Brazil

COVID-19 in Brazil: Impacts and Policy Responses

Attachments

EXECUTIVE SUMMARY

The COVID-19 pandemic is exposing Brazil to an unprecedented challenge. With a view to containing the pandemic, Brazil, as almost all other countries, has implemented measures to slow the spread of the virus (or “flatten the curve”). This was an attempt to avoid overwhelming the health care system with large numbers of severe case patients. Although Brazil has one of the strongest health care systems in Latin America, capacity is highly uneven across the country. The spread of the virus toward poorer areas with lower health care capacity, especially in the North and Northeast of Brazil, poses a threat to the system’s ability to respond to an increased demand for services. This would add pressure to the already overcrowded public health care system, and endanger more lives, particularly among the poor and vulnerable. As of June 25, 2020, Brazil had recorded 1,228.114 confirmed cases of COVID-19, and 54.971 deaths, according to the Brazilian Ministry of Health data. Brazil is the second most exposed country globally, only behind the United States in number of cases and deaths. The spread of the virus has not slowed down so far, with the number of cases doubling every ten days, on average. Efforts have been made—by both federal and subnational governments—to ramp up the health care system’s capacity, including through the purchase of new intensive care beds, medical equipment and ventilators, and the recruitment of additional health care professionals. In addition, Besides, the federal government has provided emergency funding to states and municipalities. As the country makes efforts to expand its treatment capacity, it is urgent to expand testing capacity as well, particularly given the estimated high percentage of under-reported cases and deaths.

The pandemic is expected to plunge Brazil into another recession. Even before the crisis struck, Brazil’s recovery from the 2015–16 recession was fragile, and its fiscal space was limited. Significant achievements to put the country on a path of rebuilding fiscal buffers, such as the 2016 spending cap rule (teto dos gastos) or the 2019 pension reform, did not have sufficient time to bear fruit before COVID-19 engulfed the world and Brazil. The pandemic, and the health policy response to it, have essentially resulted in two shocks for Brazil: an external shock, including foreign demand and prices; and a domestic shock, as domestic demand and supply are affected by consumers’ decision to avoid physical interactions, and by the restrictions on economic activity imposed to prevent contagion. In addition, as a net oil exporter, Brazil has also been hit by the oil price shock. Due to a sharp decline in demand, oil prices have been reduced by half, with some contracts even falling into negative territory in April 2020. The result of these three shocks is Brazil’s sharpest recession on record. World Bank estimates point to a −8 percent growth in 2020. While services are expected to be hit the hardest, export-oriented crop sectors (such as soy) should expand, benefiting from a more competitive real effective exchange rate. Although inflation is generally low, the crisis is expected to put some pressure on food prices.

Still weakened from the 2015–16 crisis, Brazil’s poorest 40 percent are particularly exposed to the fallout from the COVID-19 pandemic. About half of Brazil’s population either live in poverty (defined as less than US$5.50 per day, PPP) or are vulnerable to falling into poverty, and thus are in a disadvantaged position with regard to protecting themselves from infection. This is particularly true for those living in favelas (urban slums), where they lack basic sanitation facilities to observe the required hygiene standards, such as regularly washing their hands with warm water. In addition, the high density in these informal settlements and the difficulty of successfully implementing containment measures, such as social distancing, make it easier for the virus to spread. While disease may spread faster in urban areas, rural populations, including many indigenous, traditional, or forest-based communities, face additional barriers to seeking medical care during the pandemic, which also places them at a higher risk. At the same time, these groups tend to rely primarily on precarious labor relations for their income, and therefore find it more difficult to avoid going to work, even if local governments tell them not to. School closures also affect the poor disproportionately and can have long-term impacts on human capital accumulation and opportunities. According to the latest estimates, the World Bank projects that, without mitigation measures, inequality should increase, and about 7.2 million Brazilians would join the ranks of the poor in 2020, bringing the poverty rate (at US$5.50 per day, PPP) to 22.7 percent of the population.

Although the pain of recession can be felt across the economy, smaller firms are expected to be more affected because they tend to be more present in sectors with high face-to-face interactions, and where home-based work is less pervasive. They also tend to employ lower-income workers, another aspect affecting the poor disproportionately. Finally, they tend to have lower cash buffers, and thus face a higher risk of illiquidity forcing them into insolvency. These smaller firms include the more than 5 million family farms that cater mainly for domestic consumption, and which are vital for food security in the country.

State (and municipal) governments constitute a third group that is highly exposed to the crisis. Many states already faced a precarious financial situation prior to COVID-19, and were already illiquid or insolvent. Brazil’s 26 states (plus the Federal District) are at the frontline of the defense against the crisis, as they are chiefly responsible for delivering health care services. They are thus faced with a combination of increased spending needs to shore up their health care systems, while simultaneously experiencing a shortfall in tax revenues, as economic activity declines. Furthermore, they do not have access to capital markets. The combined impact of these risks is estimated to create a funding gap equivalent to 1.5 percent of GDP. A financial support package has already been approved by the federal government and the National Congress to shore up state finances in 2020, reducing the gap to about 0.3 percent of national GDP. However, the states will still face challenges in 2021, as federal financial support winds down and the fiscal situation remains vulnerable. Although this report is limited in its assessment of municipalities, they also experience high levels of fiscal pressure, which often has its roots in a weak pre-crisis financial position.

Special attention will need to be devoted to the infrastructure sector, including energy, water, and transport, due to their strategic nature in the economy and potential contingent liabilities for the government. Their exposure to the crisis is subject to considerable variance depending on sector, location, revenue structure, initial financial health, and position in the supply chain. In the energy sector, oil producers such as Petrobras have been strongly hit by the oil shock, with impacts on finances, jobs, and royalties paid to states. While consumers— including households, industry, transport and others—might, in principle, benefit from lower oil prices, pass-through tends to be low, not least due to administered prices, which reduce the net benefit of lower oil prices for consumers. Given Brazil’s reliance on hydropower, the oil price shock is not going to reduce the cost of inputs. Problems are expected across the whole supply chain, with the biggest hits affecting energy distribution companies due to the demand shock, both from low demand and potential non-payments. These might cascade into non-payment to generators under take-or-pay contracts, as well as transmission operators. Just as subnational governments, many electricity distributors already had a weak financial situation at the onset of the crisis. With respect to water utilities, losses are estimated to potentially reach US$1–1.3 billion over 10 years. Besides, some of the financially weakest states also have the least robust water utilities, which might constitute an important contingent liability. Finally, in the transport sector, impacts vary considerably from one subsector to another. Airlines and the urban public transportation sector are hit the hardest, whereas freight transport has been less affected so far, as the flow of goods has remained relatively uninterrupted (although demand is lower). The survival of both major players (such as air carriers and transport infrastructure concessionaires) and a myriad of SMEs acting as logistics operators (mostly in the trucking subsector) is at stake. In the short term, this may trigger massive bankruptcies and layoffs; in the medium term, a supply shock might hamper the recovery.

The financial sector was in a position of strength when the COVID-19 crisis started, and it will play a critical role during both the crisis and the recovery phase. Having learned from previous crises, such as the 2007–08 Global Financial Crisis, and having adopted global regulatory standards such as Basel III, Brazil’s banks are in a sound position, with comfortable capital buffers and liquidity cushions. Banking sector stress tests suggest that the financial sector should be able to weather this shock. However, a prolonged crisis might lead to the deterioration of such financial stability, which would exacerbate the negative linkages with real sector recovery and fiscal sustainability. This risk calls for continuous monitoring. Moreover, given increased credit and market risks, banks may be unwilling to lend, which would contribute to the deterioration of financial conditions. The credit crunch would in turn make it more difficult for firms and households to navigate the crisis. As banks play a critical role in ensuring liquidity in critical times, they are pivotal to tiding companies over during the crisis and supporting their return to normality once containment ends. Considering firms’ and households’ balance sheets, the longer the crisis lasts, the deeper the damage will be. This would limit banks’ ability or willingness to offer them credit. A robust support package put together by the government and the Central Bank will be critical to ensuring a flow of credit and supporting recovery—indeed, it can determine Brazil’s economic recovery altogether.

The COVID-19 crisis undermines the resilience of Brazil’s macroeconomic framework. On the fiscal side, the recession and associated drop in revenues caused by COVID-19, coupled with higher spending needs, including various contingent liabilities (such as the debt of states, municipalities and state-owned enterprises), are expected to increase public debt by about 20 percentage points of GDP and stabilize within about four years. This might raise the cost of financing for Brazil and undermine much of the recent progress in reducing Brazil’s indebtedness. Further fiscal measures may need to be considered to rebuild fiscal buffers. Exposure to a significant currency depreciation, both for the public and private sectors, is moderate, and although the magnitude of the depreciation is large (about 30 percent), it is expected to be relatively temporary and manageable for most entities. External funding needs of an estimated 14.4 percent of GDP in 2020 are likely to be covered with Brazil’s ample international reserves, reinforced with additional swap-lines between the Brazilian Central Bank and the US Federal Reserve. The monetary policy framework remains a source of resilience in Brazil, and the Central Bank’s credibility has helped to anchor inflation expectations and allowed for further monetary easing. However, Brazil’s policy rate—known as SELIC—is already at a level below neutral, a factor which reduces the effectiveness of further rate cuts. New unconventional monetary policy measures, such as quantitative easing, provide new tools and opportunities to cope with the recession, but could also call for reinforcing the institutional setup (for instance, ensuring de jure central bank independence).

New risks have also emerged with regard to the environment and the sustainability of natural assets. While more evidence is needed on this, one of the potential areas of increasing vulnerability is deforestation, as the attention of environmental agencies and civil society shifts to short-term pressing needs over the longer-term climate change agenda. This is likely to weaken the enforcement of environmental preservation policies and increase incentives for deforestation.

Brazil has already put in place significant measures to address the economic crisis. In order to protect the poor, the government has expanded its wide conditional cash transfer program (Bolsa Família) by more than 1.2 million families. In addition, an innovative transfer program known as Auxílio Emergencial (or Emergency Aid, which pays just over half of a minimum wage for three months to informal, self-employed, and uncovered unemployed workers) is estimated to cushion the blow of the crisis. Significant financial support is availed to SMEs, especially through the BNDES. States have already received some emergency funding, and federal transfers have been secured at last year’s level (rather than adjusted to the declining national economy). The overall fiscal response is estimated at about 8.6 percent of GDP—relatively large by emerging market and developing country standards. In this sense, Brazil has mustered a strong economic response to the crisis, but implementation remains key.

Beyond the immediate containment of the crisis, Brazil will need to focus on laying the groundwork for a speedy and equitable recovery. Many analysts expect a V-shaped recovery—both across the world and in Brazil. The World Bank estimates a somewhat weaker recovery for Brazil, with growth at 2.2 percent in 2021, somewhat reflecting the experience of the previous recession of 2015– 16. Generally, it can be expected that the deeper the recession is, the more damage will be done to firms, households, and public balance sheets, adversely affecting credit provision and thus softening the recovery. This shows how critical it is to successfully implement mitigation measures to the COVID-19 pandemic, so as to quickly “flatten the curve” and avoid or contain a second wave. As a sequencing of priorities, the World Bank proposes the following (noting that Brazil has already made progress in many areas): 1) containing the damage; 2) protecting the poorest and most vulnerable; 3) supporting firms and jobs; 4) strengthening the fiscal situation of subnational governments; 5) preventing a financial sector collapse and supporting credit provision; 6) shoring up the protection of natural resources; 7) strengthening public sector management, enhancing transparency, and collecting (real-time) data; 8) organizing the management of assets (should the government decide to bail out strategic companies); 9) setting and clearly communicating a strategy to exit fiscal and economic crisis measures; and 10) agreeing and recommitting to a structural reform agenda. Reviving the reform agenda to support the economic recovery will be critical as a means to offer guidance to economic agents, provide additional flexibility, and ensure an orderly adjustment to the new economic reality emerging in the aftermath of the pandemic.