Itaú BBA - Signs of Weakness in 3Q13 and the Outlook for GDP Growth

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Signs of Weakness in 3Q13 and the Outlook for GDP Growth

September 4, 2013

We revised our forecast for 3Q13 GDP to -0.5% from 0% qoq/sa.

Several indicators point to weaker economic activity in the current quarter. Worsening financial conditions, declining confidence and higher inventories suggest a retreat in industrial GDP of 3Q13. Agricultural and livestock activity, which grew sharply in the first half of the year, should slide in the July-September period. Hence, we revised downward our forecast for GDP growth in 3Q13 to -0.5% qoq/sa from 0%. Though we anticipate a retreat this quarter, GDP growth in 2013 should be slightly higher than we previously estimated, due to a better-than-expected result in 2Q13. We raised our forecast for GDP growth this year to 2.3% from 2.1%. Our estimate for 2014 remains at 1.7%.  

Financial indicators point to slower growth

In late May, financial variables in many emerging nations felt the impact of signals by U.S. Federal Reserve members that monetary stimuli would be tapered off in the near future. Brazil was no exception. Stock market indexes slid, while long-term yields and risk premiums climbed. The local currency depreciated and exchange-rate volatility increased.

Though some indicators interrupted this worsening trend and others partly reversed losses, financial conditions tightened, in a move that tends to contribute to further slowdown of economic activity, particularly investment. Risk premiums are approximately 100 bps higher, meaning corporate borrowing costs increased in international markets. A weaker and more volatile exchange rate is a sign of uncertainty and higher investment costs, especially when it comes to imports of machinery and equipment.

Data show strong correlation between financial indicators and economic performance. In some cases, financial indexes work as leading indicators of the behavior of economic activity. And these figures point to a contraction of activity in 3Q13.

Declining confidence and signs from the real economy

Worsening financial indicators were followed by a sharper decline in business and consumer confidence, especially in July. Business and consumer confidence were already losing strength through May, as a result of tightening monetary conditions in the domestic market and uncertainties surrounding a rebound in domestic activity. That month, consumer confidence was already 12% lower than its recent peak. The indicator fell slightly in June and dropped 4.1% in July, then recovered in the following month, rising 4.4%, but the scenario of lower consumer confidence was unchanged.

Confidence among industrial entrepreneurs was 1.5% lower in May than its recent peak. From June through August, the indicator fell by an additional 5.7%. In the service sector, confidence had slipped 4.8% from its recent peak in May. In August, even though there was some recovery in relation to the July slide, the index was 2.4% lower than in May.

These numbers show that confidence indicators were already falling; even before international events that affected financial variables and even before material domestic events (street demonstrations). Events that happened in late May and in June contributed to additional declines, especially in July. Some losses were reversed, others were not. For economic activity, the important aspect is that these indicators stand at lower levels, which suggest weaker investment and weaker consumer spending.

The scenario of worsening financial conditions and lower confidence tends to hurt investment in particular. In the face of higher costs and lower confidence in the future, a slow-down in indicators related to gross fixed capital formation is expected. In fact, some figures are already showing this trend. 

The breakdown of the industrial survey by FGV suggests a cool-down in demand for capital goods. The index related to the assessment of internal demand for machinery and equipment is declining, and was 15.3% lower in August 2013 than in December 2012. In July, production and imports of capital goods retreated, driving our index for gross fixed capital formation to its first quarterly drop since December. Preliminary data for August suggest a new drop in capital goods imports, while sales of trucks and buses were sluggish.

In the first half of 2013, gross fixed capital formation led the increase in demand, and boosted manufacturing activity and GDP. Despite higher real interest rates, lower confidence and currency depreciation, investment expanded, and did so at a brisk pace. With fundamentals pointing to a decline in investment and current data corroborating this scenario, demand should be weak in 3Q13.

Industrial, agricultural and livestock activity should all retreat in 3Q13

Industrial production should lose momentum as investment slows down. July figures already show weakness. The first data coming out for August also point in that direction. After expanding 2.0% qoq/sa in 2Q13, industrial GDP should thus retreat in 3Q13.

There are signs of undesired inventory accumulation in the manufacturing sector. The difference between the share of companies assessing their inventories as excessive and the share of companies assessing their inventories as insufficient reached 6.9 p.p. in August, the highest level in 20 months. In other words, the number of overstocked companies is rising in relation to the number of understocked firms. Excessive inventories mean lower production ahead if there is no strong rebound in demand. Considering that signs point to a cool-down in demand, production must adjust — and growth will be slower.

Regarding agricultural and livestock activity, strong contribution to growth as seen in the first half should be interrupted in 3Q13. An increase of 20% in the soybean crop this year positively impacted agricultural GDP in the first half. Now, without the positive effect provided by soybeans and worse harvests more recently for oranges and manioc (falling 5.6% and 9.5%, respectively), agricultural and livestock activity should retreat. We forecast a decline of 3.4% qoq/sa for agricultural and livestock GDP in 3Q13.

Update on GDP growth forecasts

Considering the latest information and data from 2Q13, we revised our forecast for 3Q13 GDP to -0.5% from 0% qoq/sa. Our previous estimates already contemplated a decline in agricultural and livestock activity, but not further deterioration in August industrial activity, following a drop in July. Preliminary indicators for August, signs of decelerating investment and undesired inventory accumulation suggest a weaker performance in industry during the August-September period than we previously anticipated. We forecast a 0.2% drop of industrial GDP in 3Q13, after a 2.0% gain in the previous quarter. With a weaker performance in the industrial sector and contracting agricultural and livestock activity, expansion in the service sector should be sluggish. We estimate 0.3% in 3Q13, slowing down from a rise of 0.8% in the April-June period.

For 4Q13, our expectation is a moderate GDP increase of 0.3% qoq/sa. In this scenario, GDP growth this year reaches 2.3%, slightly higher than our previous forecast (2.1%). For 2014, our growth forecast remains at 1.7%. 

The Monthly Service Survey and its impact on GDP

One additional piece of uncertainty surrounding growth forecasts in 2013 is the incorporation of the Monthly Service Survey (PMS) by census bureau IBGE into National Accounts, starting with the release of 3Q13 figures on December 3. The revision should affect results for three sub-sectors in service GDP: (i) Transportation, storage and mailing; (ii) Information services; and (iii) Other services.

IBGE is still assessing the adjustments that will be implemented. There is still no definition on the deflators that will be used. Furthermore, the abovementioned sub-sectors will not be fully rebuilt, as some information currently applied to the calculation of GDP will be maintained. Hence, there is a lot of uncertainty surrounding the impact that such change will play on GDP growth in 2012 and 2013, the period in which the new survey will affect National Accounts.

But some assumptions enable us to estimate the magnitude of this impact. Using data from the Monthly Service Survey and data from National Accounts, including the breakdown by value added to service sub-items, we estimate a slightly-positive impact of 0.1 p.p. on overall growth in 2012. This impact is largely attributable to higher nominal growth in the sub-item “Information services” in the PMS than in National Accounts — if we assume the same deflator. However, the revision may be slightly negative in 2013. PMS figures suggest lower growth in “Other services” than currently estimated by National Accounts, and this item weighs 13.2% on GDP.

Conclusion

Despite a positive surprise with 2Q13 GDP, there are increasing signs that the economy is headed to a contraction in the current quarter. There is evidence of weakening investment and industrial output. In this scenario, growth should reach 2.3% this year, slightly higher than we previously estimated (2.1%). There is uncertainty surrounding the impact on GDP after the inclusion of the Monthly Service Survey in National Accounts, which may change growth readings this year. For 2014, our expectation for GDP growth remains at 1.7%.

Aurélio Bicalho
Economist



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