(27 JULY 2019)DAILY MARKET BRIEF 2：Brazil after pension reform: the growth agenda

Economic growth has been anemic in Brazil over the last decade, averaging just 1.2% a year. The pension reform’s approval is necessary for the country to achieve higher levels of growth. But it cannot do so single-handedly. In our view, the reform momentum must continue and business conditions improve to fully restore confidence and rejuvenate investment spending. The good news is that the administration’s economic team appears to understand this necessity and is now working on a series of initiatives toward this end.

•  The "economic freedom law": The government aims to improve Brazil's position in rankings of economic freedom and ease of doing business through a sweeping reduction of red tape and broad improvements in public sector transparency to tame corruption.

•  Tax reform: The current tax system is difficult to entangle even for corporations. Although tax cuts are unlikely due to the country’s fragile fiscal situation, lawmakers may opt to simplify the tax structure. Various proposals are under consideration, and the chances for reform to the tax regime are increasing.

•  Infrastructure investment framework: The Ministry of Economy has drawn up a bill to give investors greater legal certainty and reduce the risk that private businesses face in large construction projects and concessions. The bill also aims to create mechanisms for a quicker resolution of related financial problems.

•  Reductions in energy costs: The economy minister, Paulo Guedes, has vowed to sell the gas distribution companies that today are controlled by the state oil giant Petrobras, thereby increasing competitiveness in the sector and reducing the cost of gas for industries and consumers.

•  Privatization program: The government is keen to privatize state owned enterprises and is developing the narrative to gain public support for such initiatives. The Ministry of Infrastructure estimates that privatizations and new concessions for airports, sea ports, railways, and highways will attract over BRL 200 billion in investments.

•  Increased trade: The South American trade bloc Mercosur and the European Union recently announced a free-trade agreement, a potentially significant boost for exporters in Brazil. Mercosur is also working on trade agreements with Canada, Singapore, and South Korea. Guedes is also eyeing a gradual, unilateral tariff reduction by Brazil that does not require congressional approval.

We see a good chance that many of the above initiatives will be implemented as the administration and a majority in Congress appear to have a pro-market tilt. In this context, we think Brazilian assets can perform well. We have therefore opened an overweight in Brazilian equities versus an underweight in Mexican equities within our emerging market strategy, and project further appreciation of the Brazilian real against the US dollar, to 3.70 in three and six months and 3.60 in 12 months. We also think investors can benefit from a good number of bottom-up opportunities in USD-denominated Brazilian bonds.

BY UBS