Itaú BBA - Monetary Tightening Closer to the End, Fiscal Result Still in Decline

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Monetary Tightening Closer to the End, Fiscal Result Still in Decline

December 6, 2013

Our estimates for GDP growth were reduced to 2.2% from 2.4% for 2013 and maintained at 1.9% for 2014.

•           Brazil’s Central Bank is nearing the end of the hiking cycle for interest rates. The change in communication by the Monetary Policy Committee (Copom) supports our scenario of just one more increase in the benchmark interest rate, of 25 basis points. We maintain our expectation that the Selic rate will be at 10.25% p.a. by the end of 2014.

•           The fiscal policy remains expansionary. However, due to high atypical revenues this year, we have revised our forecast for primary surplus to 1.8% of GDP, from 1.7%. For 2014 we maintain our forecast at 1.3% of GDP.

•           We have revised upward our estimate for the IPCA in 2014 to 6.0% from 5.9%, as our scenario contemplates a partial return of tax breaks for the auto sector. Our call for 2013 remains at 5.8%.

•           We maintain our exchange rate forecasts at 2.35 reais to the U.S. dollar by the end of this year and at 2.45 by the end of 2014.

•           Our estimates for GDP growth were reduced to 2.2% from 2.4% for 2013 and maintained at 1.9% for 2014.

Copom: Tightening cycle closer to the end

The tightening cycle continued in November. Once again, the Copom raised the benchmark Selic rate by 50 basis points, to 10% p.a., as widely expected.

However, the post-meeting statement surprised some in the market. After four meetings repeating the same statement, the Copom made two changes in the text. First, the beginning of the cycle was mentioned (“started in the April 2013 meeting”), which seems to be an indication that the hiking cycle is already longstanding. Second, the Copom withdrew the following sentence: “The Committee evaluates that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year.” In our view, by leaving out this sentence, the Copom may be suggesting that the goal of curbing inflation is largely ensured by the monetary tightening that has already been implemented.

It is our understanding that the changes in the statement signal that the end of the tightening cycle is near, although this intention is not being clearly indicated by using the wording that has previously been employed on these occasions. The minutes of the meeting reinforced this signal. Just-moderate economic growth and recent inflation readings may have weighed on the decision.

The signal that the end of the tightening cycle is near is in line with our scenario. We maintain our forecast of an additional 25-bp increase in the Selic rate in January, to 10.25%, a level that should be maintained at least until the end of 2014.

Fiscal policy: Still expansionary

The consolidated primary budget balance remains on a downward trend. The public sector's primary surplus stood at 6.2 billion reais in October, once again disappointing market expectations (9.1 billion reais). The balance equals 1.5% of GDP, the lowest for the month in the series (started in 2002). Over 12 months, the conventional (unadjusted) primary balance fell from 1.58% of GDP in September to 1.44%, the narrowest since November 2009. Meanwhile, the recurring primary surplus (i.e., excluding atypical revenues and expenses) dropped from 1.1% to 0.9%, a three-year low.

A widespread pickup in public spending. Central government expenses increased 10.7% year over year in real terms, confirming a pickup (re-)started in September, when outlays climbed 12.4% year over year. In the first eight months of the year, federal spending had increased about 5% in real terms. Administrative expenses and transfers are still responsible for most of the pressure. But spending on subsidies, personnel and investment also increased faster at the margin.

The accelerating trend in federal spending offsets the effects of a recovery in tax collection. In October, real net federal revenues (after transfers to regional entities) increased 3.7% year over year, boosted by tax receipts. In the past six months, core tax collection (i.e., administered by the Revenue Service) advanced 2.9% from a year ago in real terms, the strongest pace in about a year.

Signals of new fiscal-policy measures are still mixed. On one hand, the government withdrew its support to a bill that would change the index that adjusts debt held by state governments (against the central government). Passing this bill would lead to a reduction in the fiscal effort of regional entities of nearly 0.2–0.3% of GDP. On the other hand, the government was able to get Congressional approval for a clause in the 2013 Budget Law which exempts the central government from having to compensate results below the budget for states and municipalities. In practical terms, this clause, already valid for 2014, reduces the lower-limit of the adjusted fiscal target to 0.9% of GDP (from 1.8%). In all, these recent moves seek to (1) increase the fiscal target margin to reduce a bit the need to resort to (additional) non-recurring revenues in the end of 2013, and (2) prevent from measures that could further damage the fiscal situation next year.

Notwithstanding the disappointing fiscal performance of late, we are raising (by a tenth) our forecast for the 2013 primary budget surplus, to 1.8% of GDP. Our scenario for the last two months of 2013 includes approximately 43 billion reals (0.9% of GDP) in atypical or non-tax revenues (e.g., Refis tax amnesty program, Libra oil field concession, and dividends paid by state-owned enterprises). Our revised projection has 10 billion reals more in proceeds from the Refis, as compared to our previous forecast. We also estimate real average growth in tax receipts for November-December at 2.7% year over year. As per spending, we still expect public outlays to lose momentum in the end of the year, repeating a pattern seen in the average for the last five years. We estimate year-over-year real growth in federal expenses around 3% in the November-December period (January-October: 6.2%).

For 2014, we forecast a decline in the primary budget surplus to 1.3% of GDP. We expect weaker results from both the central government and regional governments (-0.2 p.p. for each). For the central government, we expect a surplus of 1.1% of GDP, reflecting real increases of about 4% for spending (2013: 6%) and 2% for tax revenues (after transfers to regional governments). We forecast a regional primary surplus of 0.2% of GDP.

Fiscal stance should remain expansionary. Our estimates indicate that the recurring structural primary result should run below 1.0% of GDP for these two years. According to our calculations, a primary result of around 2% of GDP is needed to stabilize the debt-to-GDP ratio, suggesting the need of fiscal tightening in 2015.

We have slightly increased our forecast for the IPCA in 2014

We forecast a 5.8% increase for the consumer price index IPCA in 2013. Hikes of 4% for gasoline and 8% for diesel oil prices at refineries did not change our expectation for consumer inflation this year. Their impact on the IPCA will be 0.11 p.p., with approximately 0.09 p.p. this year and 0.02 p.p. in January. In this scenario, market-set prices climb 7.2% (6.6% in 2012), while regulated prices advance 1.2% (3.7% in 2012). Core inflation measures remain close to 6% (average of core measures at 6.1% this year, vs. 5.8% in 2012).

Our call for the IPCA in 2014 was slightly revised upward to 6.0% from 5.9%. The adjustment was driven by a reassessment of our assumption regarding the IPI tax rate for automobiles. We now incorporate a partial return of the tax on passenger cars with 1000 cc engines, rising to 5% from 2% (we previously assumed the rate would stay at 2%.)

Inflation in 2014 should include a smaller increase in market-set prices and sharper hikes in regulated prices. We estimate that market-set prices will climb 6.5%, with some relief in food and service prices. For the sub-group comprising food consumed at home, the change in the prices should be modest (around 5.5%), given the outlook for more favorable supply conditions. We expect moderate deceleration in service prices, due to expectations of less tightness in the labor market, a smaller adjustment in the monthly minimum wage and some accommodation in demand. Regulated prices should rise 4.5%, without the effect of discounts in electricity bills (we assume that electricity costs will increase 5.5%, after a 16% tariff cut in 2013).

We have revised our forecast for the general price index IGP-M to 5.6% from 5.5% this year due to the larger and earlier hike of diesel prices than we expected. Producer prices (IPA-M) should rise 5.2%, with industrial prices increasing 8.1% and agricultural prices dropping 2%. As for the other components, we anticipate gains of 5.5% for the IPC-M and 8.1% for the INCC-M. Our estimate for the IGP-M in 2014 remains at 5.5%.

Exchange rate: Central Bank should keep intervening in 2014

We maintain our forecast for the exchange rate at 2.45 reais to the U.S. dollar by the end of 2014. In our view, 2014 will be another year of sharp volatility in the markets, possibly weakening the Brazilian real beyond this level. But once the main sources of uncertainty are resolved (monetary policy in the U.S. and the presidential election in Brazil), the currency should finish next year weaker than at the end of the current year (2.35 at year-end 2013, according to our call). Facing these factors, the Central Bank should continue to act beyond 2013 to prevent excessive fluctuation in the exchange rate. Recently, the BCB stated that the interventions program will be extended “with some adjustments”. As of the end of November, the central bank was short by USD 68 billion, or 18% of the nation’s international reserves.

The current-account deficit widened again in October, reaching USD 7.1 billion. After posting surpluses for two months, the trade balance had a deficit in October, fueling the current account gap. Spending on international travel and equipment rental is increasing month after month, widening the service deficit to USD 5 billion in October. On the funding side, foreign direct investment (FDI) stood at USD 5.4 billion, with 53% of the amount involving intercompany loans. This volatile component represents 32% of FDI entering the nation in 2013, up from 21% one year earlier. In the local capital markets, inflows fell sharply, to USD 196 million for fixed income and USD 204 million for the stock market (vs. USD 7.2 billion and USD 2.3 billion in September, respectively). For 2014, we maintain our expectation of a gradual improvement in the current account deficit, to 3.1% of GDP. Our forecast for 2013 was adjusted slightly, to 3.7% of GDP from 3.6%, as we incorporated the latest data.

GDP declined in 3Q13, but we anticipate a moderate rebound

After sliding in 3Q13, the economy should rebound in 4Q13. Indicators still point to a gradual recovery. GDP fell 0.5% qoq/sa in 3Q13. Declines in agricultural and livestock activity, and in investment were behind economic weakness between July and September. We expect a rebound ahead, with moderate growth during 4Q13. The latest information does not change the scenario of low confidence and high inventories, which, along with rising interest rates and less room for fiscal expansion, point to moderate economic growth.

Investment fell in 3Q13, breaking a sequence of gains. Gross fixed-capital formation dropped 2.2% qoq/sa in 3Q13, after three quarters of increases. Currency depreciation affected imports of capital goods, while rising interest rates and lower confidence started to impact demand for capital goods and construction projects. These factors should continue to influence the dynamics of gross fixed-capital formation in the following quarters. The latest data show that the perception of businessmen in the capital goods industry (FGV Survey) is that internal demand continues to decline.

GDP revision lifted slightly 2012 growth. We have reduced our forecast for GDP growth in 2013, but we have not changed our estimates for 2014. The revision in National Accounts had an impact of 0.1 p.p. on 2012 GDP growth (growth was revised to 1.0% from 0.9%), with near-zero impact in 2013. Taking into account the revision and the weaker than expected growth in Q3, we have revised our forecast for GDP growth in 2013 to 2.2% from 2.4%. For 2014, we maintain our forecast at 1.9%.

Working population shrinks again on a year-over-year basis, but unemployment does not increase. In October 2013, there were fewer people working (-87K) than in October 2012. It was the first decline since 2009, during the peak of the crisis. Moderate economic growth, higher wages and the outlook for modest growth ahead prompt adjustments in the labor market. However, despite the drop in new hires, the unemployment has not increased, remaining a little over 5.0% in October. The size of the labor force also decreased, particularly among youths. Despite a low unemployment rate, the outlook for consumer spending is less favorable. Deceleration of growth in the working population is slowing growth in the real wage bill, holding back gains in consumer spending.

New loans were weak in October. The daily average of new non-earmarked loans fell 4.5% mom/sa in real terms. But the decline cannot be read as a trend, because of the distortion caused by a strike by bank tellers in September and October. The credit stock of banks in the private sector sustained real annual growth of 0.7%. For state-owned banks, there was a slowdown to 17.0% from 19.3%, vs. an average of approximately 20% in the past year. Nevertheless, the market share of state-owned institutions recovered from a small drop in September, widening to 50.7% from 50.6%. Delinquency sustained the downward trend observed in recent months, falling to 3.2% from 3.3%, with declines in overdue payments for both earmarked and non-earmarked loans.

Raising approval ratings for the Rousseff government. According to a Datafolha poll carried out on November 28 and 29, 41% of respondents regard the government as excellent or good, a small increase from the survey released on October, when 38% shared this view. In July, after street demonstrations, approval ratings had fallen to 30%, the lowest since the beginning of the Dilma Rousseff administration. When simulating an election, in most scenarios Rousseff had enough votes to win in the first round, as she would get more votes than all the other candidates combined. But this result must be interpreted carefully, as the poll excludes blank and null votes and undecided voters, a share of respondents that is still quite high and should decline as the election approaches. Furthermore, the awareness of voters about the candidates is still mixed, hindering comparisons between them.

Infrastructure concessions advance. Airport and highway auctions were successful in the past month. Premiums in the concession amounts for the Galeão (Rio de Janeiro) and Confins (Minas Gerais state) airports reached 293% and 66%, respectively. There was also demand for auctioned highway stretches, with substantial discounts on toll fares. Some concessions are in progress, but others, such as those for ports and railways, are still being designed. With adjustments to make auctions more attractive, we believe concessions tend to advance, which would be a positive development for economic growth in the medium and long run.

Forecast: Brazil

Source: IMF, IBGE, BCB, Haver and Itaú


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