Letter IEDI n. 910–External sector: less trade, more FDI
Despite all the problems that Brazil has been facing in recent years, at least in one front we have been spared: there has been no external accounts strangulation. Both on the commercial side and the financial side, our Balance of Payments did not register any recent upsets. Judging by the results of 2018, this favorable phase has not ended and may also extend through 2019, despite growing risks in the international economy.
This Letter IEDI analyzes in detail the external performance of the Brazilian economy in 2018 and outlines some trends for 2019. Although the picture remains calm, not everything goes in the best direction. It is possible to identify some undesirable movements, especially in view of the slowness of the economic recovery.
An example is that in 2018, after three consecutive years of strengthening, our trade balance surplus (US$ 53.6 billion) registered a decline of -16.3% compared to 2017. As the IEDI has been warning since the beginning of last year, this was due to the fact that, although very low, current economic dynamism was already enough for the imports growth rate (+21%) exceed exports' (+10 %). This acceleration of foreign purchases could have been even greater if the real effective exchange rate had not depreciated (8% compared to 2017).
In the case of exports, the reduction in international trade dynamism in 2018 was decisive for their more limited expansion. It is worth remembering that, in 2017, our shipments had grown 18%, that is, almost double what we saw last year. This performance little contributed to a more robust economic recovery.
Due to the trade balance, the current account deficit (CAD) of the Brazilian economy totaled US$ 14.5 billion in 2018, more than double the figure registered in 2017. Despite this, it remained below the 2016 deficit. As a percentage of GDP, the CAD reached 0.77% at the end of 2018 against 0.35% in 2017.
This deterioration, however, was more than offset by the improvement in the performance of foreign direct investment (FDI), a more stable form of foreign capital, avoiding a relative weakening of our external accounts. If we consider the evolution of the External Financing Needed - EFN (difference between the CAD and the FDI), the ratio EFN/GDP fell to its lowest level since October 2015 (-3.9%), since FDI/GDP rose from 3.4% to 4.7%, an increase of 1.28 pp, well above that registered by CAD/GDP (0.27 pp).
In fact, on the financial side of the balance of payments, one of the highlights of 2018 was the 46% advance of direct investment, which reached US$ 74.2 billion. This was mainly due to the greater inflow of investment in the country (which corresponds to FDI) and, secondarily, to the smaller outflow of investments. But what kind of investments were these?
Intercompany loans pulled FDI in 2018. They surpassed in more than 5 times the value registered in 2017, after a contraction of 53% in relation to 2016. This performance, however, is inseparable from the ongoing national picture regarding the conditions of corporate financing.
That is, the difficulties of obtaining credit in Brazil may have led many companies with foreign businesses to ease their shortage of domestic funding through foreign intercompany loans. In addition, despite the lower level of our base interest rate (Selic) and the US interest rate hike, the current profitability differential continues to favor financial operations in Brazil, favoring strategies of interest rate arbitrage through intercompany loans.
Therefore, the 2018 FDI improvement is only partially positive. Another unfavorable aspect is that the item "capital participation" declined 12.5%. The other types of financial flows also registered a negative sign.
The deterioration of monetary and financial conditions throughout 2018, associated mainly with the greater pace of the process of monetary policy normalization in the advanced economies and the (now confirmed) fears of a shutdown of the American government activities, led to a net outflow of "Portfolio investments (liabilities)" in an amount (US$ 8.4 billion) five times higher than in 2017.
In the item "Other Investments (OI)", there was also a net outflow of funds due to a 36.8% increase in assets (OI of residents abroad), as well as a reduction in liabilities (OI of non-residents abroad).
Thus, due to direct investments, the financial account recorded a net inflow of foreign resources of US$ 9.3 billion. Although much higher than the figure recorded in 2017, this result was the second lowest in the period after the 2008 global financial crisis.
Finally, in relation to the outlook for 2019, January's updated IMF projections still give a negative bias to the balance of risks in the short term. The growth estimate went from 3.7% to 3.5% —bad news for Brazilian exports this year.
The biggest uncertainty, however, lies in the international financial environment, due to: a greater-than-expected deceleration in China, a complicated situation for Italian banks, and the lack of agreement between the United Kingdom and the European Union regarding Brexit. The Fund's current scenario does not consider the risk of a new financial crisis highlighted by some analysts, associated to the strong accumulation of debts by companies and families.
Thus, the net outflow of financial resources (portfolio investments and other investments) away from the Brazilian economy may increase. Any market disappointment in relation to the results of the Bolsonaro government's economic policy can also reinforce the exits. Still, even if there is no complete shielding and despite the risks of an even thinner trade balance and of additional capital outflows, the Brazilian economy should not face external financing difficulties in 2019.