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 June 2019
Vol 36 Issue 6 ISSN: 0969-5966

Contents

Latin America Monitor

Growth Outlook Weakening
Amid Headwinds 3
Three Downside Risk Scenarios 5
Brazil
Bolsonaro Will Struggle To
Maintain His Restive Coalition
Key View
• Brazilian President Jair Bolsonaro's 'honeymoon' period is likely nearly over, and he will
face significant obstacles to pursuing his economic policy priorities due to his weak
coalition, infighting and public opposition.
• At Fitch Solutions, we believe there is a path to passing minimal pension reform and
other liberalising reforms, although economic policy will be increasingly led by Congress
and result in significantly less ambitious reforms than markets anticipate.
• Bolsonaro's policymaking will become increasingly reactive, as core constituencies use
threats of withdrawing support to advance their priorities.

Brazilian President Jair Bolsonaro will struggle to advance his core economic policy
priorities over the coming quarters, risking a significant erosion of investor sentiment
towards his administration. The first three months of his administration have unfolded
largely in line with our expectations, as Bolsonaro has devoted a large portion of his energy Copy Deadline: 26 April 2019
into his social policy priorities as he attempts to maintain the enthusiasm of his core
Analysts: Jeffrey Lamoureux
...continued on page 2
Editor: Katherine Weber

Growth Outlook Weakening Amid Headwinds 3 Sub-Editor: Margeaux Erasmus

We at Fitch Solutions expect Brazil's cyclical recovery to continue over the coming quarters, Subscriptions Manager: Lyan Chan
driven by private consumption. However, we have revised down our real GDP growth forecast Marketing Manager: Julia Consuegra
for 2019 in light of weakness in the mining and industrial sectors and policy uncertainty.
Production: Neeraj Kumar

Three Downside Risk Scenarios  5

In this analysis, we at Fitch Solutions summarise our core view for the Brazilian economy in
the coming years and explore three downside risk scenarios that if triggered now would see
lower growth and could drag Brazil's economy into recession.

REGIONAL INDICATORS
Latin America 2017 2018e 2019f 2020f
Nominal GDP, USDbn 5,533.8 5,373.7 5,318.4 5,646.8 Head Office
Population, mn 644.47 650.89 657.17 663.33 30 North Colonnade, London
GDP per capita, USD 8,586.6 8,255.9 8,092.9 8,512.8
Real GDP growth, % 1.8 1.5 2.1 2.7
E14 5GN, UK
Inflation, % 6.6 6.6 7.0 5.6
Goods exports, USDbn 1,075.3 1,166.2 1,237.4 1,315.2
Goods imports, USDbn 1,028.6 1,144.4 1,213.7 1,294.9 Company Locations
e/f = estimate/forecast. Source: Fitch Solutions London | New York | Singapore
Hong Kong | Dubai | Pretoria
© 2019 Fitch Solutions Group Limited. All rights reserved.
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 Brazil | June 2019

LATIN AMERICA RISK INDEX

Our Country Risk Index scores countries on a 0-100 scale, evaluating short-term and long-term political stability, short-term economic
outlook, long-term economic potential and operational barriers to doing business. For a detailed methodology, visit fitchsolutions.com
or contact us using the details on page 1.

RISK INDEX TABLE

Short Term Long Term Operational Country
Political Economic Political Economic Risk Risk
Chile 77.1 67.1 83.2 66.0 64.9 70.3
Uruguay 68.1 62.7 75.3 64.8 54.9 63.2
Mexico 56.5 62.1 58.3 67.9 51.6 58.0
Peru 60.2 68.5 62.5 67.6 48.3 59.4
Brazil 52.9 58.1 68.9 61.4 47.4 56.0
Colombia 63.2 65.8 61.7 63.6 48.7 58.5
Argentina 59.8 50.4 61.6 54.4 48.1 53.6
Ecuador 51.3 58.3 49.1 58.3 45.9 51.4
Venezuela 29.2 25.6 44.8 24.9 27.5 31.0
Regional Average 57.6 57.6 62.8 58.8 48.6 55.7
Global Average 63.1 52.8 62.0 54.2 49.8 55.1
Note: Scores out of 100; higher scores indicate lower risk. Source: Fitch Solutions

BRAZIL – POLITICAL OUTLOOK

...continued from front page
supporters (see 'Brazil's Bolsonaro Unlikely To Make Quick Progress On Economic Reforms', Bolsonaro's Personal Approval Falling Sharply
Presidential Approval, %
January 4). On the economic front, his administration's pension reform effort, a linchpin of the
economic agenda that has bolstered investor confidence, faces significant obstacles, reflecting
his lack of broad legislative coalition, infighting within the administration and public opposition.

As a result, Bolsonaro's 'honeymoon' period is likely nearly over. He already faces

substantial pushback from his ostensible allies in the legislature, as his administration has
been alternatingly passive and divisive in its attempts to establish working relationships
with legislators and build a coalition. His decision to focus on pension reform has rankled
parts of his evangelical Christian base, who see their own priorities being put on hold,
while provoking pushback from well-organised interest groups including police officers,
Source: Ibope Inteligencia, Fitch Solutions
agricultural workers, civil servants, teachers and the military. Although Bolsonaro's personal
approval rating remains above 50.0% in March 2019 polls, his approval has fallen 16 points
since taking office, and his government's approval is just 34.0%, well below the last three
presidents at the same point in their first terms.
Bolsonaro Already In Weaker
Bolsonaro's relationships with his economic team will likely remain particularly volatile. We Position Than Predecessors
First-Term Administration Approval
do not believe economic policy ranks highly among Bolsonaro's personal priorities, and he After Three Months, %
is likely keenly aware that his election is far more attributable to his vows to crack down on
crime and corruption than to reform the economy by cutting pensions. He has played little
role in building public and legislative support for pension reform, frustrating his economic
team and key legislators. Minister of the Economy Paulo Guedes, who had no previous
legislative experience, has hinted that he would resign if pension reform fails.

While we still believe that minimal pension reform and other less controversial reforms can
be enacted, investors' expectations are likely to be disappointed. There is a broad enough
set of political parties in favour of liberalising economic reforms to push forward elements
of Bolsonaro's economic team's priorities, including pension and tax reform, privatisations Source: Ibope Inteligencia, Fitch Solutions

www.fitchsolutions.com Page 2
THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.
 Brazil | June 2019

of state-owned enterprises, the reduction of subsidised credit and regulatory liberalisation to attract foreign investment. A core group of
parties from the broad 'centrão' bloc is committed to advancing reforms, and although there is limited appetite for the most ambitious
proposals advocated by Bolsonaro's economic team, we believe there is a path to building a supermajority by moderating most efforts.

On pension reform, we expect to see the government make a broad range of concessions. These could include relaxing minimum
lengths of contribution during the transition, lengthening the transition, reducing contributions, increasing benefit rates and allowing
exemptions for particular industries (see 'Brazil's Pension Reform Faces Significant Obstacles', March 14). Until a package is finalised, it
is unclear how much savings the reform will provide, but we believe the final reform will under-deliver on market expectations, which
appear to anticipate a comprehensive reform that would reinforce long-term fiscal sustainability.

We also expect the administration to move forward with privatisations of state-owned enterprises, although we see little likelihood that
these efforts will extend to the largest, and most prominent, firms, such as Petrobras, Banco do Brasil or Caixa Econômica Federal.
The partial or complete privatisation of Eletrobras appears to remain under consideration, although Bolsonaro's statements on the firm
have been inconsistent. Efforts to ease regulation can largely proceed through executive action.

Congress will likely begin to take the lead on economic policy. As noted, we believe there is a critical consensus in favour of liberalising
reforms within the legislature, and these parties are aware of the potential for a market backlash if they fail to pass reforms. The legislature
is already demonstrating its willingness to act independently of the administration. On March 27 2019, the Chamber of Deputies
overwhelmingly passed a constitutional amendment limiting the executive's authority to alter federal budgets in consecutive votes of
448-3 and 453-6. The amendment now goes to the Senate. Over the coming weeks, we believe legislative leaders will become more
assertive in driving pension reform, which will both keep alive the path to enactment while also watering down many of its previsions.

The administration's policymaking will become increasingly reactionary. Bolsonaro has forgone the typical practices of distributing cabinet
positions to leaders of other parties in order to create alliances, instead assembling a cabinet with little political experience, few ties to
Congress and varying political objectives. Moreover, he often pronounces policies without consulting or coordinating with other members of
his administration and frequently backtracks. As a result, his core constituencies – evangelicals and other cultural conservatives, the military,
economic liberals and anti-corruption advocates – lack confidence that their goals are being advanced by the administration.

To ensure that their goals are accommodated, many of these constituencies appear prepared to publicly threaten to withdraw their support.
This will force Bolsonaro's decisions to be driven by the short-term need to please restive constituencies. It will also reduce his political
capital and exacerbate the lack of strategy, because ad hoc policy formation risks generating new tensions within his base. For example,
the administration initially withheld its proposal for military pensions and eventually released a proposal widely deemed to be generous,
prompting protest from legislators. At the same time, an anti-corruption effort led by Justice Minister Sergio Moro erupted into a public and
highly personal argument with Rodrigo Maia, the leader of the Chamber of Deputies, who is essential to passing pension reform.

BRAZIL – ECONOMIC OUTLOOK

Growth Outlook Weakening Amid Headwinds

Key View
• We at Fitch Solutions expect Brazil's cyclical recovery to continue over the coming quarters, driven by private consumption.
• However, we have revised down our real GDP growth forecast for 2019 to 2.0%, from 2.4%, in light of weakness in the mining and
industrial sectors and policy uncertainty.
• President Jair Bolsonaro's administration will struggle to enact comprehensive pension reform, which will keep investment subdued.

At Fitch Solutions, we maintain our core view that Brazil's cyclical recovery in economic activity will pick up steam over the coming
quarters. However, we have revised down our growth forecast for 2019 in light of headwinds facing the mining and industrial sectors,
and an earlier than anticipated weakening of business sentiment due to policy uncertainty that will limit investment growth. From 2.4%
previously (see 'Brazil's Recovery Will Pick Up, But Risks Remain', January 8), we now forecast real GDP growth of 2.0% in 2019. We remain
slightly below the Bloomberg consensus forecast, which has come down from 2.5% to 2.1% over the last quarter.

www.fitchsolutions.com Page 3
THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.
 Brazil | June 2019

Private consumption will continue to drive growth. A strengthening labour market, low interest Growth Constrained By Sentiment
Quarterly Real GDP Growth, % y-o-y
rates and positive sentiment is underpinning household's willingness to spend and take on
debt. While unemployment rose to 12.4% in the first two months of 2019, the labour market
added a net 489,520 formal jobs in the 12 months through February, of which 207,452 were
added in January and February. Retail sales are among the economy's most consistent growth
areas, expanding by an average of 2.2% y-o-y in the six months through January. Moreover,
after a period of deleveraging, the household debt servicing ratio is near multi-year lows, at
19.8% overall in January and 17.4% when mortgages are excluded, supporting debt appetite.
Growth in credit to individuals is well outpacing growth in the corporate sector. However, we
see three major headwinds undermining the growth recovery over the coming quarters.

Source: IBGE, Fitch Solutions

First, mine closures will limit mining sector production following the deadly Brumadinho dam
collapse in January 2019. Our Mining team expects iron ore production to be stagnant as a
result of Vale's decision to suspend and close operations at several sites, and judicial and
legislative scrutiny raises the possibility of further production cuts. While production at other
sites will likely make up for Vale's production cuts, overall iron ore production growth will be flat.

Second, industrial production faces minimal investment and negative spillover from Consumer Optimism Underpinning Recovery
Consumption Indicators
Argentina. Despite a substantial improvement in business sentiment since the election of
President Jair Bolsonaro, industrial production growth has been in a broad slump. Although
production rose 2.0% y-o-y in February 2019, growth in the six months through February
contracted by an average 1.1% y-o-y. This largely reflects a sector holding back on investment
pending concrete progress on the policy reforms promised by the administration. Credit
to the corporate sector only emerged from a more than two year contraction in Q418.
Additionally, Argentina's deepening recession will crimp demand for Brazilian autos and
auto parts, a substantial setback for the industry.

Third, business sentiment is weakening earlier than we anticipated in response to the

Source: BCB, CNI, Fitch Solutions
Bolsonaro administration's political struggles. We have long expected that Bolsonaro
would significantly dial back his economic team's most ambitious reforms, particularly
a comprehensive pension reform, which we believed would disappoint investors and
limit growth (see 'Q&A: What Would A Bolsonaro Presidency Look Like?', October 18
2018). However, the administration's pension reform efforts have begun to languish
more quickly than we expected, as Bolsonaro has struggled to pull together a legislative
coalition, infighting has beset his administration and interest groups have organised strong
opposition. Investor sentiment is weakening, putting pressure on Brazilian assets and likely
depressing capital investments. Although we have revised down our interest rate forecast,
Gap Between Hard And Soft Indicators
we expect that the Banco Central do Brasil will raise its benchmark interest rate by 50 basis Industrial Production & Confidence
points over the coming quarters to limit pressure on Brazilian assets (see 'Disappointing
Pension Reform Will Lead To Rate Hikes In Brazil', March 21).

We believe that a minimal pension reform and other less controversial reforms will be enacted
over the coming quarters, which should buoy sentiment heading into 2020 and keep the
growth recovery broadly on track (see 'Brazil's Bolsonaro Will Struggle To Maintain His Restive
Coalition', March 29). We forecast real GDP growth to rise to 2.4% in 2020, reflecting a modest
improvement in investment. That said, we believe risks to our outlook remain weighted to the
downside given the possibility of a substantial erosion of investor sentiment. Over the coming
weeks, we will explore the potential implications of such downside scenarios. Source: CNI, Fitch Solutions

www.fitchsolutions.com Page 4
THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.
 Brazil | June 2019

BRAZIL – ECONOMIC OUTLOOK

Three Downside Risk Scenarios

Brazil's economy has been in expansion since Q117, after exiting its longest recession of Growth Dynamics Under Our Different Assumptions
Real GDP Growth Forecasts, % y-o-y
24 months. The recession was triggered by a sharp collapse in oil prices and a slowdown in
China, and was accompanied by a political crisis that saw the impeachment of then-president
Dilma Rousseff in April 2016. However, compared to previous economic expansions, the
current average growth rate is much weaker than in previous post-recession recoveries
(1.1% y-o-y currently vs 3.6% y-o-y). Inflation is also much lower on average compared to
previous cycles (3.5% y-o-y vs 7.1% y-o-y), and at 4.6% in March 2019, it remains within the
Banco Central do Brasil (BCB)'s target range (4.5±1.5%). In this analysis, we at Fitch Solutions
summarise our core view for the Brazilian economy in the coming years and explore three
downside risk scenarios that if triggered now would see lower growth and could drag
Brazil's economy into recession. These include:
Note: Represents stylistic outcomes of various scenarios.
Source: Fitch Solutions

• Scenario 1: EM volatility sinks Brazil into recession (30% probability)

• Scenario 2: Political stalemate & unrest causes a sharp slowdown (15% probability)
• Scenario 3: A new commodity price meltdown of 50% causes recession (10% probability)

Core View: Slow And Steady Recovery, But Bolsonaro Underdelivers

Since October 2018, our core view at Fitch Solutions has been that sentiment towards Inflation On The Rise Partially
President Jair Bolsonaro's administration would support Brazilian assets over the near term Due To A Weaker Currency
Inflation & Exchange Rate
given the anticipated policy reforms. Stronger financial markets would in turn support the
ongoing tepid economic recovery, but the likelihood of the administration under-delivering
on key economic reforms would dampen the economic outlook and disappoint markets
thereafter, and this is a view that is playing out (see page 3). The biggest challenge will be
around fiscal and pension reforms, as Bolsonaro may not have enough support in congress
to push them forward at a time when these reforms remain unpopular among the electorate.

We forecast real GDP growth to accelerate from 1.1% in 2018 to 2.0% in 2019, and average
about 2.2% out to 2021. We also forecast inflation to rise from an average of 3.7% y-o-y in 2018
to 4.5% at end 2019, and to reach 4.7% by end 2021. Based on the recovery in the economy and Source: Bloomberg, Fitch Solutions
the slight acceleration in inflation we forecast for 2019 and beyond, we expect the BCB to raise
the Selic rate to 7.00% by the end of 2019, from 6.50% currently, in order to address incipient
inflationary pressures, while also providing some support to the real given the ongoing volatility
across emerging markets (EMs). After the real sold off by 17.2% in 2018, we forecast the currency
to average BRL3.88/USD and BRL4.05/USD in 2019 and 2020 respectively. Higher Inflation Tends To Weaken Currency
Monthly Average Consumer Price Index &
Currency Performance During Recessions
Under three different downside risk scenarios, we believe that the initial slowdown or
recessionary period would likely be followed by a sluggish recovery. We would expect a
negative growth shock to further accentuate some of the existing structural constraints
that the country faces, which would limit growth over the coming years. First, higher levels
of public debt would reduce policy flexibility and likely weigh on overall growth. Second,
we believe that policymaking in the country would become even more challenging, given
already-high tensions between the left and the right. Third, Brazil's business environment
not only remains challenging, but has deteriorated slightly in recent years according to the
World Bank, which could depress private sector investment if the economy goes through
another weak patch. Source: Fitch Solutions

www.fitchsolutions.com Page 5
THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.
 Brazil | June 2019

Scenario 1: EM Volatility Sinks Brazil Into Recession (30% Probability)

We find some similarities between the current emerging market (EM) landscape and events in 1997 and 1998 when Asian economies and
Russia respectively were in crisis. At the time, Brazil ran a twin deficit of about 10% of GDP, and the country's import cover had fallen to six
months due to declining reserves. In response, the government allowed its currency to float against the US dollar, which eventually led
to a sharp devaluation of about 50% and resulted in Brazil seeking a USD41.5bn bailout package from the IMF. However, at the time, the
country did not fall into a technical recession.

Brazil's economy is structurally stronger now than it was then. While Brazil has a high level of government debt of 77% of GDP and a
fiscal deficit of 7.1% of GDP at end 2018, it now enjoys a flexible currency, much lower inflation (and hence interest rates) and much
higher reserves, equivalent to 26 months of import cover. Meanwhile, the current account deficit is narrower at 0.8% of GDP, smaller than
the average 2.0% deficit registered during the past two decades. The challenge is that trend growth is substantially lower nowadays,
providing less cushion to a slowdown in growth.

However, a substantial new rout in EM assets, similar to what we saw in Turkey and Argentina in 2018, would likely have multiple effects
on the Brazilian economy. We at Fitch Solutions would expect to see a sharp slowdown in growth as the currency would sell off and the
BCB is forced to raise interest rates. Importers would also get squeezed, undermining consumption and investment. Unless drastic fiscal
austerity measures are enacted, the fiscal deficit would widen, adding to public debt. In contrast to the 'Samba Crisis' in 1999, we would
expect the economy to contract in 2019 by between -1.0% and 0.0% y-o-y, but would not foresee the country needing to seek external
aid from the IMF. The mild recession would likely be over by the end of 2019 or early 2020 and would be followed by a tepid recovery. We
would expect such a scenario to play out in two broad phases:

Phase 1 – Currency Weakness And Inflation: The Brazilian real depreciated by 17.2% against the US dollar in 2018, and we at Fitch
Solutions believe that the exchange rate would likely push below BRL4.00/USD, and possibly sinking to as low as BRL4.20/USD on
average, a 10.7% depreciation from end 2018. Most of the stress would be expected in 2019, lasting between two and three quarters, as
was the case for Argentina and Turkey in 2018. Consequently, inflationary pressures would likely mount further due to FX pass-through
effects. We would expect inflation to rise to between 6.0% y-o-y and 8.0% from 4.6% in March 2019, although it would remain below the
average inflation rate of 9.4% seen in past recession cycles given that inflation is structurally lower than before.

Phase 2 – Higher Interest Rates And Mild Recession: The sell-off in the currency would reflect large capital outflows and would likely
prompt the central bank to raise interest rates in order to contain rising inflationary pressures and defend the currency. Under this scenario
we at Fitch Solutions would expect the BCB to raise the policy rate to the 8.00-11.00% range (above our core view of 8.00% by end 2020/2021)
in order to maintain a real interest rate of around 3.0-4.0%, which is approximately in line with the average real level that the central bank has
raised interest rates to in past recessions. The combination of capital outflows, a sell-off in the currency, and higher interest rates would slow
credit growth, which has only just started to recover from the 2015-2016 crisis. As a result, we would expect to see a decline in private sector
investment and private consumption. Given that both credit growth and economic growth currently lack momentum compared to previous
expansionary phases, we do not believe that it would take much to see the Brazilian economy fall back into recession.

We currently maintain a constructive view with regard to the broad commodity complex, which should limit the magnitude of the
recession as commodity exports account for almost 10% of GDP. Under this scenario we at Fitch Solutions forecast growth in line with
the average of previous recessions (-0.3%). That said, given the low base effects, real GDP growth could fall slightly deeper into negative
territory, somewhere between -1.0% and 0.0% y-o-y. Moreover, growth would likely fall more significantly if the broad commodity complex
underperforms our expectations, a risk we explore in Scenario 3. We believe that the performance of the economy would be worse than
the 1999 'Samba Crisis' when Brazil's economy slowed to 1.0% y-o-y growth on average between October 1997 and May 1999.

Scenario 2: Political Stalemate And Unrest Causes A Sharp Slowdown (15% Probability)
We expect that Bolsonaro will under-deliver relative to bullish market expectations with regard to the most important fiscal and pension
reforms, a view we have held since October 2018 and that is starting to play out (see 'Q&A: What Would A Bolsonaro Presidency Look
Like?', October 18 2018). However, the larger risk to our view is if a policy stalemate emerges and results in a much more 'strong-man' and
populist leadership approach, similar to what we have seen in Russia (Vladimir Putin), the Philippines (Rodrigo Duterte), Turkey (Recep

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THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.
 Brazil | June 2019

Tayyip Erdoğan) and Hungary (Viktor Orbán). This could lead to a weakening of Brazil's democratic institutions, an increased use of
military force and ultimately result in significant social unrest. The combination of a deterioration of economic momentum and a populist
government, which could be inclined to boost spending, could result in a low-growth, higher inflation, weaker currency and high interest
rate environment throughout the rest of Bolsonaro's first term until 2022. Such a scenario would weigh heavily on investors' perceptions
of Brazil and could result in a sharp sell-off in the currency and slower growth.

Phase 1 – Political Risk Would Rise On The Back Of Policy Missteps: Given Bolsonaro's self-admitted limited understanding
of economic policies and his preference for more nationalist and protectionist policies, we at Fitch Solutions see an elevated risk of
policy missteps that could reduce the prospects of his administration successfully implementing pension and fiscal reforms, as well as
curbing corruption. At the same time, another risk is the potential fracturing of Bolsonaro's relationship with his economic advisors and
congressional coalition, which could even weaken democratic institutions.

Against the current backdrop of a weak economic recovery and a volatile external environment for EMs, we believe that policy missteps
could lead to growing discontent that could eventually result in mass street protests. Given Bolsonaro's professed admiration for Brazil's
previous military dictatorship, we see the potential for military-led responses to crime and social unrest and looser gun laws. There is also
a risk that mass protests could be met with a forceful military response. This could result in greater social discontent and weaken the
security environment, particularly in the poorest regions, some of which tend to be more left-leaning politically.

Because markets have high expectations for Bolsonaro to deliver major progress on his economic pledges within his first year, a sharp
reversal in sentiment could begin in 2019 if any of the above risks were to materialise and cause policy paralysis. Foreign investment
would slow and we would expect to see a rise in capital outflows. Consequently, the real would likely depreciate and could weaken to as
low as BRL4.30/USD on average, spurring a sharp increase in interest rates.

Phase 2 – Wider Fiscal Deficits And Higher Debt To Weigh On Economic Activity: A political stalemate and financial market
weakness would start to feed through to the real economy. Given that the primary catalysts of this scenario are domestic, it would
unlikely be accompanied by weakness in iron ore and oil prices, which would help limit downside pressure on the economy. However,
if Bolsonaro's government failed to seek any form of moderate compromise, the slowdown could potentially persist for longer and the
economy could eventually fall into recession as it could get stuck in a weak equilibrium.

Under such a scenario, Bolsonaro could be tempted to push populist policies in order to boost his approval ratings, but also to try to
stimulate a slowing economy. Under this scenario, we see the government budget deficit widening to around 10% of GDP, from about 7%
in 2018, and government debt would continue to rise, counter to our core view for debt to plateau at 83% (from 77% in February 2019).
We believe that this could worsen the sell-off in Brazilian assets, particularly given that EMs remain exposed to the risk of a stronger US
dollar. Although the country would not necessarily fall into a recession, it could be caught in a weak equilibrium of lower growth, higher
inflation and a weaker currency, despite higher interest rates. Moreover, given the fiscal impulse, the current account deficit could remain
slightly wider. In order to improve the economic outlook in such a scenario, we believe that a dramatic policy U-turn would be necessary
to shore up investor sentiment and stabilise movement in Brazilian assets.

Scenario 3: A New Commodity Price Meltdown of 50% Causes Recession (10% Probability)
Brazil's economy has only seen a tepid recovery since March 2017, after it exited the recession caused by the slump in commodities
and stock market crash in China in 2015, and exacerbated by a domestic political crisis in Brazil. Given that the previous recession was
the most severe and longest in Brazil's recent history (24 months vs 12 months on average), and taking into account the current weak
growth dynamics, there is chance that a significant slump in commodity prices could induce another long and painful recession. In such
a scenario, quarterly real GDP could potentially contract by as much as 2.5% to 3.5% y-o-y at the worst point of the scenario. We believe
that the effects of such a commodity meltdown could be felt until late 2020 or early 2021.

We believe that the main channels through which such a recession would play out include a large contraction in exports and a sharp
decline in investment similar to what happened in 2015. The price of Brazil's main commodity exports collapsed between 2013 and 2015:
Brent crude and iron ore prices fell by about 70-75%, while sugar and soybean prices dropped by 60% and 45% respectively. Consequently,

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 Brazil | June 2019

the country saw the value of its exports contract by as much as 25% y-o-y in 2014 and quarterly real GDP growth contracted by an
average of 3.4% y-o-y between March 2015 and December 2016.

Phase 1 – Commodity Prices Collapse Dragging Brazil's Exports Down: Against the backdrop of rising global trade uncertainty,
a slowdown in global trade and rising risk aversion could result in a scenario in which broad commodity prices see a decline of about
50% between 2018 and 2020. Given Brazil's reliance on commodity exports, it would not be surprising to see exports contract again by
approximately 15-25%, as was the case in 2015. Such a scenario would likely see a sell-off of Brazilian assets as capital leaves the country
and the Brazilian real would tumble once again, possibly reaching new lows around the BRL4.50-4.75/USD range. This would mark a
sharp depreciation of about 20% from current levels, although less of a sell-off compared to the 2014-2015 recession when the real lost
almost half of its value.

Phase 2 – Exports Contract, Economy Slows, But Current Account Deficit Narrows: Over the past decade, there have been
two episodes in which Brazilian exports contracted significantly. First during the great financial crisis in 2008/2009 as global economies
collapsed, and second in 2013/2014 when oil prices stalled and then dropped. Contracting exports dragged down growth. We believe that
real quarterly real GDP could contract between 2.5% and 3.5% on a year-on-year basis in the worst quarters of the recession, roughly in line
with the previous -3.4% average recorded during the last recession. That said, the recovery following the recession would likely be slightly
stronger than under the other scenarios given the potential for a bigger output gap to emerge, as well as year-on-year base effects.

While this scenario would probably mark one of the worst economic episodes in Brazil's history, we believe that the commodity meltdown
would also negatively impact other commodity exporting countries. On a relative basis compared to some of its peers, Brazil appears
relatively shielded against external shocks as its external accounts remain stable with a healthy stock of foreign reserves, modest levels
of external debt and only a small current account deficit of 0.8% of GDP as of February 2019. Furthermore, as noted in Scenario 1, we
would expect the current account deficit to eventually narrow and potentially flip into a surplus as imports would likely contract more
than exports. During the previous commodity-led recession in 2015, Brazil's external finances started to improve a year ahead of the
improvement in real GDP growth.

BRAZIL – DATA & FORECASTS

2015 2016 2017 2018e 2019f 2020f 2021f
Population, mn 205.96 207.65 209.29 210.87 212.39 213.86 215.28
Nominal GDP, USDbn 1,799.9 1,797.1 2,053.1 1,867.8 1,872.4 1,919.3 2,000.6
GDP per capita, USD 8,738 8,654 9,809 8,857 8,815 8,974 9,293
Real GDP growth, % y-o-y -3.5 -3.3 1.1 1.1 2.0 2.4 2.3
Industrial production, % y-o-y, ave -8.2 -6.4 2.5 1.2 3.0 3.1 3.1
Consumer price inflation, % y-o-y, ave 9.0 8.8 3.5 3.7 4.5 4.7 4.7
Consumer price inflation, % y-o-y, eop 10.7 6.3 2.9 3.7 4.2 4.7 4.6
Central bank policy rate, % eop 14.25 13.75 7.00 6.50 7.00 8.00 8.00
Exchange rate BRL/USD, ave 3.33 3.49 3.19 3.66 3.88 4.05 4.16
Exchange rate BRL/USD, eop 3.96 3.26 3.31 3.88 4.00 4.11 4.22
Budget balance, BRLbn -613.0 -562.8 -511.4 -487.4 -462.0 -438.3 -398.2
Budget balance, % of GDP -10.2 -9.0 -7.8 -7.1 -6.4 -5.6 -4.8
Goods and services exports, USDbn 223.9 217.8 251.7 273.1 287.7 299.1 305.1
Goods and services imports, USDbn 243.1 203.2 221.5 253.4 277.0 293.5 307.1
Current account balance, USDbn -54.5 -24.0 -7.2 -14.5 -25.4 -31.6 -40.7
Current account balance, % of GDP -3.0 -1.3 -0.4 -0.8 -1.4 -1.6 -2.0
Foreign reserves ex gold, USDbn 356.5 365.0 374.0 374.7 401.0 409.0 417.2
Import cover, months 17.6 21.6 20.3 17.7 17.4 16.7 16.3
Total external debt stock, USDbn 543.4 543.3 543.0 515.5 499.2 488.1 486.5
Total external debt stock, % of GDP 30.2 30.2 26.4 27.6 26.7 25.4 24.3
Crude, NGPL & other liquids prod, 000b/d 2,527.0 2,614.1 2,732.7 2,694.3 2,775.6 2,899.4 2,978.6
Total net oil exports (crude & products), 000b/d 458.9 599.6 691.7 693.5 731.3 821.3 868.3
Dry natural gas production, bcm 20.4 20.6 23.8 21.7 22.2 22.7 23.4
Dry natural gas consumption, bcm 42.4 36.6 37.3 35.4 35.8 37.1 37.5
e/f = Fitch Solutions estimate/forecast. Source: National sources, Fitch Solutions

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THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are
solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.