Itaú BBA - Markets Stabilize, GDP Grows 2.3% in 2013

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Markets Stabilize, GDP Grows 2.3% in 2013

March 3, 2014

The Brazilian economy in February 2014

The Brazilian economy in February 2014

Financial markets have stabilized, with appreciation of the Brazilian real and a decline in country risk. The GDP for the fourth quarter of 2013 came in higher than expected. Economic activity, however, shows signs of weakness so far this year, with low business and consumer confidence and still-high industrial inventories. The hot, dry weather early this year affects the harvest and puts pressure on energy prices, adding uncertainty to the scenario. Inflation also continues under pressure. In this environment, the Copom continued the interest rate hike cycle, albeit at a more gradual pace than in previous meetings, and the government announced its fiscal surplus target for this year, trying to signal its more conservative approach to public spending. The government's approval rating slipped, but President Dilma Rousseff continues to lead the polls.

Markets stabilize after a turbulent January

After a turbulent start to the year, Brazilian financial markets stabilized in February. The real appreciated 3.8% during the month, helped by a less volatile external environment and positive market perception on the announcement of the fiscal effort in Brazil. Country risk fell by 17%, to 170 points from 206, while the Ibovespa decreased marginally by 1.1% in reais but increased by 2.8% in dollars.

GDP ends 2013 slightly above expectations...

Brazilian GDP grew by 0.7% in the fourth quarter of 2013, above our expectations (+0.3%). The highlight was the better-than-expected performance of the Industrial and Services sectors. On the demand side, the highlight was the moderate growth in gross capital formation during the quarter, despite several indicators showing a drop in investment. Based on these results, GDP was up by 2.3% at year-end 2013. This strong 4Q13 number limits the downside risk to our growth forecast for 2014 (1.4%).

...but business and consumer confidence slipped.

FGV's Industrial Business Confidence Index fell by 1.0% in February. This is the second consecutive monthly decline, following a slight recovery at the end of last year. A greater number of businesspeople assessed internal and external demand as weak and recorded an increase in inventories. Consumer confidence is also subdued. FGV's indicator retreated 1.7% for the month, the third consecutive monthly decline. The survey also reported a greater number of people indicating that employment is hard to get.

Unfavorable weather conditions creates uncertainties over the harvest and energy production

The unusually hot and dry weather observed until mid-February has been affecting the expected production of various crops (mainly coffee, sugarcane and corn) and reducing energy generation from hydroelectric power plants. The drought was followed by heavy rains in the Midwest region, affecting the soybeans and beans crops and bringing additional problems to corn. In our view, the risk of energy rationing is significant (depending on rainfall), and the use of thermal power plants will likely be even greater than in 2013 – which means higher costs for the industry and more pressure on inflation and/or public spending.

Unemployment rate remains at historical lows...

The unemployment rate stood at 4.8% in January, below our estimate and the market consensus (both at 5.1%). Seasonally adjusted, the unemployment rate reached 4.9%, the lowest level since the series started in 2002. The data show employment advancing at low rates. The unemployment rate, however, remains low as a result of limited growth in the labor force.

...and inflation still causes concern.

Inflation measured by IPCA-15 stood at 0.70% in February, slightly above our and market forecasts (both at 0.68%). Food away from home and electronic appliances surprised on the upside. With the result, the 12-month IPCA-15 rate rose to 5.65% in February from 5.63% in January.

The Brazilian central bank continues to hike interest rates, but at a more gradual pace...

The BCB increased the monetary policy rate (Selic) by 0.25 pp, to 10.75% per year. The decision to reduce the pace of interest rate hikes (from 0.50 pp in the previous meeting) was unanimous and was in line with our expectation. The easing volatility in international markets, low growth and the announcement of the fiscal target for 2014 probably explain the decision to slow the pace of monetary tightening. In our view, the post-meeting statement indicates that the hiking trends will likely continue. We expect a final 0.25 pp hike in April from the Copom, to ensure inflation stability (or decline).

...and the government tries to signal a more austere fiscal stance.

In its first budget revision for 2014, the government announced a BRL 44 billion cut in spending and reduced the surplus target for the consolidated public sector (central government, states, municipalities and state-owned enterprises) to 1.9% of GDP, below the previous target of 2.1%. The review signaled the government's intention to adopt a less expansionary fiscal stance this year. But there are risks to the implementation of the announced spending cuts, since part of the adjustment was on mandatory spending (including intra-budget transactions with no impact on the primary surplus). Moreover, official revenue projections were based on an above-consensus GDP growth forecast (2.5% for 2014).

External deficit shows signs of improvement

The service deficit shrank in January, as international travelling retreated, pointing to a gradual decline in the current account deficit. Still, the 12-month rolling deficit increased from USD 81.4 billion to USD 81.6 billion (3.7% of GDP). Foreign direct investments topped our estimate, but once again a relevant share was made up of intercompany loans, in addition to a large equity capital transaction. This supports our expectation of a gradual weakening of these flows ahead.

Government approval declines, but Dilma continues to lead polls

The CNT/MDA survey indicated a decline in the federal government's approval rating in the first weeks of February. Approval stood at 36.4%, compared with 39% in the previous survey, conducted in November 2013. Despite the lower approval rating for President Dilma, a survey of voters remained relatively unchanged, with 43.7% indicating they will vote for her (43.5% in the previous survey). Aécio Neves came in second with 17% (19.3% previously) and Eduardo Campos reached 9.9% (9.5% previously).

What’s next?

Markets will continue to monitor closely the fiscal and balance of payments numbers, and their impact on business and consumer confidence. The uncertainties about the energy sector also will continue to draw attention. There is no monetary policy meeting schedule for March.



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