Moody's: Brazil's weak demand to limit benefits of falling interest rates

Friday, April 21, 2017


By Moody's

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Sao Paulo, April 19, 2017 -- The sharp drop in interest rates and inflation in Brazil will initially provide only a limited boost to the economy and the nation's borrowers', says Moody's Investors Service in a report. A more robust improvement will only come with a sustained improvement in demand.

After three years of tight monetary policy, Brazil's central bank is cutting rates and will likely continue to do so through at least 2018 as inflation slows. The SELIC, Brazil's policy rate, currently at 11.25%, may drop below 9% by year end, after peaking at 14.25% in 2016.

Lower benchmark rates won't quickly translate into lower rates for consumers and businesses though. Lending rates in Brazil also incorporate other factors such as the credit risk on the bank's balance sheets, taxes and deposit insurance. These will take longer to adjust.

As rates come down, credit conditions in Brazil will improve in two stages. "First, there will be a period of deleveraging that will last through 2018 and limit the potential gains from lower rates. This will then be followed by a gradual increase of credit supply, consumption and investment," said Marianna Waltz, a Managing Director at Moody's.

Lower rates will have differing impacts on diverse sectors within the economy.

The government's interest bill will fall with lower rates. While Brazil will still have a high ratio of interest payments to revenue among its sovereign peers, we expect that the ratio will hold at the pre-crisis average of around 20% in 2017-18. The decline in rates should also support stronger investment in Brazil starting in 2018.

For banks, lower rates will reduce asset risk and loan-loss provisioning needs, but lenders will still be reluctant to get back into riskier market segments without clearer signs of a stronger economic recovery after they retrenched during the recession.

Declining rates will benefit Brazil's non-financial companies by lowering their interest expenses. However, credit metrics for Brazilian companies that Moody's rates have deteriorated sharply since 2015, and are only now starting to recover. Ultimately, a robust improvement in credit quality will depend largely on sustained recovery in demand.

A similar dynamic will be observed in the infrastructure sector, where Brazil's weak growth will hold back demand for utility service and curb traffic levels, offsetting some of the benefits of lower rates.

Consequently, Moody's expects only moderate improvements in credit metrics for infrastructure companies in 2017.