Itaú BBA - Lower Growth and a Weaker Currency

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Lower Growth and a Weaker Currency

June 7, 2013

We reduced our growth forecasts to 2.4% in 2013 and 2.8% in 2014 (from 2.8% and 3.3%, respectively)

Following the release of a weaker-than-expected GDP in 1Q13, we reduced our growth forecasts to 2.4% in 2013 and 2.8% in 2014 (from 2.8% and 3.3%, respectively). As the U.S. dollar strengthens on a global level, we changed our call for the exchange rate by year-end to 2.07 reais per dollar from 2.00. 

• With higher current inflation and the outlook for a weaker currency, we raised our forecast for the consumer price index IPCA this year to 5.8% from 5.6%. We now expect a total adjustment of 150 bps in the benchmark Selic interest rate this year.

• We lowered our forecast for the trade balance in 2014 to USD 8 billion from USD 12 billion. Our call remains at USD 6 billion for 2013. Our estimates for the public sector’s primary budget surplus are unchanged at 1.5% of GDP this year and 0.9% of GDP in 2014.

Lower economic growth

GDP surprised negatively in 1Q13.The expected acceleration in growth did not materialize, even with a large contribution from agriculture. The economy grew 0.6% qoq/sa in 1Q13, matching the rate seen in 4Q12. Agricultural and livestock GDP advanced 9.7%, accounting for virtually all the expansion in GDP in the first three months of the year. The disappointment was concentrated in the service sector, which grew less, probably as a lagging effect of weakness in industrial activity and slower income gains.  

We cut our growth estimates for 2013 and 2014.We reduced our forecasts for GDP growth to 2.4% (from 2.8%) this year and to 2.8% (from 3.3%) next year (Macro Vision - We Revised Brazilian GDP Growth Forecast Down to 2.4% in 2013). After a negative surprise in 1Q13, we expect growth to pick up somewhat in 2Q13. However, the economy should go back to lower growth rates in following periods due to low business-confidence levels and slower productivity gains. Figures from recent quarters show that, despite all policy stimulus, the economy has not grown (even temporarily) above its long-term rates. This situation reinforces a scenario of slower productivity growth, even when cyclical factors are taken into account. Concession plans (highways, railways, airports, ports, oil exploration etc.), some of them advancing in the short term, may contribute to increase investment and to boost efficiency, which may improve potential growth in the long run.

Consumption slowed down while investment increased sharply in 1Q13. Consumption growth was below expectations in 1Q13. Slower real income gains, which were already behind a moderation in retail sales, are now probably hurting services demand as well. On the other hand, capital investment grew sharply. Credit expansion at subsidized interest rates played an important role in the acceleration of gross fixed-capital formation early in the year. Maintenance of the growth composition seen in 1Q13 – more investments and less consumption – would contribute to bring back sustained growth. However, business confidence remains at low levels and could curb investment growth ahead.

Credit market shows signs of deceleration. New loans slowed down in April, probably because of lower aggregate demand, but likely also due to deleveraging in some income brackets. New loans fell 0.5% yoy in real terms. The deceleration is more evident for non-earmarked corporate loans, possibly a consequence of slower expansion in economic activity. Replacement of non-earmarked credit with earmarked credit, which enjoys lower interest rates and has been increasing sharply, may also be contributing to slower growth in non-earmarked credit. Total delinquency in loans over 90 days past due remained constant, as delinquency in non-earmarked loans to consumers kept improving and fell for a fourth straight month, while delinquency in non-earmarked corporate loans rose 0.1 p.p., after four months of stability.

Dollar strengthens and sets new level for the exchange rate

As the dollar appreciated on a global level, the Brazilian real dropped 6.5% in May, and hit 2.15 per dollar. The prospect of an earlier-than-expected withdrawal of monetary easing measures in the U.S. lead to a worldwide strengthening in the dollar this month.

The Central Bank resumed interventions in the currency market and the IOF-tax was removed. Concerned about the impact on inflation,the Central Bank intervened through currency swaps, selling a total of USD 880 million in the market. Also, the government removed the 6% IOF-tax on foreign investments in fixed income, in force since 2010. We expect the strong dollar scenario to persist globally, but also the domestic currency weakening to be bounded by the concern with domestic inflation. We revised our forecast for the exchange rate, although it may remain in weaker levels in the short run, the Brazilian currency will reach 2.07 reais per dollar by year-end and to 2.10 by the end of 2014 (we previously estimated 2 reais per dollar for both periods).

Strong foreign-exchange flows were recorded in May, reaching USD 10.8 billion, with USD 14.1 billion in trade flows. The funds are probably related to high borrowing volumes during the month, adding up to USD 13 billion, with USD 750 million in sovereign-bond issues.

Current-account deficit reaches 3% of GDP. In April, the current-account gap stood at USD 8.3 billion, as the trade balance contributed negatively with USD 1 billion. The deficit over 12 months amounts to USD 70 billion or 3.0% of GDP. Foreign direct investment (FDI) surprised positively, reaching USD 5.7 billion, out of which 75% came from equity capital transactions. We maintain our forecasts for the current-account deficit at USD 75 billion and for FDI at USD 58 billion in 2013.

Trade surplus stood at USD 760 million in May, even with historically high contribution from soybeans exports. Crude oil exports rebounded slightly, but not enough to reach a surplus in the month (the result was a deficit of USD 335 million). Regarding the imports, the end of delayed registration of fuel imports stood out. We believe that the trade balance will improve over the year. As a result, we maintain our forecast for the trade surplus in 2013 at USD 6 billion. Our estimate for 2014 was reduced to USD 8 billion from USD 12 billion, as a consequence of revisions in our forecasts for exports of grains and mining products, in addition to price changes for Brazil’s main exports. With the change in our trade balance forecast, our call for the current-account gap in 2014 is now USD 83 billion.

More pressure on current inflation and a weaker currency prompt an increase in our forecast for the IPCA

Food prices should start to reverse the steep hike seen in recent months. The pass-through of lower grain prices and normalization of the fresh-food supply will contribute to cool down inflation in coming months. Tomatoes, potatoes and onions, which were responsible for a 64% lift in the item comprising tubers, roots and legumes between January and April, will enter a seasonally favorable period, thanks to dry weather and to the winter crop. This should ensure a material decline in prices until September, at the earliest. However, this drop should be less intense than in the past, as part of the recent price movement reflects more permanent effects, such as the reduction in the planted area and higher freight and labor costs. We anticipate an average monthly increase of 0.34% for the IPCA from June through October.

We raised our estimate for the IPCA in 2013 to 5.8% from 5.6%. Our scenario now incorporates more-pressured inflation at the margin and a weaker currency by year-end. Our forecast points to increases of 7.0% in market-set prices (6.6% in 2012) and only 2.0% in regulated prices (3.7% in 2012). Market-set prices ex-food should climb 6.3% (5.1% in 2012). The discount in electricity tariffs will be the main factor behind lower inflation for regulated prices this year, with impact amounting to -2.4 p.p. on the group and -0.6 p.p. on the IPCA. For 2014, our call remains at 6.0%, with market-set prices rising 6.5% and regulated prices advancing 4.5%.

Despite the lower headline IPCA in coming months, the underlying inflation should remain under pressure. Core inflation should run at around 6.0% in annualized terms. Despite sluggish economic growth, labor-market conditions should remain tight, pressuring services inflation. A tougher monetary-policy stance should bring favorable effects to inflation expectations. However, the increase in long-term inflation expectations in recent years will contribute to keep inflation at higher levels.

Monetary policy: Accelerating the fight against inflation

The Central Bank accelerated the pace of interest-rate hikes. The monetary policy committee (Copom) raised the benchmark Selic rate by 50 bps to 8.0% p.a. in its May meeting in a unanimous decision. The step signaled a more assertive stance by the committee in the fight against inflationary pressures.

Inflation resilience is at the core of public debate, government concerns and statements. Notwithstanding a recent decline, inflation remains under pressure and requires attention from the government and the central bank. The impact of tax breaks and the temporary decline in food prices have indeed reduced inflation, but less sharply than anticipated.

In public statements, Copom members are signaling greater determination in their fight against inflation. The goal is to “put inflation on a declining trend in the second half”, and “to ensure that the trend will continue next year.” The unanimous decision reveals a stronger commitment to curb inflation.

Our scenario contemplates a total 150-bp increase in the Selic rate. We expect an additional 50–bp increase in the next meeting and a final increase of 25 bps in August.

Fiscal policy: Heading toward a narrower primary surplus

Results for the public sector’s budget keep pointing to a reduction in the fiscal effort. The primary budget surplus stood at 10.3 billion reais in April, or 2.6% of GDP, below the average for the month since the collapse of Lehman Brothers (5.2%, for 2009-2012). The recurring primary balance, which excludes revenues and expenses that we regard as atypical, hit 1.45% of GDP accumulated in 12-months, the lowest in over two years.

Lower fiscal result reflects weak tax revenues and higher expenses. The sluggish recovery in central government revenues follows the high volume of tax cuts and the gradual recovery in economic activity. Furthermore, government outlays outpace trend growth, with administrative costs and transfers behind the increase in central government expenses. Considering that federal investment advances modestly, we conclude that budget stimuli through the expense channel seem to be directed more toward consumption than investment.

The government announced an initial budget adjustment (contingenciamento).On May 22, the government published the contingenciamento decree, blocking 28 billion reais in expenses written in the 2013 Budget Law. Revenues were also revised down by about 68 billion reais, out of which 20 billion imply lower transfers to states and municipalities.

The government signaled that the budget program will seek a lower primary balance. The government now estimates the public sector’s primary surplus at 2.3% of GDP in 2013 vs. 2.6% previously. This revision includes a greater use of fiscal target deductions via spending in the Growth Acceleration Program (PAC, its acronym in Portuguese) or via tax cuts. The leeway created by the deductions increased to 45 billion reais (0.9% of GDP) from 25 billion reais (0.5% of GDP).

Three elements suggest that the public sector’s primary result will fall short of the budget forecast. First, the assumption that the primary balance of regional governments will stand at 1.0% of GDP seems too optimistic, considering that the annual result has been hovering around 0.4% of GDP. Furthermore, there are incentives in place for states and municipalities to accelerate spending, particularly on investments, which seems inconsistent with a fiscal consolidation at regional level in the short term. Second, recent changes indicate that the central government will no longer be required to compensate below-budget results for states and municipalities, reducing the central government’s willingness to make precautionary savings or to seek mechanisms to ensure greater fiscal efforts by regional entities. Third, the budget law allows deductions from the 2013 fiscal target up to 65 billion reais (1.3% of GDP), suggesting additional room for the government to reduce the federal surplus to as low as 0.9% of GDP (official forecast: 1.3%).

We maintain our forecast for the public sector’s primary surplus at 1.5% of GDP in 2013. Basically, the gap between our forecast and the budget program stems from our estimate for the primary surplus of regional governments this year, 0.3% of GDP. Our scenario counts on central government’s real revenue growth around 2%, and a real spending clip close to 5%. In both cases, the growth rates are lower than in the newly revised official budget forecasts.

Oil field auctions could potentially prompt an upside surprise for the fiscal accounts this year. If such extra revenues top our estimate of 17 billion reais, the full-2013 budget reading may be slightly better. Further upside risk comes from the delayed negotiations about the change in the cost of regional governments debt owned by the central government. By the end of the day, the lack of agreement could reduce the pace of deterioration in the fiscal performance by states and municipalities. Downside risk for this year’s budget result stems from the (remote) possibility that the National Treasury loans more than the 4.5 billion reais signaled by authorities to the Energy Development Account (CDE, in Portuguese acronym), as part of the plan to reduce energy costs.

Forecast: Brazil

Source: IMF, IBGE, BCB, Haver and Itaú



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