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Food for Thought

April 11, 2014

Food and transportation costs boost inflation in March.

• Food and regulated prices brought fresh inflationary pressure: we increased our estimate for the consumer price index IPCA this year to 6.5% from 6.2%. For 2015, we increased our forecast to 6.5% from 6%, incorporating the need for increases in regulated prices. 

• We view the recent appreciation of the Brazilian real as temporary, but it may last longer than we expected. We changed our year-end estimate for the exchange rate to 2.45 reais per U.S. dollar from 2.55, and we maintained our call at 2.55 in 2015.

• The positive surprise in activity for 1Q14 does not change our forecasts for the full year. We maintain our GDP growth estimates at 1.4% in 2014 and 2.0% in 2015. Fiscal policy is still struggling to adjust: we maintain our forecasts for the primary budget surplus at 1.3% in 2014 and 1.7% in 2015.

• The Central Bank’s monetary policy committee (Copom) signaled the end of the tightening cycle. We forecast the benchmark Selic rate at 11% by year-end, but inflationary pressures could require an additional increase in interest rates in May (to 11.25%). We lifted our 2015 estimate to 12.50% from 12%.

Food and regulated prices brought fresh inflationary pressure: we increased our estimate for the consumer price index IPCA this year to 6.5% from 6.2%. 

Food and transportation costs boost inflation in March. The IPCA climbed 0.92% in March (0.69% in February), above our estimate (0.83%) and the median of market expectations (0.85%). The deviation in relation to our forecast was driven by a sharper increase in costs for food consumed at home (2.43% vs. an expected 1.85%). Foodstuffs are being pressured by the shock in agricultural prices caused by weather-related issues early in the year (drought and excessive heat). The largest upward contributions came from fresh fruits and vegetables, meat and milk. Year over year, the IPCA rose to 6.15% from 5.68% in February. In addition to foodstuffs, the transportation group also provided an important contribution, as airfares, fuel prices and owned vehicle increased. Our preliminary forecast for the IPCA in April, still pressured by food prices, points to a 0.83% hike, leading the year-over-year figure to 6.45%.

We increased our forecast for the IPCA in 2014 to 6.5% from 6.2%, as we incorporated some of the shock in food prices and an upward adjustment in our estimate for regulated prices. The sharp increase in agricultural prices led us to lift our estimate for the change in cost for food consumed at home this year, to 7.3% from 6%. Shortly before the impact caused by agricultural prices, this sub-group had advanced only 4.5% yoy. With greater pressure on the food group, we upped our estimate for market-set prices to 7.0% from 6.7% (7.3% in 2013). Our forecast for regulated prices was adjusted to 5.1% from 4.8%, with an upward revision in the estimate for electricity tariffs (to 9% from 6%), more than offsetting the reduction in the estimate for landline phone calls (to -4% from -1%). The recent strengthening of the Brazilian currency, if it lasts longer, may provide some relief in terms of inflation in the second half.

For 2015, we revised upward our estimate for the consumer price index IPCA to 6.5% from 6%, as we incorporated the need for increases in regulated prices. We now envision an 8% hike for regulated prices (vs. 6% previously), with larger increases for electricity tariffs, gasoline and urban bus fares. For market-set prices, we anticipate a 6.1% jump.

Agricultural prices climbed 6.2% in March, with an impact of 1.1 pp on the IGP-M for the month (1.67%). The hike in agricultural prices reflected the impact of adverse weather (drought and excessive heat in important farm regions). Bad weather conditions hurt the supply of fresh fruits and vegetables as well as pastures, increasing production costs for beef and dairy. Regarding beef, an additional source of pressure on domestic prices comes from rising exports due to scarcity in international markets.

We increased our 2014 forecast for the IGP-M to 6.8% from 6.4%. Considering more pressure on agricultural prices and their additional impact on food prices in the industrial and retail sectors, we increased our forecast for the IGP-M this year to 6.8%. For the IPA (producer price index, the component with greater weight on the IGP-M), we estimate a 6.9% increase this year, with industrial prices climbing 6.3% and agricultural prices advancing 8.5%. Expected price reductions for soybeans (grain and meal) and iron ore – items which have a large weight in the index – should prevent an even higher reading for the general price index. As for the other IGP-M components, we estimate that the consumer price index IPC could rise 6.3%, while the construction cost index INCC is likely to climb to 7.6%.

Exchange-rate appreciation is temporary but may last longer 

The exchange rate in March and early April held to the strengthening trend that began in February. The currency appreciation is related to a global movement of stronger emerging currencies, higher domestic interest rates and the perception by some international investors that certain Brazilian assets were excessively depreciated.

A stronger currency may help in the fight against short-term inflationary pressures. Recent statements by central bank directors and by Finance Minister Guido Mantega suggest that the government is comfortable with the recent exchange rate appreciation. The movement may also lead the central bank to limit its intervention in the market.

We see the appreciation in the Brazilian currency as temporary, although it may last longer. We maintain our view that U.S. yields will eventually resume an upward trend, driving the U.S. Dollar up globally. On the domestic front, a relatively-wide current account deficit, uncertainties involving economic adjustments ahead and the electoral calendar are key factors that we believe will cause the exchange rate to weaken again.

Our year-end forecast for the exchange rate was revised to 2.45 reais per dollar in 2014 and maintained at 2.55 in 2015.  We now expect the exchange rate to take longer to resume its weakening trend. We thus changed our year-end forecast to 2.45 from 2.55. For 2015, our call remains at 2.55. A weaker currency is important because it ensures a downward trend in the current account deficit in coming years.

The current account deficit over 12 months continued to widen in February, but there are signs of stabilization.  The current account gap was narrower than expected in February, but the deficit over 12 months increased to USD 82.4 billion (3.7% of GDP) from USD 81.6 billion. The deficit over 12 months was driven by a larger trade gap. The deficit in the service account was virtually stable from the previous month, as the deficit related to international travelling grew smaller. The move is consistent with recent exchange-rate depreciation and slower growth in the real wage bill.

In the capital account, faster inflows to the local capital markets stood out. FDI remains robust.  Foreign investment in the local capital markets was positive in February and picked up in March. The interest-rate differential is a key driver behind the recent increase in inflows, although inflows to the stock market also grew. Foreign direct investment (FDI) remains strong, with few signs of deceleration at the margin. FDI stands at 2.9% of GDP in the 12 months through February. Our forecast for 2014 is 2.4%.

Positive surprise in 1Q14 activity does not change expectations for the full year

We revised our GDP growth forecast for 1Q14. Industrial production expanded in the first two months of the year, back to the production level seen before a sharp decline in December. Retail sales also started the year growing strongly, largely boosted by high temperatures, which fueled sales of air conditioners, fans and beverages. Stronger-than-expected activity data led us to revise upward our forecast for GDP growth in 1Q14, to 0.3% qoq/sa (0% before).

However, there are signs of undesired inventory accumulation in the Manufacturing sector. The FGV Survey in March shows that the excessive-to-insufficient inventory ratio is close to the level seen in mid-2011, a situation that led to production cuts in the following months.  High inventory levels are spread across different manufacturing segments. Furthermore, confidence among entrepreneurs remains low, with further declines in recent months, suggesting that the positive surprise in industrial production early in the year was not matched by improved fundamentals in the sector. In the Retail sector, rising interest rates, slower growth in the real wage bill and declining consumer confidence indicate a more moderate expansion in sales ahead.

Broad dataset points to moderate growth in economic activity. Our economic activity diffusion index, which includes 48 indicators, has been declining, with the average for the three months through March nearing 46%. Our estimates show that dissemination in activity tends to define future GDP growth (with a lag of one to three quarters). Hence, the current low diffusion index is another sign that economic growth will be just moderate in the next quarters.

We maintain our forecasts for GDP growth at 1.4% this year and at 2.0% in 2015. The upward revision in our estimate for 1Q14 GDP was offset by lower estimates for the next quarters. The abovementioned fundamentals are compatible with this scenario. Uncertainties in the Electric Utility sector, which spur production costs and lower business confidence, are an additional downside risk to economic activity. Our latest forecasts stand at 0.2% for 2Q14 (from 0.4% previously), 0.4% for 3Q14 (from 0.5%) and 0.5% for 4Q14 (from 0.6%).

Ongoing power rationing risks. Despite the normalization of the rainfall levels since mid-February, affluent natural energy (ANE) registered only a modest increase and is currently 25% below the historical average for the period. Recent developments have raised the risk of a deficit in the nation’s energy balance and confirm a scenario of high thermal-power-plant usage for the foreseeable future. If thermal-plant usage remains near the levels recorded in March (14.2 GW average), we believe the previously-announced measures will be insufficient to cover distribution company costs in 2014.

Unemployment rate remains low, and wage gains accelerate. The unemployment rate was close to expectations in February (5.1%), but both the working population and the labor force disappointed. In our view, less job searching, particularly among youths aged 18-24, should keep the unemployment rate at historically low levels in coming quarters, even if job growth remains modest. With little slack in the labor market, wages continue to rise. The average real wage increased 0.4% mom/sa, after sliding 0.2% in January. The annual growth rate (based on the average for the past three months) accelerated to 3.3% in February from 3.1% in January. Change in the real wage bill (the working population multiplied by the average wage) edged up to 3.1% from 2.7%. However, this growth rate is about half of what we saw between 2010 and 2012, as there is no longer a positive contribution from the working population growth.

New non-earmarked loans were virtually flat in February. In real terms, the daily average fell 0.1% over January. Interest rates and spreads remained on an upward trend. The overall delinquency rate was unchanged, as a drop in delinquency rates for non-earmarked consumer loans was offset by higher delinquency in corporate non-earmarked loans and consumer earmarked loans. State-owned banks continued to widen their market share, reaching 51.8% in February (from 51.6% in January). However, annual growth in outstanding loans of state-owned banks slowed to 16.1% from 16.5% in real terms, extending the moderating process that began in late 2013. Private banks, which had been experiencing faster growth rates, decelerated to 1.4% from 1.6%.

Fiscal policy: short-term results are consistent with a primary balance below its target in 2014

Budget execution in the short term shows that it could be difficult to reach the target for the primary surplus this year (1.9% of GDP). The public sector’s primary balance stood at BRL 2.1 billion in February. Although above market expectations, this reading (as a share of GDP) is lower than the average for February in recent years.

In the first two months of the year, the public sector’s primary result stood at 2.7% of GDP, down from an average of 3.7% of GDP in the post-crisis period (2009-2013) and last year. On one hand, the fiscal performance of regional governments improved significantly early in the year, with the regional balance ending the two-month period at 1.6% of GDP (2009-2013: 1.3%; 2013: 1.1%). This improvement reflects a temporary increase in federal transfers (offsetting the sharp decline seen in December). The central government’s performance is still worse than its recent average: the federal primary balance year to date stands at 1.1% of GDP, vs. 2.5% on average in 2009-2013 and in 2013.

Despite slower growth in February, central government expenditures remain on an upward trend. In the past six months, central government real spending is up 8% in real terms, topping our estimate for potential GDP (2.0%-2.5%). Year to date, expenditures stand at 19.4% (2013: 18.4%).

Despite some changes in the breakdown of federal spending in the two first months of the year (e.g., a deceleration in transfers to households and resumption in spending on personnel), budget stimuli still seem geared toward consumption. Administrative expenses climbed 0.5%, to 4.0% of GDP, while personnel expenses rose 0.2%, to 4.4% of GDP. Subsidies including transfers to the Energy Development Account (CDE) also expanded (+0.1%, to 0.3% of GDP). Capital investments excluding the Minha Casa Minha Vida housing program increased 0.4%, to 1.4% of GDP. On the other hand, outlays related to Minha Casa Minha Vida declined 0.2%, to 0.4% of GDP. Transfers to households were stable, at 8.7% of GDP.

In the 12 months through February, the public sector’s recurring primary surplus (excluding atypical revenues and expenses) reached 0.91%, one of the lowest readings in the historical series (the unadjusted primary balance stands at 1.76%). In our view, fiscal results are below the level that stabilizes public debt (2.0%-2.5% of GDP), which indicates the need for budget adjustments ahead.

We maintain our forecast for public sector primary surplus at 1.3% of GDP in 2014, while the official target stands at 1.9%. We still think slow growth in economic activity will cause total public revenues to be lower than the official forecast by about BRL 30 billion (0.6% of GDP). Although we anticipate a smooth slowdown in federal and regional expenditures this year, we don’t foresee any big adjustment in outlays in the short term, which will likely weigh on the budget performance this year.

For 2015, we forecast the primary surplus at 1.7% of GDP. The increase in the fiscal effort next year should reflect an increase in the federal tax burden as well as slower momentum in central government spending. We also anticipate an improvement in the regional contribution to the public sector’s primary surplus in 2015.

The change in our year-end forecast for the exchange rate (to 2.45 reais per dollar from 2.55) implies a small downward revision in the nominal deficit and an increase in our forecast for the public sector’s net debt this year. The first effect is due to the central bank’s short position in currency swaps (short in U.S. dollars), as a stronger real reduces net interest payments by the public sector. The increase in net debt is driven by a smaller value in reais for foreign assets held by the public sector (basically, the central bank’s international reserves). We forecast the nominal deficit at 4.4% of GDP (vs. 4.5% previously) in 2014 and at 4.6% of GDP in 2015 (unchanged forecast). We expect net debt as a share of GDP to accelerate from 33.6% by the end of 2013 to 35.2% by the end of 2014 (vs. 34.7% previously) and 36.6% by the end of 2015 (unchanged forecast).

Government approval ratings slide, but President Rousseff still leads in the polls

Government approval ratings drop.  An Ibope survey showed that the percentage of voters who consider the government “great” or “good” fell from 39% in February to 36% in March, marking the lowest level since July 2013, when approval ratings dropped to 30%. A survey by Datafolha also put the approval rating at 36%.

Despite lower approval ratings, President Rousseff still leads in the polls. According to Ibope, Dilma Rousseff maintains the same 43% seen in the November survey, followed by Aecio Neves, who gained 1 pp to 15%, and Eduardo Campos, who has 7%. Datafolha captured a decline in Rousseff’s voter support to 43% from 47% in the simulation against Aecio Neves and Eduardo Campos. Despite the slide in the Datafolha survey, both surveys indicate that Rousseff would win the election in the first round. However, the share of voters who are undecided or wish to annul their ballots is still large, but it will likely narrow as the elections near.

Throughout the first half of the year, all political parties are entitled to unpaid slots on TV and radio stations. PSB, led by Eduardo Campos and Marina Silva, had its turn in March. In April, it will be Aécio Neves’s PSDB and, in May, Dilma’s PT. Pre-candidates are expected to formally announce their plans to run for president in coming months, but legal registration with the Electoral Supreme Court will occur only on July 5.

Copom: An end to the cycle, if allowed by food inflation 

The Brazilian central bank’s monetary policy committee decided in early April to raise the Selic rate by 25 bps, to 11.00%, as widely expected.

Importantly, the Copom changed the post-meeting statement to signal the end of the tightening cycle. Compared with the previous statement, the committee removed the expression “continuing the adjustment process” from the last statement and added “at this moment.” Both moves signal, in our view, the intention to end the tightening cycle briefly. The statement also added that the “committee will monitor the evolution of the macroeconomic scenario until its next meeting, to then decide the next steps on its monetary policy strategy.” Based on past Copom communications, we take this as a sign that the end of the cycle is near.

The higher food inflation may lead to an additional interest-rate hike. The statement and the minutes of the meeting left some room for another rate increase, if deemed necessary. The persistence of the current food inflation shock could lead to this scenario.

We maintain our call for the Selic this year and increased our forecast for 2015. In our view, the statement and the minutes of the last Copom meeting are consistent with our scenario, in which the Copom will maintain the Selic rate at its current 11.00% level (or 11.25%, at most) until the end of 2014. For 2015, inertia caused by higher inflation this year and the need for a bigger adjustment in regulated prices may require greater effort in monetary policy to keep inflation stable. Our estimate for the Selic rate by the end of next year was revised upwards, to 12.50% from 12.00%.

Forecasts: Brazil,


Source: IMF, IBGE, BCB, Haver and Itaú.

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