Itaú BBA - We Forecast GDP Will Contract 0.5% in 2015. Additional risks remain.

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We Forecast GDP Will Contract 0.5% in 2015. Additional risks remain.

February 2, 2015

There are signs of deterioration in economic activity in December and early this year.

We reduced our forecast for GDP growth in 2015 and now expect a contraction of 0.5%. Recent data signal a slowdown in economic activity in December and the outlook for 1Q15 has deteriorated. Other factors are also negative. In the oil sector, the cuts in capital expenditures and the reduction in our projection for output growth will impact economic activity. We also believe that difficulties involving some construction companies will impact the execution pace of their infrastructure projects in the short term. There is also risk of water shortages ahead, which have not been included in our scenario. Weak rainfall levels in January point may require additional cuts in water usage in important areas in the Southeast region. Moreover there is also risk of electricity rationing. We estimate the impact of a joint water and electricity rationing at an additional -0.6 p.p. on GDP growth in 2015.

GDP growth in 2015

We revised our 2015 GDP forecast to -0.5% from +0.2%. 

There are signs of deterioration in economic activity in December and early this year. Our diffusion index (based on a broad dataset which includes business and consumer confidence, retail sales and credit demand) is expected to end December with just 31% of its components showing improvement in economic activity, way below the historical average of 57%. We anticipate declines in industrial production and broad retail sales (including vehicles and building material). We thus revised our forecast for 4Q14 GDP to 0.2% qoq/sa from 0.3%. Still, our forecast for 2014 remains at 0.1%. Economic weakness in December impacts the statistical carryover into 1Q15. With business confidence still at low levels, consumer confidence at an all-time low, and high industrial inventories, we see no signs of recovery in 1Q15. We thus revised our estimate for 1Q15 GDP to -0.2% from +0.1%. Revisions in recent data have an impact of approximately -0.3 p.p. on growth in 2015.

We also incorporated the impact on the oil sector of cuts in capital expenditures and reduction in our projection for output growth in 2015. Our current output growth projection of 4.5% is much lower than our previous assumption of 8.8%. The investment program is 10% smaller than our previous call.

We also believe that difficulties involving some construction companies will impact the execution pace of their infrastructure projects in the short term. Our estimates now assume a 10% cut in infrastructure investments, with an impact of -0.2 p.p. on growth in 2015.

All in all, weaker data at the margin lately, cuts in production growth and capital expenditures by the oil sector and the likely reduction in the execution pace of projects by some construction companies reduce our 2015 growth forecast to -0.5% from 0.2%.

What if there is not enough rainfall?

This year started off with relevant rationing risks.

A shortage of rainfall in January increased risks to water and energy supply in the Southeast. The Cantareira water system, which supplies part of the greater São Paulo metro area, is at critical levels. There are risks that low reservoirs will require an additional 25% cut in water supply to dozens of cities of great economic importance in São Paulo state. That would have an impact of -0.1 p.p. on growth in 2015.

Moreover, the low reservoir levels and the effects of low rainfall levels in December on afluente natural energy in January imply risks of electricity rationing.

The problem became more serious as rainfall levels were low in January, and regionally concentrated. Rainfall levels in January stood at 65% of the historical average, according to our estimates. The basins whose reservoirs are at the lowest levels, Southeast/Center-West and Northeast, had the most unfavorable rainfall patterns, at 56% and 26% of the historical average for the month, respectively.

Our framework for assessing rationing risks[1] suggests that, even in a scenario in which rainfall levels are normalized between February and April, aggregate reservoir levels would end the rainy season below 40% capacity. Importantly, aggregate levels mask a situation that will probably be worse in the Southeast/Center-West basin.

Using a simplified estimate, aggregate reservoir levels below 40% capacity (or below 35% in the Southeast/Center-West) by the end of the rainy season would lead to some type of program to reduce electricity consumption.[2]

The size of the power cut will depend on how much reservoirs are below the rationing threshold. A cut of 5% in electricity usage during six months is enough to prevent reservoirs from reaching their minimum operational levels until the beginning of the next rainy season if aggregate reservoir levels reach 36% by late April. Meanwhile, a cut of 10% during the same period would be enough if reservoirs stand at 30% by late April.

Whether or not a mandatory reduction in electricity consumption is put in place, any estimate on the impact on economic activity must consider the impact of higher prices in response to restrictions in energy supply.

With a technological restriction to energy supply in the short term, power demand and supply must adjust through some combination of lower energy consumption, higher prices in the free market or higher regulated prices in services provided to residential consumers. A decline in energy supply has a direct effect on production among power-intensive industries.

As the price system signals a shortage of electricity (through higher prices for electricity in the free market, which serves mainly the manufacturing sector), industrial energy consumers are expected to reduce consumption, by adopting different production techniques or reducing output and the need for electricity. Alternatively, as quantitative restrictions come into place (such as consumption quotas), prices in the free market are likely to adjust so as to reflect the shortage of power. Finally, increases in regulated prices for residential consumption also affect activity through a reduction in consumers’ real income.

We thus designed a model for the impact of rationing on GDP, combining quantity and price effects, contemplating the different effects of free and regulated prices. For that purpose we have created an index for energy availability which is a linear combination of energy consumption, free and regulated prices, after due normalization for fluctuation by the same amount.[3] We put together our energy availability index, which is a weighted average of the deviation of energy consumption from its trend (weighting 50%), the real price for energy in the free market (25%) and the real price for energy in the regulated market (25%).[4]


The energy availability index is correlated with GDP growth, but this correlation does not imply causality – after all, a drop in energy consumption may be caused by a recession, for instance. In order to estimate the causal effect of energy availability, one must identify the changes in energy availability which were not caused by fluctuations in GDP.[5] The aggregate reservoir level serves this purpose, being a variable that does affect energy availability in the future, but does not have direct effect on GDP or any other macroeconomic variable.

We then estimated the effect of a negative shock on the energy availability index on GDP using reservoir levels as an instrumental variable (please see detailed results in the appendix). In a nutshell, we concluded that a 1-point reduction in energy availability in one quarter has the effect of reducing quarterly GDP by approximately 1 p.p.

So we considered a scenario of a 5% cut in the energy volume between May and October. In this case, there is a decline in energy consumption related to the no-rationing scenario of two thirds of 5% in 2Q15, 5% in 3Q15 and one third of 5% in 4Q15. Using our estimated equation, the impact of a 5% power rationing for six months (starting in May and ending in October) would lead to a reduction in the GDP growth rate for 2015 of approximately 0.5 p.p.

If a power rationing decision is needed, we estimate the necessary cut in energy consumption at around 5%, which is less than in 2001 (about 20%), but will still have considerable impact on the economy, of approximately 0.5 p.p.

The combination of water and electricity rationing would lead our projection to a contraction of 1.1% in economic activity in 2015.


Irineu de Carvalho Filho, Artur Manoel Passos and Rodrigo Miyamoto


[1] Please see the details of our risk-assessment framework in Macro Vision: Energy rationing risks are likely in 2015 if rain repeats recent pattern. The text also addresses the causes of the current situation.

[2] This rationing threshold may be reduced slightly by low economic growth or by higher prices in the regulated market.

[3] For energy consumption, free and regulated prices, we calculated normalized values – i.e., we subtract the average and divide it by the standard deviation.

[4] We used ad hoc weights but those are close enough to weights estimated by an econometric procedure. Moreover, our results are not materially affected if we use econometrically-estimated weights.

[5] The aggregate reservoir level is an instrumental variable, using the econometricians’ jargon.


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