Itaú BBA - The economy continues to recover

Brazil Review

< Back

The economy continues to recover

October 1, 2012

The economy continued to recover and inflation began to feel the impact of the surge in global grain prices.

The Brazilian economy in September 2012

The economy continued to recover and inflation began to feel the impact of the surge in global grain prices. The government announced a package to reduce electricity tariffs. The Central Bank reduced reserve requirements and signaled that the easing cycle is close to the end. The primary fiscal balance continued to decline, while balance-of-payments financing conditions remained easy. Asset prices rose again. The mensalão trial, the largest ever in Brazil involving corruption charges, advanced. The first round of municipal elections is scheduled for October 7 and the second round for October 28.

The economy continued to recover…

Several industrial indicators for August suggested that the recovery in production is now under way. Up to July, the upturn was mostly concentrated in the sectors that received government help, such as autos. Higher business and consumer confidence are further indicators of a rebound. Job creation continued to slow, but that was not enough to increase the unemployment rate, which fell further to a new record-low of 5.3% (seasonally adjusted). We forecast GDP growth to have accelerated to 1.2% qoq/sa in the third quarter, from 0.4% in the second quarter.

…and inflation began to feel the impact of the surge in global grain prices.

September’s IPCA-15 inflation preview came out above the consensus, at 0.48%, boosted by a 1.41% increase in food prices. The pressure from food will probably continue in the coming months, bringing the 12-month inflation reading to 5.5% by the end of this year, from 5.3% currently.

The government announced a package to reduce energy tariffs.

According to government estimates, electricity tariffs for consumers will fall by 16.2%, for commercial users by up to 20%, and for industrial users by up to 28%. Part of the decline in residential tariffs will come from the reduction in sector-specific taxes and part from the early renewal of concessions expiring between 2015 and 2017. The reduction in residential electricity rates will have a direct impact of -0.53 pp on consumer inflation; the indirect impact on inflation in 2013, if there is any, would be around -0.10 pp. Our scenario already incorporated part of the announced adjustment.

The Central Bank reduced reserve requirements…

The “additional reserve requirement” ratio fell to 0% from 6% for demand deposits and to 11% from 12% for time deposits. The Central Bank also increased the share of non-interest-yielding reserve requirements from 36% to 50%, and further stimulated larger banks to meet those requirements through the purchase of loan portfolios and debt from smaller-sized banks. The monetary authority estimates that the measure will free around 30 billion reais out of the 380 billion reais in total reserves.

…and indicated that the easing cycle is close to the end.

In its quarterly inflation report, the Central Bank changed its characterization of the balance of domestic risks to inflation from “favorable” to “neutral.” We still see a final 25-bp cut to 7.25% as likely, although chances fell a bit after the report. The Central Bank also emphasized that the neutral interest rate has declined, which suggests that the next tightening cycle will be small.

The primary fiscal balance continued to decline…

The central government recorded a primary balance of 1.6 billion reais in August, below the average of previous years when measured as a percentage of GDP. Both a cyclical slowing of revenues and a consistent pick-up in spending explain the smaller balance. Transfers to households account for the largest part of spending growth, although other expenditures such as capital spending and administrative costs accelerated too.

…while balance-of-payments financing conditions remained easy.

Foreign direct investment reached $5.0 billion in August, after an impressive $8.4 billion result in July. Year-to-date, FDI flows already amount to $43.2 billion, the second largest ever. In twelve months, FDI stands at 2.8% of GDP. Foreign inflows to the local equity market reached $1.3 billion, much higher than in previous months. The current-account deficit came in at $2.6 billion, slightly wider than expected but at a comfortable 2.1% of GDP in twelve months.

Asset prices rose again.

Domestic markets improved for a second month, on the back of a better global mood. The Ibovespa gained 3.7% both in local currency and in dollar terms. The five-year CDS fell to 112 bps, from 130 a month ago. The exchange rate continued to trade within a tight range and closed at 2.03 reais per dollar, almost unchanged from the previous month.

The mensalão trial, the largest ever in Brazil involving corruption charges, advanced.

A total of 38 defendants, including high-profile politicians, were accused of misusing public funds between 2002 and 2005. João Paulo Cunha, a former president of the Lower House, was found guilty. Other politicians will be tried next. The case is setting new, more rigorous, jurisprudence standards for corruption cases.

What’s next?

The first round of municipal elections is scheduled for October 7 and the second round for October 28. Polls indicate that a second round is likely in São Paulo. So far, the best-placed candidates are federal lawmaker Celso Russomanno (PRB), former mayor Jose Serra (PSDB) and former Education Minister Fernando Haddad (PT). Also, the next monetary policy meeting will take place on October 10.



< Back