Itaú BBA - Tensions subside

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Tensions subside

October 1, 2013

Signs of stabilization in the economy and in the FX market.

The Brazilian economy in September 2013

After weakening throughout the wave of protests in June and July, the economy is showing signs of stabilization. The exchange rate appreciated as the Central Bank initiated its dollar auction program, and the expectation around Fed's actions changed. Inflation remains under pressure, but the hike in interest rates and a more appreciated exchange rate reduce risks. Highway concession auctions started, but the result fell short of expectations. Dilma Rousseff recovered some ground on voting intention polls.

Signs of stabilization in the economy...

After weakening throughout the wave of protests, the economy is showing signs of stabilization. Core retail sales grew above expectations in July (1.9%, seasonally adjusted) and consumer confidence rebounded. With less tension in the markets, financial conditions improved. However, business confidence in the industry and services sectors remains low. The percentage of inventory deemed as excessive by industrial businessmen increased, and job creation is still slow. In any event, the trend points to a fourth quarter better than the third, which will probably post a negative result.

... and in the FX market.

The dollar auction program held by the Central Bank, the U.S. Fed’s decision not to reduce quantitative easing and better data in China led to the appreciation of the real. After reaching 2.45 per dollar in August, the currency ended the month at 2.23, having reached 2.20 on 9/19.

Inflation slightly lower, but still high ...

The IPCA-15 gained 0.27% in September, in line with our forecast and market expectations. As a result, annual inflation fell from 6.1% in August to 5.9% in September. Food prices retreated less than expected, but on the other hand, inflation of durable goods and services came in below estimates. The less depreciated exchange rate reduces the risk ahead, but the level of inflation remains high.

... should lead the Central Bank to keep hiking interest rates.

In its latest inflation report, the Monetary Policy Committee (Copom) of the Central Bank reinforced the current implementation strategy of tightening monetary conditions. The report brought inflation forecasts for 2014 at 5.7%, above expectations, in both the reference scenario (constant interest rates and exchange rate) and the market scenario (market forecasts for interest rates and exchange rates). Given current moderate growth and recent stability in the exchange rate, we maintain our expectation of higher interest rates. We forecast a 50 bp-hike in the Selic rate in the next Copom meeting in October, followed by a 25 bp-hike in the November meeting, ending the tightening cycle with the Selic rate at 9.75% p.a.

Fiscal stance remains expansionary

The public sector posted a primary deficit of 432 million reals in August, below our estimates (1.5 billion reals) and market consensus (1.6 billion reals). In the last twelve months, the primary fiscal surplus fell to 1.8% from 1.9% of the GDP. The recurring primary surplus – stripping out atypical revenues and expenses – fell by 0.1 p.p. to 1.4% of the GDP in August. This is the lowest result since February. The weak primary fiscal surplus is influenced by the poor performance from regional governments, tax breaks, slow economic recovery and spending growth ahead of trend GDP.

Highway concessions start, but interest was lukewarm

The Planalto consortium, composed of a group of companies in sectors related to construction and transport, was the winning bidder for the concession of federal highway BR-050 between Cristalina, state of Goiás, and Uberaba, state of Minas Gerais. The group presented a toll fee proposal of R$ 0.04534 per km, which represents a discount of 42.38% to the ceiling set by the government. However, contrary to expectations, there were no offers for BR-262, highway connecting Espírito Santo to Minas Gerais.

Dilma recovers some ground in the polls.

According to the IBOPE poll, President Dilma's voting intentions are rebounding, after a steep decline in June, month marked by popular protests across the country. The President reached 38% of electorate preference, compared to 30% in June and 58% in March. This recovery had already been signaled by popularity polls released in August. Marina Silva comes in second, with 16% of voting intentions. Marina, who had 22% in June, was the candidate who lost the most ground in recent months. Aécio Neves with 11%, and Eduardo Campos with 4% complete the poll. Dilma also wins in the runoff simulations.

The real appreciated, country-risk fell, the Stock Exchange went up

The exchange rate fell from 2.37 to 2.23 per dollar. The Ibovespa index rose 4.7% in reais and 11.3% in dollars. Brazil risk measured by the 5-year CDS fell 15% to 177.

Upcoming events.

October 5 is the deadline for potential candidates to the presidency to join or change parties, and new parties to be approved by the Superior Electoral Court. The date is crucial for candidate Marina Silva, who still awaits approval of her party, Rede Sustentabilidade. Data on economic growth in August and September will help complete third-quarter GDP estimates. The market will also be paying attention to the dynamics in the exchange rate market.

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