Letter IEDI n. 1072—Brazil's external accounts and the COVID-19 crisis
Today's Letter IEDI presents the main figures of Brazil's external accounts in 2020, which saw a reduction in the current account deficit, but also a much lower attraction of foreign capital than the previous year. The analysis will pay special attention to the main contagion channels of the COVID-19 crisis: exports, imports, international travel and financial flows.
The current account deficit (CAD) of the Brazilian economy totaled US$ 12,517 million in 2020, its lowest level since 2009. In relation to 2019, the drop reached 75%. In other words, the crisis caused by the COVID-19 pandemic interrupted the upward path of the deficit that started in 2018. This effect is even more evident when we analyze the evolution of the CAD as a share of GDP: 0.83% in Dec/20 compared to 2.7% at the end of 2019.
A negative movement was also recorded in the capital and financial account: after two consecutive years of increase, its result fell to US$ 11,135 million, that is, -77.6% compared to the figure for 2019, due to a reduction in net capital flows. The difference between the CAD and the result of the capital and financial account was financed by the sale of international reserves by the Central Bank of Brazil.
The contagion effect of the COVID-19 crisis on Brazilian current transactions was different from that observed in the global financial crisis of 2008/2009, a consequence of the unique characteristics of the present crisis, such as the greater impact on the service sector. All subaccounts were affected and Brazil showed specificities compared to other emerging economies. This is due to the nature of the Brazilian external insertion, which determines the sources of revenue in foreign currency.
Within current transactions, the trade balance of goods reacted positively, recording a surplus of US$ 43,230 million or +6.8% against 2019. This favorable reaction resulted from the larger fall in imports: -9.7% versus -6.7% of exports, in the wake of the contraction in domestic demand.
The 20% exchange rate depreciation in real effective terms in 2020 (deflated by the IPCA), a record among emerging market economies, was not enough to stimulate exports. This stemmed from the sharp drop in external demand, as well as the terms of export contracts that delay the positive effect of the currency depreciation on the foreign competitiveness of Brazilian products. It is also worth noting that the significant increase in wholesale prices produced a 1% appreciation of the real effective exchange rate when deflated by the IPA-DI, not helping exports of certain goods.
The outlook at the beginning of the pandemic, however, suggested a much more intense adjustment of the trade balance, which did not materialize due to a combination of factors: the lower-than-expected intensity of the global recession, resulting in a less acute decline in the volume of trade in goods; the rise in the prices of agricultural and metallic commodities, given the reactivation of the Chinese economy; and the performance of domestic economic activity, which was also less unfavorable than expected, thanks to the emergency measures to mitigate the impact of COVID-19.
The decline in the balance of services’ deficit (-43.2%), which includes spending on international travel, was even more intense than in the trade balance due to the direct impact of confinement and mobility restrictions. Worldwide, tourism was one of the main channels of transmission of the crisis, causing damage to many countries. But as Brazil spends more than it earns on international tourism, the effect of the pandemic was favorable, reducing the deficit in the sub-account “travel” and in the total balance of services.
Regarding financial flows, as noted by the IMF and other multilateral organizations, the contagious effect of COVID-19 on emerging markets was much more intense than in the 2008/2009 global crisis. It was no different in Brazil. The pandemic has negatively affected all items of our financial account. Net inward flows totaled US$ 11,146 million, a 77% drop compared to 2019.
The first channel of contagion on the financial account was the liquidation of positions of non-resident investors in the domestic financial market. Capital flight due to heard behavior was record among emerging economies. The outflow of these investments totaled US$ 35 billion between Feb/20 and May/20. In addition to the magnitude, the composition also differed: during the COVID-19 crisis, this liquidation was greater in public debt securities than in the stock market.
The record outflow of capital from emerging economies—and notably from Brazil—was due not only to the greater dimension of the current crisis and the increased participation of non-resident investors in the stock and government bond markets in the capital flows boom seen after the 2008–09 crisis, but also to the change in the profile of these investors, who respond much more quickly and intensely to changes in global financial conditions.
Thus, the COVID-19 crisis made it evident that the change in the composition of external liabilities since 2005—characterized by a reduction in the share of external debt and an increase in the presence of global investors in the domestic capital market—did not necessarily make the Brazilian economy less vulnerable, but changed the nature of our external vulnerability, as detailed in this Letter.
In the case of the Brazilian economy, the liquidity of the public debt, stock and foreign exchange markets facilitates the liquidation of positions by non-resident investors. At the same time, it helps to explain, together with cheap assets and a depreciated currency, the return of these investors as of Jun/20, in the context of the resurgence of portfolio flows to emerging economies. Brazil was the main destination of these flows among the main emerging countries (except China), absorbing around US$ 30 billion in Jun–Dec/20.
The net inflow of direct investment in the country (i.e. FDI), which summed US$ 34,167 million, down -50.6% compared to 2019, also contributed to the lower result of the financial account, as well as the net return of direct investment, of US$ 16,419 million. In other words, the context of global recession discouraged FDI and stimulated the repatriation of capital by Brazilian transnational companies, taking advantage of the exchange rate depreciation as well.
Considering the prospects for our external sales in 2021, the projections recently released by multilateral institutions indicate a favorable international scenario both in terms of commodity prices and of the dynamism of international trade, which should provide a better performance for our exports. On the other hand, the return of economic growth will stimulate imports. The net result should be an increase in the trade surplus and a decline in the CAD.
The uncertainties about new COVID-19 waves in the world, on the other hand, should weigh on global financial conditions and, therefore, on the performance of capital flows to Brazil. Thus, the 0.75 pp increase in the base interest rate (Selic) by the Central Bank may not be sufficient to maintain the attractiveness of securities traded in the domestic financial market and securities issued abroad by residents.
It is never too much to remember that capital flows to emerging economies in general, and Brazil in particular, are primarily determined by the conditions of the international financial market. Domestic factors, such as the internal level of interest rates, asset prices and the exchange rate, are secondary determinants, affecting mainly the distribution of flows between these economies.