Itaú BBA - Recovery yet to come, more stimuli ahead

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Recovery yet to come, more stimuli ahead

August 1, 2012

Job creation moderated, confidence retreated, but credit rebounded in June. Inflation picked up again.

The Brazilian economy in July 2012

The economic recovery remained slow and narrow-based. Job creation moderated, confidence retreated, but credit rebounded in June. Inflation picked up again. The Brazilian Central Bank cut the benchmark interest rate by 50bps to 8.00% and signaled additional cuts. The primary surplus declined due to weak revenues given the economic deceleration and higher public spending. Capital flows were positive in June, following outflows in May. Financial markets improved while the exchange rate remained stable. There were some deals in the capital markets. The government announced plans to lower taxes on electricity.

The recovery is still slow and narrow-based. Vehicle sales rose sharplyin June (up 30% month-over-month), thanks to the IPI tax cut. However, most indicators show the economic rebound is still slow and narrow-based. National job creation decelerated again to a seasonally-adjusted 57 thousand in June, compared to an average of 117 thousand in the first quarter. In the five largest metropolitan regions, the working population contracted following a string of gains, according to IBGE, the census bureau. Confidence is receding due to uncertainties in the international scenario. In July, confidence among industrial companies fell for the second consecutive month, while consumer confidence, though still at a high level, slid for the third month in a row.

Credit rebounds in June. New consumer loans rose by 5.5% (adjusted for seasonality and inflation) while new corporate loans advanced by 1.6% during the month, marking a fifth consecutive increase. Once again, interest rates and spreads narrowed for companies as well as consumers. Delinquency retreated in nearly all categories, suggesting the upward cycle may be coming to an end. State-owned banks continued to gain market share.

Inflation picks up. Preliminary inflation indicators for July were higher than expected. The IPCA-15 was up by 0.33% (consensus was 0.18%, with the highest estimate at 0.25%), after rising by 0.18% in June. The main contribution for the increase came from the food group (0.20pp), in line with expectations. Though automobile prices still posted declines due to the IPI tax cut, the reading for the sector was higher than anticipated. Some services also caused surprise, particularly wages for household help, rentals and building maintenance fees, pushing service inflation up to 0.76% from 0.46%. The average of the three most used core inflation measures also advanced, reaching 0.39% in July from 0.25% in June. Year-over-year inflation for the headline index went up to 5.24% from 5.00%.

The Central Bank lowers the benchmark interest rate by 50bps to 8.00% and signals further cuts. In the statement accompanying the decision, the central bank disclosed its intent to continue to lower the SELIC rate “with parsimony”. The authority still understands that the external environment has a “disinflationary bias” and that the recovery in domestic activity has been “very gradual”. We continue to expect 50bp-cuts in the next two monetary policy meetings (in August and October), driving the SELIC rate to 7.00%.

Capital flows are positive in June, following outflows in May.The roll-over rate for medium and long-term external debt rebounded and hit 200%. The equity market recorded inflows of $150 million, after a sharp outflow in May ($2.4 billion). Foreign direct investment stood very strong, reaching $5.8 billion, and our preliminary estimate is for an even higher reading in July, of about $7 billion. Accumulated FDI over 12 months is at 2.7% of GDP, which is more than enough to finance the current account deficit of 2.2% of GDP. The trade balance posted a weak result in June ($807 million), due to lower crude oil exports, among other reasons. The trade surplus over 12 months retreated to $23.9 billion from $27.5 billion, and we expect it at $18 billion by year-end.

Primary surplus declines due to weak revenues given economic deceleration and higher public spending. The 12-month accumulated surplus, which fell in June to 2.7% from 3.0% of GDP, was the lowest since January 2011. Weak revenues and quickening expenditures, reflecting a slower economy and a fiscal policy response on the expenditure side, continued to reduce the primary surplus. We forecast a primary surplus between 2.8% and 2.9% of GDP in 2012, from 3.1% in 2011, assuming a recovery of the economy and, thus, of tax revenues, in the second half of the year.

Markets improve, stable exchange rate. The exchange rate remained relatively stable, ending July at 2.05 per U.S. dollar, compared to 2.02 in the end of June. The Ibovespa rose by 1.4% in dollar terms and by 3.2% in local currency. The 5-year CDS fell to 134bps from 153bps one month ago.

Some deals in the capital markets.Investment bank BTG Pactual sold its stake in STR Projetos, an oil and gas company which owns 91% of Petra Energia, for $345 million. French hotel chain Accor bought the operations of Mexico’s Posadas in South America. The $275 million-transaction included 11 hotels located in São Paulo and Rio de Janeiro.  Canada’s Public Sector Pension Investment Board invested $630 million in Isolux Corsán, a service provider to toll-road operators.

What’s next? The government announced plans to reduce taxes on electricity. According to Aneel, the national electricity agency, the priority is to lighten the tax burden on the manufacturing sector. Measures are expected to be announced by early September. Furthermore, all eyes will be on expected signs of a rebound in economic growth, in response to economic policy measures that were already implemented.

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