Itaú BBA - Local Assets Slide as the Global Mood Deteriorates

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Local Assets Slide as the Global Mood Deteriorates

February 3, 2014

The Brazilian economy in January 2014

The Brazilian economy in January 2014

In another tough month for emerging markets, Brazilian assets also depreciated. Economic difficulties in Argentina may negatively impact Brazil. The Central Bank extended the monetary tightening cycle. The government increased the primary budget surplus, but thanks to larger extraordinary revenues. Inflation is still a concern, despite a temporary retreat, while the current account deficit remained larger than direct investments. The government has begun a cabinet reform. In the spotlight for February are the GDP report, the meeting of the Monetary Policy Committee (Copom) and the announcement of the fiscal target.

Domestic assets drop during a tough month for emerging markets

In an environment of lower global liquidity and more risk to Chinese growth, emerging markets posted losses. In Brazil, the real weakened 3.6% against the U.S. dollar, while the five-year Brazilian CDS rose 6.5%, to 206 from 194. The Ibovespa fell 7.5% in local currency (10.7% in dollars).

Deterioration in Argentina may affect the Brazilian economy

Argentina is the third largest destination for Brazilian exports (after China and the U.S.) and the largest market for manufactured products made in Brazil. In 2013, the country bought 8% of Brazilian exports (USD 19.6 billion). Each 10% decline in exports to Argentina may shave 0.2 pp from Brazilian GDP growth in 2014, considering tighter financial conditions. The largest impact will be on the manufacturing industry.

Copom extends the tightening cycle

The Copom lifted the benchmark Selic rate by 50 bps to 10.50% p.a., in a move that was largely priced in but was bigger than we and most market analysts expected (25 bps). In the minutes released in the week that followed the meeting, the Copom described a stronger external scenario but a domestic situation that is more favorable in terms of inflation.

Primary budget surplus increases in late 2013

The primary budget surplus reached 91.3 billion reals in 2013, or 1.9% of GDP. However, a substantial part of the surplus was driven by atypical revenues, without which the primary surplus would have been equivalent to 1.0% of GDP. These revenues are unlikely to be repeated in the same magnitude in 2014, so the surplus will likely tend to decline, unless expenses retreat sharply. Therefore, we maintain our forecast for a primary budget surplus in 2014 at 1.3% of GDP.

IPCA-15 comes in below expectations in January, but it is set to increase

The mid-month consumer price index (IPCA-15) climbed 0.67% in January, below our call (0.82%) and the lowest of market estimates. The main deviation in relation to our forecast came from transportation, particularly airfares. The year-over-year reading fell to 5.6%, but we expect inflation to increase, driven by a weaker exchange rate and a tight labor market. Our inflation estimate for 2014 stands at 6.2%.

Current account deficit is still greater than direct investment inflows

The current account deficit reached USD 8.7 billion in December and USD 81.4 billion for the full year, or 3.7% of GDP, up substantially from 2.4% of GDP in the previous year. For 2014, a stronger global economy, moderate domestic activity and a weaker exchange rate should prompt a gradual decline in the current account gap. In 2013, foreign direct investment (FDI) added up to USD 64 billion (2.9% of GDP) and continued to be the largest funding source for the current account deficit, though no longer enough to fully cover the gap. For 2014, we estimate a drop in FDI to USD 50 billion.

Monthly GDP advances 0.2% in November

Itaú Unibanco monthly GDP (PIBIU) expanded 0.2% in November and 2.4% from one year earlier, driven by retail and agricultural and livestock activity. Construction, mining and oil exploration posted the worst performances of the month. The first signs available for December point to weakness. Coincident indicators for industrial production suggest a substantial contraction, while retail sales should also be softer. In this context, monthly GDP is expected to decline after four consecutive increases. Retail sales provided a positive contribution to monthly GDP in November. Broad retail sales (including vehicles and construction material) expanded 1.3%, topping market estimates after two months of disappointing readings. The performance was widespread across sectors. The first signs for December point to another increase in core retail sales but a drop in broad retail sales.

Cabinet reform takes off

The government announced the names of three new ministers: Aloizio Mercadante, currently the Education Minister, will be the new Cabinet Chief, replacing Gleisi Hoffmann, who will run for Paraná state governor; Henrique Paim, currently the executive secretary of the Education Ministry, who will replace Mercadante in his post; and Arthur Chioro, currently Health Secretary for the city of São Bernardo do Campo, who will become the new Health Minister, replacing Alexandre Padilha, who is expected to run for governor of the state of São Paulo. These announcements were expected. According to press reports, the government is set to announce more replacements in the coming weeks.

What’s Next?

The fiscal target for 2014 is to be announced by February 20. There will be a monetary policy decision on February 26, when the Central Bank will likely increase the interest rate once again. The GDP report will be released on February 27, and we expect a gain of 0.6% on a quarterly basis.

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