedly instructed
Source: Trade Map
Anglo to halt operations until the pipeline's security is confirmed, however, given the
relatively small scale of the incident, a 90 day suspension suggests heightened sensitivity
over the matter.

As for Anglo American, an extended disruption to operations at Minas-Rio will weigh on

earnings, however the boost to higher grade iron ore prices will likely offset the loss of sales.
According to one Anglo executive, the repairs will cost approximately USD18mn, excluding
losses from exports. In 2017, Minas-Rio accounted for approximately 5% of total revenues Elevated Prices Could Offset Some Loss From
and 12.6% of Anglo's underlying earnings. The pipeline leak and subsequent investigation Operational Disruption
Anglo American – Underlying Earnings By Segment
will likely delay Anglo's expansion plan at Minas-Rio, which is targeting a ramp up in (USDmn), 2017
production to reach nameplate capacity of 26.5mnt annually by 2019.

The suspension at Minas-Rio will pose near-term upside risks to our iron ore price forecast,
which is a global average, as the disruption will exert upward pressure on high-grade iron
ore prices. China's efforts to raise environmental standards and curb overcapacity in the
steel sector have been behind the growing divergence between high and low-grade iron
ore prices, as mills prefer higher quality ore to reduce emissions. Minas-Rio produces 67%
iron content, compared to the average iron ore content of around 62%. Brazil is a key source
of high grade iron ore for top importer China, accounting for 21% of the country's total iron
ore imports in 2017. Source: Company report

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