Itaú BBA - Global Growth Does Not Improve Domestic Outlook

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Global Growth Does Not Improve Domestic Outlook

January 17, 2014

Global growth is set to be faster than had been expected, tending to favor Brazil’s economy.

•           Global growth is set to be faster than had been expected, tending to favor Brazil’s economy. We see this factor acting to reduce downside risks to economic growth.

•           We maintained our forecasts for Brazilian GDP growth at 1.9% and for the trade surplus at USD 7 billion in 2014. We expect a wider current account deficit this year (3.5% of GDP, vs. 3.1% previously), as we reassessed some items in the service account, namely equipment rentals.

•           Given the uncertainties in the global and domestic scenarios, we changed our year-end estimates for the exchange rate in 2014 and 2015 to 2.55 reais per U.S. dollar (from 2.45). A weaker currency and higher inflation in 2013 led us to revise upward our inflation forecasts. Our estimate for the consumer price index IPCA in 2014 rose to 6.2% from 6.0%. On the fiscal front, we expect the consolidated primary budget surplus to reach 1.3% of GDP this year.

•           There are risks related to stronger global growth. If the expansion leads to tighter financial conditions, costs may come before benefits, particularly for the more fragile economies, which need weaker exchange rates and tighter fiscal and monetary policies to face the global scenario.

Downside risks to growth remain, despite improvement in the global economy

Weakening investment represents downside risk to GDP growth. Investment shows signs of weakness, in reaction to less favorable fundamentals, such as higher real interest rates, a weaker exchange rate and lower confidence levels. Production of capital goods fell 2.6% mom/sa in November and we expect another decline in December. Truck production, for instance, declined more than 20% in the final month of 2013 and should drag down the production of capital goods.


Still-high inventories also add downside risks to growth in early 2014. Industrial inventories, particularly in the auto sector, remain high, despite slow manufacturing output. If demand does not pick up, there will be more adjustments. Economic activity indicators are still compatible with 0.6% GDP growth in 4Q13. However, there is increasing downside risk to our 0.4% forecast for 1Q14. A weak kick-off hurts the outlook for the full year.

Improvement in the global economy moderates downside risks, but does not raise growth outlook. Global growth should be faster than expected, tending to favor Brazil’s economy. Exports may increase, confidence among industrial entrepreneurs tends to rise, the outlook for commodity prices may improve and investment may rebound. However, if long-term yields in developed nations, particularly the U.S., increase beyond expectations, the Brazilian economy may bear the impact of market volatility, capital outflows, a weakening exchange rate and rising uncertainty.

We maintain our 2014 GDP growth forecast at 1.9%. Downside risks arise from falling investment and high inventories, but better prospects for the global economy still sustain growth near 2.0%. In our view, the risks to the downside are still higher than those to the upside. GDP growth this year should be somewhat lower than our estimate for 2013 (2.2%). For 2015, we forecast GDP to grow 2.2%.

Employment remains low and concessions advance. The labor market is showing the same signs as before. There is a slowdown on course, fewer people are working, but the unemployment rate remains low (close to a seasonally-adjusted 5%), as fewer people look for jobs. The highway concessions continued to advance in the last month, as stretches of BR-040 and BR-163 were auctioned. The toll fares had discounts of 61.1% and 52.7%, respectively, to the maximum value proposed. In our view, these infrastructure concessions will be positive for economic growth in the long run, but the impacts on economic growth in 2014 should be negligible.

New loans increase in November. As the strike by bank tellers came to an end in mid-October, the daily average of total new non-earmarked loans recovered in November, rising 5.4% mom/sa in real terms. Consumer and corporate delinquency rates sustained a downward trend. Spreads narrowed, despite the increase in interest rates. The market share of state-owned banks increased to 50.8% from 50.6%, but growth in their credit stock is showing signs of slowdown.

President Rousseff’s approval ratings rise again. The percentage of the population that perceives the current administration’s performance as being “good” or “excellent” rose to 43%, from 37%, according to an Ibope poll published on December 16. This is the highest result since the street demonstrations in June, when approval ratings fell to 30%. An earlier poll by Datafolha showed an increase to 41% from 38%. Politicians are now preparing for the beginning of the election season, which is set to kick off with the deadline for the registration of presidential candidates in July. On December 16, José Serra announced that he will not be running for president, clearing the way for Senator Aécio Neves to become the PSDB candidate. Mr. Neves expects a final decision from his party by March. Pernambuco state Governor Eduardo Campos, of the PSB party, announced that he will leave his post on April 4 – the official deadline for him to be able to run for president in October.

A weaker exchange rate in 2014 and 2015

We changed our year-end exchange rate forecasts in 2014 and 2015 and now expect the currency at 2.55 per U.S. dollar (from 2.45 previously). Domestic and external uncertainties are bound to weaken the Brazilian real. Abroad, long-term yields in the U.S. could rise further if growth becomes stronger. The perspective of this scenario has already put pressure on the real. In the domestic front, there are uncertainties surrounding economic growth and the fiscal stance this year, which are also factors that pressure the exchange rate. Late last year, the central bank provided details on the swaps program, which will be in place "at least" until June. A total of USD 1 billion are being sold weekly (from USD 2 billion previously), and there are no longer scheduled auctions of dollar repo-lines. If all swaps are placed until June, the central bank’s derivatives position will be short by USD 100 billion, representing about 27% of international reserves.

The current account gap narrowed in November, as the service deficit declined. The current account deficit reached USD 5.1 billion in the month, down from USD 7.1 billion in October. In addition to a positive contribution from the trade balance, which swung from a USD 200 million deficit to a USD 1.7 billion surplus, the highlight was the decline in the service deficit. Net spending on travelling fell to USD 1.3 billion in November from USD 1.8 billion in the previous month, starting to reflect slower growth in the working population and the accumulated depreciation of the real exchange rate. Foreign direct investment (FDI) totaled USD 8.3 billion, out of which USD 4.1 billion were concentrated in the oil and gas industry, due to the signing fee related to the auction of the Libra field. With such significant flow, we revised upward our FDI forecast in 2013 to USD 63 billion from USD 60 billion. As for portfolio investments, foreign investors withdrew resources from the local fixed income market, after several consecutive months of all-time high inflows.

Trade surplus in 2013 totaled USD 2.6 billion, USD 16.8 billion less than in 2012. Exports fell slightly to USD 242.2 billion from USD 242.6 billion, but rising imports – to USD 239.6 billion from USD 223.2 billion – were the main reason for the decline in the surplus. Imports in all large sectors expanded over 4%, as fuels and lubricants stood out, climbing 15%. As output fell, crude oil exports declined by USD 7.4 billion and the balance for this commodity swung to a USD 3.4 billion deficit in 2013 from a USD 6.9 billion surplus in 2012. Pro forma exports of oil-drilling rigs also stood out last year, adding USD 7.7 billion to the balance (USD 1.5 billion in 2012).

We revised our forecast for the current account deficit in 2014 and 2015. On one hand, a weaker currency and stronger global growth would point to narrowing of the external deficit at a faster pace. On the other hand, some specific factors in the balance of payments have been showing risk pointing to a wider gap. For instance, equipment rentals in the services account: as the oil drilling activity expands, more rigs and platforms are being rented, and these rental payments tend to increase going forward. Also, we anticipate substantial declines in soybean and iron ore prices, in addition to much lower corn exports, due to a large crop in the U.S. As for manufactured products, there are uncertainties regarding Argentina’s trade policy and the number of oil-drilling platforms that will be formally exported. Faced with these different drivers, we expect the current account deficit at 3.5% of GDP in 2014 (3.1% previously) and at 2.9% in 2015 (2.8% previously). Without currency depreciation, the reduction of the current account deficit in 2015 from 2014 would be milder. The exchange rate has an impact on the current account with extended lags and the effect of this scenario with a weaker currency will show more clearly starting next year.

Our forecast for the trade surplus in 2014 remains at USD 7 billion. For 2015, we now expect USD 16 billion (USD 12 billion previously). In other words, we continue to see an improvement in external accounts, albeit more gradually.

2013 inflation and a weaker exchange rate increase our 2014 IPCA forecast

We revised our forecast for the IPCA in 2014 to 6.2% from 6.0%, driven by the revision in our year-end forecast for the exchange rate and by higher inflation in late 2013. A weaker exchange rate should put more pressure on tradable goods and raise inflation this year. Higher inflation in late 2013 increases the inertia and impacts price adjustments in 2014. However, inflation in January may be lower than one year earlier (0.86%), as food prices and airfares should behave more favorably.

Slowdown in activity prevents a faster advance in the IPCA, but it is not enough to reduce inflation. Slower economic growth has contributed to prevent sharper increases in inflation expectations and price pressures. But as long-term inflation expectations approach 6.0%, the current economic slowdown is not enough to bring inflation close to its 4.5% target. Still-tight conditions in the labor market, despite the slowdown in hiring, sustain inflation at high levels, particularly in the service sector. 

Milder increases in market-set prices and sharper hikes in regulated prices in 2014. Market-set prices should climb 6.7% (7.3% in 2013), thanks to some relief in price increases for food and services. Our estimate for regulated inflation stands at 4.5% (1.5% in 2013), as electricity tariffs will not be cut again this year. We assume an increase of around 6% for electricity this year, after a reduction of about 16% in tariffs in 2013. Gasoline at the pump should become 5.8% more expensive (6.5% in 2013).

Steep hike in service prices and above-target inflation expectations sustain inflation firmly around 6%. Inflation is resilient at around 6% (average of the past four years). Such resilience became stronger in recent years, given the pickup and resistance of service inflation at high levels. Service costs climbed 6.4% in 2009, 7.6% in 2010 and 9.0% in 2011, then stabilized at 8.7% in 2012 and 2013. As this group represents more than one-third of the IPCA (current weight of 35.5%), sustained and large price changes hinder the decline of headline inflation and ultimately contribute to consolidate market expectations for the IPCA above the 4.5% target (6% in 2014 and 5.5% in 2015). Recent pressure on the exchange rate and lack of alignment in some regulated prices also get in the way of the process to reduce inflation.

We have increased our forecast for the IGP-M in 2014 to 5.8% from 5.5%, also driven by the weaker exchange rate. Producer prices (IPA-M) should climb 5.5%, with industrial prices rising 6% and agricultural prices increasing 4%. We note that part of the currency pressure on the IPA should be cushioned by the expected price decline of some commodities, particularly soybeans (grain and meal) and iron ore. As for the other components of the IGP-M, we forecast gains of 6% for the IPC-M and 7.5% for the INCC-M.

Better fiscal results at the margin, but the stance is still expansionary

The consolidated primary budget surplus in November reached BRL 29.7 billion, the highest for the month since the beginning of the historical series. The figure was influenced by non-recurring revenues amounting to BRL 35.4 billion (0.8% of GDP), such as intakes under Refis (a program for refinancing corporate tax debt, totaling BRL 20.4 billion) and the signing bonus related to auction of the Libra oil field (BRL 15 billion). The November reading boosted the primary surplus over 12 months to 2.2% of GDP from 1.4% in October.

According to our calculations, the recurring primary budget balance (adjusted for atypical revenues and expenses) had a deficit of about BRL 6 billion in November. The recurring balance in 12 months remained stable at 0.9% of GDP, one of the lowest levels in the historical series. Such low fiscal effort (lower than the level of 2% of GDP needed to stabilize public debt in the long run) signals an even more expansionary fiscal policy. The recent path of public spending also shows large budget stimulus: spending by the federal government in the past six months expanded at a real average rate of 7.2% from one year earlier, exceeding the economy’s GDP growth trend (estimated at 2.0%-3.0%) and the current pace of tax revenue growth, around 2.5%.

In early January, the Finance Ministry anticipated by nearly one month the release of central government results, showing its concern with market perceptions of fiscal policy. The importance of such concerns increases given the possibility of a sovereign rating downgrade. Along with lower monetary stimulus in the U.S., this factor has been contributing to a pickup in funding costs for the public sector.

The anticipated announcement showed the central government’s primary budget surplus at around BRL 14 billion in December, implying the balance for the year is at 75 BRL billion – topping the central government’s adjusted target for 2013 (BRL 73 billion, or 1.5% of GDP). There are signs that the December balance was again reached with some extraordinary revenues (probably related to Refis) and delays in the effective disbursement of some expenses (leading to disbursement deferrals in late 2013). Available information for December is consistent with a consolidated primary balance of BRL 11 billion in the month and 1.9% of GDP in 2013.     

We maintain our forecast for the consolidated primary budget surplus at 1.3% of GDP in 2014. This estimate contemplates nearly half of the extraordinary revenues of the 2013 (around 1.0% of GDP). We also expect lower fiscal effort from regional governments (primary balance of 0.2% of GDP in 2014 vs. 0.4% in 2013).

There are risks to our estimate. On one hand, we again see upside to extraordinary revenues (for instance, installment payments under Refis in 2013). On the other hand, our basic scenario assumes a substantial slowdown in the real growth pace of federal expenses to 3.0%-4.0% in 2014 from 6.0-6.5% in 2013, due to slower growth in pension benefits (reflecting a lower adjustment in the minimum wage) and a sustainably-slow pace of execution of federal investments. The expectation of slower public spending may not materialize if economic policy is set to maintain a certain level of budget stimulus.

Copom: Extending the cycle

The Brazilian Central Bank’s monetary policy committee (Copom) raised the benchmark Selic rate by 50 basis-points to 10.50% in its January meeting. The decision was unanimous. The increase was larger than we and most market analysts expected (25 bps), but was mostly priced in by future markets. In our view, the 50bp-lift was driven by higher-than-expected inflation in 2013 and by the need to bring inflation to a declining path. 

The post-meeting statement added the expression “at this moment” to the statement released in the previous meeting: “Continuing the adjustment process of the basic interest rate, started in the April 2013 meeting, the Copom unanimously decided, at this moment, to increase the Selic rate by 50 bps to 10.50% p.a."

The decision to implement a new 50 bp-hike in the Selic was probably influenced by still-high inflation for market-set prices and by the fact that last year’s inflation came out above Copom expectation. In fact, when commenting the 2013 IPCA result, Central Bank Governor Alexandre Tombini recognized that inflation showed “slightly-greater resilience than anticipated.”

The inclusion of the expression "at this moment" was relevant. In previous occasions, the expression signaled a change in monetary policy in the near future. In our view, the Copom will reduce the pace of monetary tightening in the February meeting. Weaker economic activity early in the year may contribute to this decision.

After January’s decision, we changed our scenario for interest rates. We now expect a 25 bp-increase in the Selic in February to 10.75%, staying at that level until the end of 2014. For 2015 we see the need for further adjustment to ensure the downward trend of the inflation rate. We expect the Selic rate to reach 11.50% until the end of next year.

Forecast: Brazil


Source: IMF, IBGE, BCB, Haver and Itaú


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