Itaú BBA - On hold for longer - November 2012

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On hold for longer - November 2012

November 7, 2012

Brazil: Slower Growth and Lower Interest Rates; European Policy Sluggishness, U.S. in Fiscal-Cliff Risk Mode

Global Economy
European Policy Sluggishness, U.S. in Fiscal-Cliff Risk Mode
European policy is back to its usual reaction mode. Without market pressure, Spain will keep postponing an aid request. In the U.S., the fiscal cliff is bound to persist into 2013. Meanwhile, global activity stabilized, but the recovery in Europe will be weaker

Slower Growth and Lower Interest Rates
A slower rebound in investment worsens the GDP growth outlook and Selic rate will likely remain low for a longer period

Do you Accept my Pesos?
The province of Chaco paid the service of domestic dollar-denominated bonds in pesos after the central bank refused to sell it dollars. A U.S. court decision raised further uncertainty on sovereign-debt payments. The economy rebounded during the third quarter

Labor Reform Back to Lower House
In spite of weaker activity, the odds of a rate hike increased. The labor reform bill took one step back, while the government pledges to submit to congress legislation that could ease foreign investment caps in some key sectors

Doubtful Slowdown
Chile's economy cooled down, but consumption continues growing very fast. Inflation was higher than expected in September, while core inflation continues running at the lower bound of the target range  

Managing the Flows
Boosted by domestic demand, economic growth is on the rise. But the speed of credit expansion and capital inflows is worrying authorities

Keep Moving
While the peace negotiations had a slow start, the country keeps moving forward with a new tax reform proposal

General Decline
Fading global optimism and higher supply led to falling commodity prices

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On hold for longer

European politicians are back to their usual sluggish reaction mode. Without market pressure, Spain prefers to wait, and European leaders make very little progress towards more integration. The ongoing uncertainty stymies a more robust recovery in the region.

In the U.S., President Obama has been reelected just after Sandy battered the East Coast. The aftermath of the storm will affect activity. The fiscal cliff risk will also be with us for longer. We continue to expect that, ultimately, only one-third of the measures will expire. Yet the uncertainty is likely to persist into 2013, with an agreement coming only by the end of the first quarter.

In Asia, the stabilization of activity in China is becoming clearer, while Japan keeps decelerating.

Most commodity prices fell in October as optimism about the impact of higher monetary stimulus in the G3 lost strength. The steepest decline came from the metal complex. Energy prices also fell due to both higher supply and lower demand growth prospects. Grain prices continued to fall, with markets pricing in the better-than-expected supply number in the U.S.

How will Latin American central banks respond to this scenario abroad? In our view, most will decide to postpone interest rate hikes further. We now expect the central banks of Brazil, Chile and Colombia to stay on hold for longer, including 2013. That was already our forecast for Peru. The only inflation-targeting country of the region where we still see rate hikes in 2013 is Mexico. In Argentina, various policies are unilaterally leading to higher interest rates.

In Brazil, growth looks weaker than we expected for this fourth quarter and points to a slower pace next year. In particular, companies are still cautious, putting off their investment plans. Firms remain worried about the international scenario and the consistency of the domestic rebound. 

The slower recovery coupled with tamed inflation, opens room for extending many of the economic stimuli into 2013. That applies not only to the interest rate, but also to the exchange rate, which we now expect to remain at current levels into next year.

Global Economy
European Policy Sluggishness, U.S. in Fiscal-Cliff Risk Mode
European policy is back to its usual reaction mode. Without market pressure, Spain will keep postponing an aid request. In the U.S., the fiscal cliff is bound to persist into 2013. Meanwhile, global activity stabilized, but the recovery in Europe will be weaker

European politicians are back to their usual sluggish reaction mode – the prominent feature of this debt crisis. Without market pressure, Spain prefers to wait and European leaders make very little progress towards more financial and fiscal integration.

It seems that Spain will ask for assistance from the ESM crisis fund only if it faces some degree of price pressure. Without ESM aid, the European Central Bank (ECB) won’t start buying Spanish bonds (through the so-called Outright Monetary Transactions – OMT). The delay is likely to push sovereign yields up, but it is unlikely to trigger the generalized financial stress of the past, because the OMT-ESM crisis-fighting framework provides a potent backstop. In any case, without actually triggering the ECB’s OMT, Spain’s yields will remain, in our view, higher than they would otherwise.

In addition, the persistent uncertainty and reform-delays postpone a more robust recovery in the euro area. The region already faces strong and prolonged headwinds from the significant fiscal and financial deleveraging in the periphery. Persistent political uncertainty only adds to the challenges. We lowered our euro-area GDP-growth forecast to 0% from 0.4% in 2013.

In the U.S., President Obama was reelected, while Sandy battered the east coast. The aftermath of the storm will affect activity. As a result, we revised GDP to 2.1% from 2.2% in 2012. However we maintained GDP at 1.8% in 2013 because the rebuilding efforts should compensate initial losses.

The fiscal cliff risk will also be with us longer. We continue to expect that, ultimately, only one-third of the measures will expire, with an impact equivalent to 1.2% of GDP. However the uncertainty is likely to persist into 2013, with an agreement coming only by the end of the first quarter.

In Asia, the activity-stabilization picture in China is becoming clearer, while Japan keeps decelerating. We revised output growth in Japan down to 2.0% from 2.4% in 2012 and to 0.7% from 0.9% in 2013. But, more importantly, recent data confirm the stabilization trend in China, albeit at a lower growth level. We maintain our view that the Chinese economy will expand 7.7% in 2013, slightly above our 7.6% forecast for 2012.


European politicians didn’t build upon the momentum created by the ECB. This is not a surprise and we have been here before. A generalized financial stress is unlikely to follow the politicians’ sluggishness. The possibility of a joint ECB-ESM intervention created a capable crisis-fighting mechanism. But Spain's reluctance to ask for aid and the difficulty in advancing with integration in the region remain as headwinds to the economic outlook.

On the integration front, leaders made little progress at the most recent European Union summit. They agreed to conclude the legislative framework for the Single Supervisory Mechanism (SSM) by January 2013. Operational implementation will then follow throughout that year. Although this implies that the SSM should be up and running by the beginning of 2014, no explicit commitment to a specific date has been made.

In some aspects, we have seen a setback in the past months. Back in June, EU leaders agreed to allow the ESM to directly inject capital into problematic banks once a SSM was in place. This created the hope that the ESM would eventually relieve Spain and Ireland of the burden of bailing out their banks. That is less likely now, as Germany and others oppose applying the new rules to “legacy assets.” In the end, it could be that ESM will only recapitalize banks that start to experience problems while being already under the supervision of the SSM.

In Greece, the situation remains delicate. Official creditors accept that the country needs more time to adjust. However, Greek debt has clearly become unsustainable again. The IMF recognizes this and is pushing the euro-area government to accept some form of debt haircuts. But European officials oppose it as politically unacceptable, at least for now.

In Spain, we now believe the government will likely continue to delay an aid request until it faces more immediate market pressure. The treasury was able to issue close to €10 billion ($12.9 billion) per month of bonds at an average yield below 4.5% in September and October (see graph). This monthly pace – if sustainable – would allow the country to fund itself in 2013 (Spain will need to issue between €100 billion and €120 billion of bonds next year). The average cost of 4.5% is only marginally higher than our estimation of the current implicit cost of debt of 4% (this also includes bills, which usually have lower yields.) The average duration of the recent bond sales remains low (4.4 years, versus  the outstanding portfolio’s 7 years), closer to the range where the ECB would act.

While the conditions described above persist, the Spanish government will feel less pressure to ask for a rescue. But we don’t believe that the benign environment would last if investors perceive the ECB is not coming. Timing the tipping point in investors’ patience remains tricky though; the current waiting game could last at most a few more months.

Meanwhile, we lowered our GDP forecast for the euro area to 0% from 0.4% in 2013. Interest rates to final private borrowers in the periphery are declining more slowly than we anticipated. Consumer and business confidence across the region is also failing to improve. Even if we expect the fiscal effort in the euro area as whole to decline to 0.7% of GDP in 2013 from 1.2% in 2012, the adjustment remains significant. And uncertainty about the size of fiscal multipliers warrants a more cautious approach. Taken together, these factors led us to see the economy stagnating next year.

We continue to foresee a 0.4% decline in GDP this year. Some one-off factors appeared to have pushed activity up in 3Q12. GDP could now be unchanged in that quarter (we previously expected a 0.2 decline). Since we expect a payback of most these gains, we have lowered our forecast for the fourth quarter and maintained the forecast for the year.

Finally, we are changing our call for the ECB from hold to additional monetary easing. This is likely to come in the form of a 0.25% cut in interest rates and occur in December of 2012. The ECB expects GDP next year to expand 0.5%. As the economy converges to our new scenario, we think the ECB will be encouraged into action. The central bank could cut the deposit and main rates, but since some board members appear reluctant to take the former to negative territory, the ECB could explore some form of quantitative easing focused on private-sector assets.


President Obama was reelected. The Democratic Party retained the majority in the Senate and the Republicans in the House of Representatives. The elections results have important immediate implications for the discussions relating the fiscal cliff. 

Before Sandy, activity data was broadly consistent with our scenario. Output increased at a 2.0% annualized seasonally adjusted rate (SAAR) in the third quarter, slightly above our expectations, but growth was revised down to 1.3%, from 1.7% in second quarter.

The storm disrupted energy supply in New Jersey and New York states (together these states account for 11% of U.S. GDP). It should trim real GDP annualized growth by 0.8pp in the 4Q12 (we now expect only a 0.8% SAAR over the previous quarter). Therefore we reduced our growth estimate to 2.1% from 2.2% in 2012. The negative wealth effect from capital stock losses (currently estimated at US$ 30 billion) should also have a negative impact to consumption and investment. However, we maintained our growth forecast at 1.8% in 2013, as the rebuilding efforts is expected to boost output in the 1H13 and to compensate for the initial losses.

Downside risks associated with the fiscal cliff are increasing. Ultimately, we foresee that two-thirds of the fiscal cliff will be rolled over, reducing the fiscal consolidation from 3.7% to 1.2% of GDP in 2013. But with President Obama reelected, and the split Congress, the negotiations will be complicated (for details, please refer to our Macro Vision – the Fiscal Cliff: Plausible Scenarios). 

And, even if our assumption of fiscal consolidation is correct, the fiscal multiplier could be much higher than we currently assume. Recent studies (see the paper co-authored by IMF chief economist Olivier Blanchard in the last World Economic Outlook) indicate that the fiscal multiplier has been in the range of 0.9-1.7 for developed economies since the financial crisis. Everything else constant, if we use the multiplier of 1, the fiscal drag would reduce GDP growth next year to 1.4% from 1.8% in our baseline scenario.

Moreover, we now believe that the fiscal-cliff impasse will extend into 2013. Politicians have little incentive to come to a compromise in the divided congress during the lame-duck session until the end of the year. Most likely they will be pressed to reach an agreement by March, when they will once again need to deal with the debt ceiling.

Fiscal-policy uncertainty might already be affecting investment decisions. Non-residential investment dropped 1.3% (SAAR) in 3Q12. Investment should resume growth in the next quarters as the uncertainty diminishes, financial conditions remain accommodative and consumption continues to grow. However, we cannot rule out that it will drop further if the current fiscal clouds persist. A further drop in investment should also have an impact on payrolls (see chart).

Consumption indicators (labor market, consumer confidence and credit availability) remained positive through October. But a renewed weakness in employment and prolonged period of uncertainty could also spill over to consumers’ spending decisions.


Recent data suggest, in a more consistent way, that the economy is stabilizing at lower growth rates. The GDP was up 7.4% in 3Q12 over the same period last year. The pace was in line with our expectations and only slightly lower than the 7.6% observed in 2Q12.

Additionally, activity indicators improved in September. Fixed-asset investments were up 22.2% yoy, rebounding from the 19.0% in August. The breakdown shows that infrastructure growth jumped to 22.9% yoy from 14.7%, although investment in manufacturing and real estate remains weak. Industrial production and retail sales expansion also picked up to 9.2% and 14.2% yoy, from 8.9% and 13.2%, respectively.

Government officials continue to signal only limited stimulus measures. The focus of these measures remains on the fiscal side, such as moving up already planned investments. We don’t anticipate any major policy changes with the political power transition, which will happen in mid-November. Without significant new stimulus ahead, we maintain our GDP growth forecast of 7.6% in 2012 and 7.7% in 2013.


According to our estimates, the Japanese economy could have contracted 0.5% in the third quarter (previously we expected stagnation), after expanding at an average quarterly pace of 0.74% in the first half of the year. Weak net exports and consumer expenditure were the main culprits. Real exports of goods dropped 6.0% in the quarter, impacted by the weak global economy, while imports expanded slightly. Meanwhile, the end of subsidies for automobiles purchases caused retail sales to fall 2.3% in the period. On the positive side, government spending and residential investment expanded, both still helped by post-earthquake reconstruction demand. However these were probably not enough to prevent a decline in GDP in 3Q12.

The Bank of Japan (BoJ) is reacting to the economic slowdown, and the prospect of undershooting its inflation target, with an additional monetary easing for the second month in a row. After a ¥10 trillion ($125 billion) increase in the asset-purchase program in September, the BoJ announced another ¥10.9 in October, taking the total to around ¥91 trillion by December 2013. Most (¥10 trillion) will be equally split between purchases of Treasury bills and Japanese government bonds (JGB), increasing the planned monthly average of JGB purchases next year to ¥1.25 trillion from ¥0.8 trillion. The remaining amount will be directed to private-sector assets.

BoJ also announced a new lending facility (known as the "Stimulating Bank Lending Facility"), in which the central bank will provide unlimited long-term funds, up to an amount equivalent to the net increase in lending, at a low interest rate to financial institutions. However, its total impact is still uncertain, as it relies on the future demand for lending, and this, in turn, depends on the strength of the demand in the real economy.

Despite the BoJ efforts, we think that these additional stimuli will have limited impact on the economic activity. Thus, we revised our GDP growth forecast down to 2.0% from 2.4% in 2012, reflecting the current weaker-than-expected indicators, and to 0.7% from 0.9% in 2013, due to carry-over effects.


Most commodity prices fell in October, as the optimism from the major central banks’ stimuli faded. Metals suffered the strongest correction, with prices dipping 8% in the month, significantly denting the 10.6% gain seen in September. Energy prices also fell by 4%, with news coming on both higher supply and lower demand. Finally, better-than-expected supply numbers in the U.S. continued to push down grain prices in the month.

Slower Growth and Lower Interest Rates
A slower rebound in investment worsens the GDP growth outlook and Selic rate will likely remain low for a longer period

We reduced our 2012 GDP growth forecast to 1.5%, from 1.7%. Our estimate for 2013 fell to 4.0% from 4.5%, given signs of a slow rebound in investments. In a more moderate growth scenario, we expect the Selic interest rate to end 2013 at 7.25% (from 8.50% previously). We raised our exchange-rate forecast for the end of 2013 to 2.02 reais per U.S. dollar (from 1.90 R$/US$). We also revised our call for the trade surplus in 2012, to US$20.5 billion from US$18 billion, and increased our estimate for 2013 to US$18 billion from US$13 billion. On the fiscal side, the recent results brought negative surprises. We expect the primary budget surplus to be lower this year. We revised our estimate for 2012 to 2.4% of GDP, from2.6%, and maintained 2.2% of GDP for next year. Our estimates for the consumer price index (IPCA) are 5.5% in 2012 and 5.3% in 2013.

Slower Rebound in Activity, Despite Stimuli

Although the economy is expanding as expected, the pace ahead may be slower than previously envisaged. Consumer spending is stronger, while exports and investments are weaker. We expected lower growth contribution from the auto sector in 4Q12, but believed that this scenario might be offset by an increase in investments, pushing GDP growth to 1.3% in the final quarter of the year. We now believe that it will not be the case.

After avoiding economic stagnation in 2Q12 and boosting GDP in 3Q12, the auto sector has lost momentum. Recent data confirm a cool-down in auto sales and production. Furthermore, industrial production was weaker in September, deepening the downward revision of our Itaú Unibanco monthly GDP growth, to -0.3% from -0.1%, for the month. In order to grow at the previously expected pace in 4Q12, GDP would need to advance at higher monthly rates. But the latest data has proved to be worse, and 4Q12 growth is expected to be lower. 

The reaction of investments to stimuli may be slower than usual due to both the uncertainties in the international scenario and doubts regarding the consistency of the domestic rebound. Real interest rates dropped and business confidence is on the rise, but machinery and equipment purchases show no strength. Public investments are also below expectation. Without a pickup in investments, growth in 4Q12 is likely to be lower, but still enough to confirm the Brazilian economic recovery. Our 4Q12 GDP growth forecast was revised to 1.0% qoq/sa, from 1.3%. For 3Q12, our call stands at 1.2% qoq/sa.

Lower growth in the final quarter of the year tends to negatively affect expansion in the following year. A lower carry-over from 2012 will contribute to a downward revision in growth forecasts for 2013. We lowered our forecast for next year, to 4.0% from 4.5%, due to three factors: i) the carry-over effect from our revised 2012 growth forecast, to 1.5% from 1.7%; ii) the expectation of a slower recovery of investments; and iii) lower growth in the global economy.

Bank loans grew in September after two consecutive months of declines. Daily average for new consumer loans rose 0.7% (adjusted for inflation and seasonality), following an accumulated drop of 6.2% in the two previous months. Meanwhile, daily average for corporate loans advanced 4.0% in September, partially reversing the 5.9% decline registered in July and August. A strike by bank workers prevented a sharper recovery in consumer loans, and led to an increase in the most expensive credit modalities - overdraft facilities and interest-bearing credit cards - which are more readily available.

Interest rates and spreads rose slightly for consumers (largely due to a temporary change in the product mix) and fell moderately for companies. Seasonally-adjusted delinquency rates for loans 15 to 90 days past due posted a small increase, while delinquency rates for loans more than 90 days past due were stable remaining at a high level. The performance of new credit facilities suggests a future decline in delinquency. In terms of market share, state-owned banks continue to increase their presence.

Rising confidence indicators, a heated labor market, growing credit demand, as well as the expectation of a decline in delinquency and a rebound in domestic activity are compatible with moderate credit expansion in the coming months.

Growth and Inflation Should Support the Current Exchange Rate Level

Our scenario of more moderate economic activity and tamed inflation in 2013 opens room for maintenance of many of the economic stimuli adopted in 2012, including the current exchange rate. Although we continue to see a decoupling between the real and its peers and risk premiums, the exchange rate seems to have a prominent role in the current policy to boost manufacturing and exports. Considering this context and our own inflation scenario (which is unlikely to threaten the strategy of a weaker currency in the period), we expect the exchange rate to end both 2012 and 2013 at 2.02 reais per U.S. dollar (from 2 reais by year-end 2012 and 1.90 reais by year-end 2013, previously).

We raised our trade surplus forecasts. In October, the trade balance reached US$1.7 billion, accumulating US$17.4 billion year to date. The main driver behind the recent acceleration in surplus was the fact that imports remained at a lower level due to a weaker currency and lower growth (although the declining trend has been interrupted). For this reason, we adjusted our trade surplus estimate for 2012 to US$20.5 billion, from US$18 billion. For 2013, we incorporated the expectation of a plentiful agricultural harvest and our new scenario, in which the real is maintained at a weaker level and economic recovery is slower. We now forecast a trade surplus of US$18 billion next year (from US$13 billion previously).

Foreign direct investment (FDI) hit US$4.4 billion in September and, for the second consecutive month, intercompany loans were prominent in the mix (35%, after 41% in August). While these flows are more volatile, they add volume to the FDI, which accumulated US$47.6 billion in the first three quarters of 2012. We therefore slightly increased our FDI forecast for 2012 to US$63 billion (from US$61 billion). For 2013, we maintained our forecast at US$64 billion. Meanwhile, the current account deficit has been flat, ending September at 2.2% of GDP over the last 12 months, which remains our forecast for 2012 year-end. For 2013, we now expect a 2.3% gap (down from 2.5%), due to a revised trade balance estimate and other effects of a weaker currency, such as lower profit and dividend remittances.

Fiscal Results Remain on a Downtrend 

The public sector’s fiscal results continued to decline throughout the year. In September, the consolidated primary budget surplus stood at 1.6 billion reais. Year to date, the consolidated primary result is at 2.33% of GDP (January-September 2011: 3.43%), the third worst performance in the series since 2003. The federal government’s surplus between January and September 2012 narrowed to 1.7% of GDP, from 2.2% in the same period of 2011. The balance of regional governments retreated to 0.6% of GDP, from 0.8% one year earlier, showing a decline in the budget performance of areas with greater weight in the public sector.

The impact of the (adverse) economic cycle on the budget and the choice to stimulate the economy through tax cuts and higher spending are behind the drop in the primary budget surplus, which reached 2.30% of GDP in the 12 months through September - the lowest level since April 2011. Despite signs of a rebound in some tax categories (such as sales and personal income taxes), the trend in central government’s revenue remains weak, down by 1.4% from year-earlier levels in the six months through September. On other hand, while expenditures have apparently lost some steam in the very recent months, the pace of expansion remains considerable. The six-month moving average for federal spending points to an annual real increase of 6.3%, topping our estimate for potential GDP growth (3% to 4%).

Given this scenario, and following a sequence of below-expectation monthly results, we revised our estimate for the public sector primary budget surplus in 2012 down to 2.4% of GDP, from 2.6%. And we still see relevant downside risks to our revised forecast for the year. Our estimates account for a gradual recovery in tax revenue in 4Q12, reflecting the improvement in economic activity and a expenditure slowdown in the final months of the year. The adjustment in expenditures could possibly mean the postponement of certain outlays (investments, for instance) to 2013. We therefore revised our estimates for the real growth rate in central government expenses, to 5.0% from 7.0% in 2012, and to 8.5% from 7.0% in 2013.

For next year, we maintain our forecast for the consolidated primary budget surplus at 2.2% of GDP. On one hand, we look for a cyclical improvement in tax revenue (following the expected acceleration in activity) and a likely accommodation of government transfers (due to a lower increase in the minimum wage). On other hand, our scenario incorporates deep tax cuts (in the range of 50 billion to 70 billion reais in the year) and a strong pickup in public investments (to 95 billion reais in 2013, from 60 billion in 2012). We believe that the fiscal stance in 2013 will be clearly expansionary.

Falling Food Prices Provide Short-Term Inflation Relief

We maintain our forecasts for the consumer price index (IPCA) at 5.5% for this year and 5.3% for 2013. Current data indicates a slowdown in food prices, partly due to the drop in agricultural producer prices. Still, we maintain our average monthly IPCA forecast at around 0.55% in 4Q12. Market-set prices are expected to rise 6.2% this year, while regulated prices are likely to increase 3.2%. Among market-set prices, we expect a 4% advance in tradable goods and an 8.2% increase in non-tradable goods.

Our 2013 IPCA forecast remains at 5.3%. Less volatile inflation indicators (core measures and diffusion indexes) remain under pressure, suggesting that the IPCA will hover around current levels. The downward revision of our economic growth and commodity price forecasts for 2013 could suggest some decline in our inflation forecast, but our expectation of a weaker currency prevented such a change.

For the general price index (IGP-M), we revised this year’s forecast to 7.9%, from 8.3%, due to a steeper retreat in agricultural prices at the margin. The producer price index (IPA) is expected to rise 8.8%, with agricultural prices climbing 18% and industrial prices increasing 5.5%. For 2013, the expectation of lower prices for some agricultural commodities, amid more favorable weather conditions, led us to revise our IGP-M forecast to 4.2%, from 4.5%.

Stable Selic Rate for Longer

The Brazilian Central Bank cut the Selic rate to 7.25% in October, referring to the cut as "a last adjustment" in monetary conditions. Looking ahead, the monetary authority signaled that interest rates will remain at the current level for a "sufficiently prolonged" period.

We previously believed that with a steadier economic rebound, interest rates would bounce back in the second half of 2013. However, given that we now foresee a slower recovery next year, we believe that the Central Bank will choose to maintain interest rates unchanged at least until the end of 2013.

Please open the attached pdf to read the full report and forecasts.

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