Analysts at Brown Brothers Harriman explained that after having a terrible 2015, 2016 does not look to be much better for Brazil. Key Quotes: "It’s gotten a bit of a breather lately, but a toxic mix of heightened political risk, ongoing recession, and institutional paralysis is likely to continue taking a toll on Brazilian assets." Economic outlook The economy remains in terrible shape. GDP is forecast by the IMF to contract -3.5% in 2016 and then remain flat in 2017 vs. an estimated -4% in 2015. GDP fell -4.5% y/y in Q3, which was worse than expected. The net impact on the economy of the upcoming Olympic Games is unknown, as the tourism outlook has been hurt by the spread of the Zika virus. Overall, we think the risks to the growth forecasts are to the downside. Price pressures are picking up, with IPCA consumer inflation rising 10.84% y/y in mid-February. This is the highest rate since November 2003, and further above the 2.5-6.5% target range. With most measures of wholesale and consumer inflation still accelerating, this suggests that the next move in rates should be up. Yet the central bank has been on hold since its last 50 bp hike to 14.25% back in July 2015. While the bank reversed its earlier signal that it would resume the tightening cycle, we do not see an easing cycle in 2016. However, the weekly central bank survey shows expectations for 150 bp of easing in 2017. This is in line with the latest survey expectations for IPCA inflation to ease to 6% by end-2017 from 7.6% at end-2016. However, we see upside inflation risks and so the expected extent of easing may be overstated. Brazil was just downgraded by Moody's, which was long overdue. The agency cut Brazil two notches to sub-investment grade Ba2 (equivalent to BB) with a negative outlook. Moody’s has now caught up with S&P's BB, with Fitch now the outlier at BB+. Our own ratings model has Brazil at BB-/Ba3/BB- and so we feel that further cuts are warranted. Moody's move wasn't a huge surprise but it underscores the feeling that the rating agencies are on the warpath. This latest downgrade could actually push Rousseff into abandoning the fiscal reforms. We are not saying this is the base case, but the leftist wing of the PT could just simply ask "Why are we doing austerity now when we are still getting downgraded?" In other words, the PT may feel it has nothing left to lose now. We know there is an internal struggle between orthodox and unorthodox policymaking, and it’s not yet clear who the likely winner will be. Fiscal policy is a key concern. The government recently backtracked on its primary surplus target for 2016, instead requesting Congress to approve a -0.5% of GDP deficit. The primary deficit ended 2015 at -1.9% of GDP, while the nominal deficit was at -10.3%. We see little relief in 2016, with both deficits expected to remain high. Brazil just reported central government budget data for January at BRL14.8 bln. Consensus was for a BRL11.3 bln primary surplus. The 12-month total fell slightly to -BRL111.4 bln from -BRL115.8 bln in December. This hardly alleviates concerns about the fiscal outlook, but at this point, a lot of bad news has been priced in. Consolidated budget data will be reported Friday. Consensus is for a BRL17.8 bln primary surplus vs. -BRL71.7 bln in December. If so, the 12-month total would still increase to -BRL114.5 bln. This would be very negative for sentiment and Brazil's outlook. The 12-month nominal deficit is expected to widen to around -BRL648 bln, or -11.1% of GDP. The external accounts are in decent shape. This is due mostly to collapsing import demand from the ongoing recession, which has more than offset weaker exports due to lower commodity prices. The current account deficit shrank to -2.9% of GDP in January, and is seen at around -2.5% in both 2016 and 2017. FDI remains strong and so this will limit the reliance on hot money to finance the current account gap. Indeed, FDI now fully covers the current account deficit, something we haven’t seen since mid-2013. Foreign reserves have fallen to around $357 bln in January from around $375 bln in Q4 2014. The central bank has maintained its FX swaps program, but continues to refrain from direct FX intervention to support the real. Short-term debt/reserves and import cover (months of imports) remains at comfortable levels." For more information, read our latest forex news.