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Voting time

October 3, 2014

Recent data suggest a slow recovery in economic activity throughout 3Q14.

• Elections on October 5. Voters will choose the president, state governors, one-third of the Senate, plus federal and state representatives. Brazil has around 142 million voters; voting is mandatory for those aged 18 to 70, and optional for those aged 16 and 17, older than 70, and the illiterate. All ballots are cast using electronic devices. In order to be elected in the first round, the presidential or gubernatorial candidate must have more than 50% of valid votes (excluding blank and null votes). If this is not achieved, the two candidates with the most votes face each other in a second round, on October 26.

• We maintained our GDP growth forecast at 0.1% for 2014. For 3Q14, we estimate a stagnant GDP reading, due to the weak recovery in economic activity and the unfavorable statistical carryover. For 4Q14, we expect economic activity to normalize, prompting moderate growth in 2015 as well. 

• We increased our forecast for the IPCA consumer price index this year to 6.4% from 6.3%, due to a 0.10 p.p. adjustment in our call for September (to 0.47% from 0.37%). Our estimate contemplates increases of 6.6% for market-set prices and 5.7% for regulated prices in 2014. For 2015, our forecast remains at 6.4%, with regulated prices expected to rise 7.0% and market-set prices set to advance 6.2%.

• The primary budget surplus remains on a downward trend. We reduced our forecasts for the conventional primary surplus to 0.9% of GDP from 1.1%, and for the recurring primary surplus to 0.3% of GDP from 0.4% in 2014. 

• The central bank’s Monetary Policy Committee (Copom) kept the Selic rate at 11% in its September meeting, and continued to signal stable rates ahead. We believe that the benchmark Selic rate will remain unchanged, but see an upward bias if the weakening trend in the exchange rate is sustained. 

• A stronger U.S. dollar and lower commodity prices put pressure on most currencies in September, as already incorporated in our scenario. For now, we maintain our year-end forecasts for the exchange rate at 2.40 reais per dollar in 2014 (possibly weakening beyond that level) and 2.50 in 2015.

Still-slow rebound in economic activity 

Recent data suggest a slow recovery in economic activity throughout 3Q14. Our diffusion index (based on a broad dataset including business and consumer confidence, retail sales and credit demand) showed increases for 60% of its components in July, and should remain close to this level in August. Despite a widespread recovery in activity since June, overall growth in indicators has been insufficient to reverse the declines seen that month. For instance, broad retail sales (including vehicles and construction material) rose only 0.8% in July, after sliding 3.45 in June. Industrial production still has not caught up to its level in May, despite two consecutive readings of 0.7% growth in July and August.

After many years expanding faster than GDP, retail sales now weigh on the recovery. In July, core retail sales dropped 1.1%, disappointing our estimate and market consensus. Broad retail sales climbed 0.8% in July, not enough to rebound from a 3.4% slide in June. Both results imply a negative statistical carryover for 3Q14.

Economic fundamentals continue to point to weak activity ahead. Business and consumer confidence levels remain low. Confidence among executives in the manufacturing, service, retail and construction sectors declined in September. Meanwhile, consumer confidence increased slightly. Still, the trend seen in the past months is one of stability at a low level.

We maintain our forecast for GDP growth in 2014 at 0.1%. Recent data point to a gradual recovery in activity, but given the still-negative statistical carryover for several indicators, we continue to forecast stagnant growth in GDP in 3Q14. For 4Q14, we expect a more favorable statistical carryover. Combined with less uncertainty in the domestic scenario, this will contribute to a moderate reading of 0.5%. We thus forecast annual GDP growth of 0.1% in 2014. For 2015, we anticipate moderate growth of 1.3%, as some factors, such as investment, return to normal levels.

Unemployment rate rises 0.4% between April and August. For the first time since the April report, census bureau IBGE published information for all six metropolitan regions in the Monthly Employment Survey (PME). The unemployment rate increased moderately, to 5.0% in August from 4.6% in April, according to our seasonal adjustment. Despite the advance, the unemployment rate remains close to its lowest reading since 2002. The recent increase was produced by an expansion in the labor force and a slight decline in the working population. If the labor force resumes a faster growth pace, reversing the trend seen in recent months, weak economic activity should prompt a moderate advance in the unemployment rate in the next months. We thus maintain our year-end forecast for the seasonally adjusted unemployment rate at 5.4% (4.6% in the unadjusted series), slightly higher than in December 2013 (5.1% seasonally adjusted and 4.3% unadjusted).

Hydropower generation set to improve as the rainy season begins in October, but risks for 2015 remain. Hydropower generation remained below its historical average in September. Even the intense usage of thermal power plants was not enough to prevent another decline in reservoir water levels. The transition to the rainy season in October should provide relief to the operational difficulties caused by low reservoir levels in the Southeast/Center-West basin, but does not change the expectation of low reservoir levels in the end of this year and beginning of next year. Thus, the outlook of intense usage of thermal power plants for a prolonged period and power-rationing risks in 2015 still stands.

Slight growth in new loans in August. The daily average of new non-earmarked loans rose 3.2% mom/sa in real terms, which was not enough to offset the drop seen in July. The moderate pace of new loans reflects the cool-down in growth of total outstanding loans. Year over year, real growth in total outstanding loans slowed to 4.3% in August from 4.7% in July. Overall delinquency remained at 3.1%, but increased for non-earmarked loans granted to non-financial corporations (to 3.6% from 3.5%). The increase in earmarked loans (which typically experience lower delinquency rates) as a share of total loans contributed to the stability in the overall delinquency rate.

We forecast 6.4% increases for the IPCA in 2014 and 2015

We revised our forecast for the IPCA consumer price index in 2014 upward to 6.4%, from 6.3% in the previous report. The adjustment was driven by a revision in our estimate for the September reading, to 0.47% from 0.37%, mainly due to the higher-than-expected result in the mid-month index IPCA-15. Market-set prices (representing 77% of the IPCA) are set to advance 6.6%, after climbing 7.3% in 2013. Breaking down by component, food consumed at home is expected to rise 5.5% (7.6% in 2013) and services to advance 8.3% (8.7% in 2013). Regulated prices (23% of the IPCA) are estimated to increase 5.7%, vs. 1.5% in 2013, with most of the upward pressure coming from electricity tariffs, health insurance premiums and gasoline. We continue to forecast an increase around 5% for gasoline at the pump before year-end.

For 2015, our IPCA forecast remains at 6.4%. Compared with our expectations for 2014, we expect lower inflation for market-set prices and higher inflation for regulated prices, which are set to climb 7.0%, due to sharp adjustments in tariffs for electricity, water and sewage, and urban bus fares. These price adjustments may put pressure on inflation early next year for the following reasons: hikes in urban bus fares, which are usually concentrated in this period, and the adoption of a system known as bandeiras tarifárias – which implies changes in electricity tariffs according to the conditions for power generation, and should prompt an earlier-than-expected increase in tariffs – starting in January. Regarding the discounts on water tariffs through a program in São Paulo that was set to last just until the end of the year, the effect of their termination may not be felt immediately. We believe the program may be extended for a few more months, as reservoir levels need to recover. For market-set prices, we still anticipate a 6.2% advance in 2015, due to smaller increases for food consumed at home and service costs. Food prices should benefit from a still-favorable scenario for agricultural supply, especially grains, amid an outlook for plentiful crops and recovery of global inventory levels. Tame grain prices this year and next year should provide relief to prices charged for animal protein and wheat byproducts. Prices for private services are set to slow down due to the easing of the labor market and the real estate sector, with a likely moderation in wage and rental costs.

The IGP-M general price index rose 0.20% in September, after four months of deflation. This reading was lower than the lowest of the market estimates. The IPA producer price index – the component with the greatest weight in the IGP-M – advanced 0.13%, with increases of 0.14% for industrial prices and 0.10% for agricultural prices. Hence, the IGP-M is up by 1.76% year-to-date, while the year-over-year change slid to 3.5% from 4.9% in August. Current data suggest another moderate increase in October, with the year-over-year change receding to a little over 3%.

We maintain our forecast for the IGP-M in 2014 at 3.5%, given the relief in producer prices. The IPA-M producer price index should climb a little less than 2%, with advances of 2.4% for industrial prices and 0.5% for agricultural prices. The largest downward contributions to the IPA should come from soybeans (grains and meal) and iron ore, while the greatest upward contributions should come from beef and coffee. For the other components, we estimate increases of 6.4% for the IPC-M consumer price index and 6.9% for the INCC-M construction cost index. We expect the IGP-M to climb 5.3% in 2015.

Copom signals stable Selic, but the exchange rate is a risk

The central bank’s Monetary Policy Committee (Copom) kept the Selic rate at 11% in its September meeting, and continued to signal stable rates ahead. In the minutes of the meeting and in its Quarterly Inflation Report (IR), the Copom repeated that “if monetary conditions are maintained – that means, the strategy that does not include the reduction of the monetary policy instrument – inflation tends to enter in a trajectory of convergence to its target in the final quarters of the projection horizon.”

The Copom made it clear that the options are to keep or to raise the Selic rate. In an interview following the IR publication, Deputy Governor for Economic Policy Carlos Hamilton stated that Copom is currently considering whether to keep or to raise the Selic rate. According to Hamilton, the monetary policy will be adjusted in a timely fashion, if the inflationary outlook so demands.

We expect a stable Selic rate ahead, but the exchange-rate dynamics are a risk. We maintain our forecast that the Selic will remain stable at 11.0% until the end of this year. For 2015, the scenario is more uncertain. The realignment of administered prices and, most of all, the ongoing depreciation of the exchange rate, may demand additional tightening of monetary policy, even in a low growth environment.

Thus, the weaker BRL trend, if intensified and maintained in the medium term, induces an upward bias to our forecast of the Selic rate remaining steady at 11.0% in 2015.

Fiscal Policy: recurrent primary surplus turns negative

The primary fiscal surplus continues on a declining trend. In August, the public sector posted a primary deficit of BRL 14.5 billion in August, despite having relied on revenues of BRL 7.1 billion from Refis and BRL 5.4 billion from dividends paid by state-owned banks. Accumulated over twelve months, the conventional primary surplus decreased from 1.2% in July to 0.9% of GDP in August, while our estimate for the recurring primary surplus fell from 0.3% to -0.1%, moving into negative territory for the first time since the beginning of the series (2002).

The payment of part of the delayed mandatory expenditures weighed on the August result, but government costs (outras despesas de custeio) also picked up. Expenses with unemployment insurance totaled BRL 9.6 billion, which was BRL 5.2 billion higher than the average of August 2013 and 2012. Other capital expenditures totaled BRL 6.6 billion, which was BRL 3.3 billion higher than in August 2013, with the expenses of the Minha Casa Minha Vida program accounting for BRL 2.6 billion of this increase. Finally, the real growth in expenditures on social security benefits accelerated to 2.0% year to date, a pace that is more consistent with fundamentals (i.e. increase in the minimum wage and in the number of beneficiaries). We also observed a pickup in government costs, which accelerated from 5.7% in real terms year to date in July to 9.5% in August.

We revised our forecast for this year's conventional primary surplus from 1.1% to 0.9% of GDP and the recurrent primary surplus from 0.4% to 0.3% of GDP. The revisions are based on data released for August and the expectation of a lower volume of atypical revenues over the coming months. We still expect a slowdown in discretionary spending in the last months of the year and some recovery in tax revenues. The recurrent primary surplus accumulated over 12 months will have a positive base effect in the last months of the year, due to negative results posted in the same period last year (the recurring result from September to December 2013 was negative by BRL 7.0 billion). The same cannot be said about the conventional primary surplus, which at the end of 2013 was lifted by non-recurring revenues.

Public debt is on the rise. Net public sector debt rose from 35.4% of GDP in July to 35.9% in August. Year to date, the net debt increased by 2.3 pp of GDP. Gross general government debt rose from 59.5% to 60.1% of GDP from July to August and is up to 3.4 pp of GDP this year. Due to the drop in the primary surplus, the nominal deficit reached 4.0% of GDP in the twelve months ended in August (3.9% in July). We expect the increase in the cost of public debt financing to generate an upward trend in interest expenses over the coming quarters. This implies that, for the same primary surplus, the nominal deficit and the upward pressure on debt will be higher. In our assessment, the primary surplus required to stabilize public debt in the long term stands between 2.0% and 2.5% of GDP.

Real weakens on changes in the international scenario

The international scenario strengthened the U.S. dollar against the Brazilian real and many other currencies in September. The exchange rate depreciated beyond 2.40 reais per dollar for the first time since the beginning of the year. Although the U.S. Federal Reserve is committed to keeping the benchmark rate at low levels for a considerable period of time, the hike in interest rate forecasts for 2015 and 2016 was read as a leading indicator of normalization in U.S. monetary policy, pressuring several currencies. Sluggish data from China and a deteriorated outlook for commodity prices also contributed to weaken the real and other currencies.

We maintained our year-end forecasts for the exchange rate at 2.40 reais per dollar in 2014 and 2.50 in 2015. Recent moves confirmed our outlook for depreciation in the real this year and next year. In the next months, the exchange rate may weaken beyond 2.40 reais per dollar.

We revised our forecast for the trade balance in 2015 due to lower commodity prices. For 2014, we continue to forecast the trade balance at USD 2.5 billion, as the decline in exports is offset by an even sharper slide in imports. For 2015, lower prices for commodities sold by Brazil, such as soybeans and iron ore, led us to revise our estimate for the trade surplus downward to $7.2 billion from $10.3 billion.

The current account deficit narrowed to USD 5.5 billion in August. The decline in the current account deficit was driven by a reduction in the service deficit. Over 12 months, the deficit was stable at 3.5% of GDP. Foreign direct investment (FDI), however, was the biggest surprise, at USD 6.8 billion during the month. Over 12 months, FDI advanced to 3% of GDP from 2.8%. Our estimate for the current account deficit in 2014 was maintained, but we revised our call for 2015 to USD 77.4 billion (3.5% of GDP) from USD 74.4 billion (3.3% of GDP).

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