BRASILIA, May 11 (Reuters) - Brazil's worst recession in decades may be close to bottoming out as Vice President Michel Temer prepares to assume power with a market-friendly agenda and broad support to end a political crisis that has paralyzed the government for months.
Optimism that Temer will pare back state subsidies and restore confidence in the world's ninth-biggest economy has spurred a rally in Brazilian stocks and prompted economists to start raising growth forecasts for this year and 2017.
Brazil, once one of the darlings of the emerging markets, will see its GDP shrink 3.9 percent this year and grow only 0.50 percent in 2017, according to the median forecasts of about 100 economists polled last week by the central bank.
Although cold comfort for a country experiencing a surge in unemployment, downdraft in consumer spending and inflation of nearly 10 percent, it was the first time that the growth projections had improved in nearly a year.
Orchestrating a turnaround will be a daunting task for Temer. The 75-year-old leader of Brazil's largest party will take over from President Dilma Rousseff if the Senate, as expected, votes on Wednesday to put the leftist leader on trial for breaking budget rules.
Job losses are piling up at a record pace, and some analysts warn that the rallying Brazilian stock market - up about 40 percent in dollar terms in 2016 - reflects investors' wishful thinking after years of interventionism under Rousseff.
Still, a few green shoots sprouted in recent weeks suggesting the economy may be slowly turning a corner.
With economic output down 7 percent since 2014, companies have depleted excess inventories and labor costs have eased. Industrial production, now at 2008 levels, grew in March at the fastest pace in more than two years.
The inflation rate has fallen from a 12-year high, paving the way for the central bank to lower interest rates, currently near a 10-year high of 14.25 percent, in the coming months, according to economists' forecasts.
Consumer and business confidence, still at record lows, have shown signs of stabilizing.
"Things have stopped getting worse," said Walter Cover, president of Abramat, an association of construction materials companies, after reporting a 10-percent plunge in April sales from the same period last year.
A sharp depreciation in Brazil's currency, the real, over the last year has also helped reduce foreign competition and offered manufacturers some breathing room after two years of pain.
Brazil's current account deficit, a measure of the country's vulnerability to global shocks, narrowed by 70 percent in the first quarter from the same period a year before, spurred by falling imports.
But the economy is still likely to contract for a second straight year in 2016, making its recession the worst in more than a century. That follows a decade of prosperity that lifted almost 30 million out of poverty, according to the World Bank.
In February, a Reuters poll showed economists expected Brazil's economy to return to its pre-crisis size only in 2019.
Temer plans to move quickly if the Senate suspends Rousseff on Wednesday, proposing changes to Brazil's costly pension system and complex tax code, his aides said. He will also seek the privatization of state-run companies.
"A new administration under Michel Temer has a golden opportunity to engineer a turnaround in the Brazilian economy," said Marcelo Carvalho, BNP Paribas' chief Latin America economist, who raised his forecast for gross domestic product growth in 2017 to 2 percent from zero.
Expectations that Temer will succeed in approving reforms are central to Carvalho's forecast. Others are less optimistic as many of the proposed changes are unpopular and will need approval from a fragmented Congress.
Economists also warn that the economy, suffocated by high taxes and bureaucracy, will be unable to grow much faster without reforms. Brazil's potential growth rate has fallen to just 1.5 percent a year, very low for a middle-income country, according to Nomura economist João Pedro Ribeiro.
Fitch's downgrade of Brazil's credit rating deeper into junk territory last week served as a timely reminder of the enormous challenge facing Temer, who until recently was largely unknown to many Brazilians.
Temer risks a government shutdown within weeks if Congress does not change the federal budget target for 2016 to account for a massive deficit that could reach 1.6 percent of GDP before interest payments, according to the government's own estimates.
The options to plug that deficit - cutting spending or raising taxes - would limit growth by reducing demand, but may be an inevitable first step in restoring Brazil's investment-grade credit rating.
Temer's pick for finance minister, Henrique Meirelles, a former central bank chief beloved by investors, has said rebalancing the budget is "primordial" in order to regain investors' trust.
Regardless of any coming reforms, many businesses are still retrenching. Unemployment is expected to keep rising this year as companies shed about 100,000 jobs per month. As many firms strip down operations and restructure debts, banks are bracing for rising defaults.
During recent earnings calls, Itaú Unibanco Holding SA , Banco Bradesco SA and Banco Santander Brasil SA said they will continue to grapple with fallout from the recession well into next year.
Grupo BTG Pactual SA, though, said it may consider ramping up loan disbursements to corporate clients in coming months should the economy show stronger signs of revival.
"The new president will have a narrow window of opportunity of approximately three months to present concrete results," wrote José Faria, chief Brazil economist at Deutsche Bank.
"The economic cycle could help Temer, as the economy seems to be close to rock bottom."
Additional reporting by Alonso Soto, Guillermo Parra-Bernal and Juliana Schincariol; Editing by Daniel Flynn and Paul Simao