Interest rates to remain low by 2022

According to Itaú’s and Santander’s economists interviewed by Overview Amec, the Selic rate is likely to be around 2% to 2.25% p.a. and remain at this level for a long time. Inflation estimates below the Central Bank’s target and the slow recovery of the Brazilian economy are the main reasons to maintain interest rates at low levels for at least the next 18 months.

“In our base scenario, interest rates will be kept at 2% for a long time. The anchoring of inflation estimates, as shown in Focus survey, shows that inflation rates are likely to remain in comfortable levels even for longer periods,” says Mr. Felipe Tâmega, Head Economist of Itaú Asset Management. Additionally, a more crucial factor is the GDP gap. “The slow pace of growth over the past years, together with the crisis of the new coronavirus, shows a clear hiatus in the economy, generating a disinflationary pressure for a long period,” he says.
According to Itaú Asset’s economist, any interest rate normalization is expected to take place only in the end of 2021. The process is estimated to be very gradual, with a terminal interest rate lower than the “pre-normalized” rate.
Mr. Maurício Oreng, head of macroeconomics Research at Banco Santander in Brazil, remembers that before the pandemic, the reduction of the Selic rate seemed to be close to the end. With the crisis resulting from the COVID-19, there was a bigger cut in interest rates, down to the current 2.25% of the Selic rate. In theory, there is room for a bigger cut in the next meeting of the Monetary Policy Committee (Copom), but the economist believes it will not happen.
“According to the Taylor Rule, which connects interest rates, inflation estimates and the GDP, the Selic rate should

be around 0% and 1%. However, we do not believe that Copom will reach this level,” Mr. Oreng says. He explains that Brazil, as an emerging country, would have fiscal problems with a sharp cut as it would result in counterproductive risks. Accordingly, Santander estimates that interest rates will remain at the current level up to March, 2022.

Countercyclical policies

With regard to economic activities, estimates suggest a very gradual recovery. Mr. Tâmega says that, like other countries, the Brazilian government has been implementing very aggressive countercyclical measures. “The Central Bank implemented a policy to cut interest rates and ensure liquidity and credit to the system. From the fiscal side, the main action was the creation of the emergency aid, intended to avoid a sudden interruption in the income of informal and self-employed professionals,” Mr. Tâmega explains.
The government introduced other measures to protect formal jobs – the temporary reduction of working hours and salaries – and launched credit lines to support businesses. It is too early to evaluate the real impact of the countercyclical measures, the economist says. He shows concern over public expenses and apprehension over the possibility of such policies becoming permanent, what would impact on the debt sustainability.
Santander’s economist says that the emergency measures adopted by the government and the Central Bank to fight the crisis are estimated to account for 7.7% of the GDP. “On the fiscal side, highlights were the emergency aid to ensure the income of informal professionals and individuals, the measures to maintain jobs and the launch of credit programs to help businesses. These measures have a relevant fiscal cost,” Oreng says.

Recovery of the GDP

The economist believes that the recovery of the GDP will be very gradual and dependent on the progress of reforms and maintenance of the fiscal “ceiling”. “If the government does not resume the discussions about the fiscal anchor and does not stick to the spending ceiling, the situation may deteriorate. We are assuming that the reform agenda will advance to help promote a recovery of the GDP from the Q3 2020 on,” he says.
The economy is likely to return to pre-crisis levels only in the Q1 2022, however. Santander expects that 2020 will close with a negative GDP growth of 6.4%. In 2021, the GDP will grow 4.4%. “It is a challenging scenario. We need to better understand the companies’ situation and also depend on the development of a vaccine to prevent new outbreaks,” he states.
Mr. Oreng remembers that the fiscal adjustment process was underway in Brazil and it suffered a setback with the pandemic. Now it is necessary to regain lost ground to continue advancing the process. If the reform agenda is resumed, as he believes, the GDP is expected to grow 2% on average in the next years.