Itaú BBA - Deceleration deepens

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Deceleration deepens

April 28, 2015

The recent weakening trend demand seems to have steepened in March and April.

With information through April 27, 2015

This report, published six times per year, summarizes anecdotal information on current economic conditions received from key business contacts, economists, market experts, and other sources outside Itaú. Apart from the “our view” section, it is not a commentary on the views of Itaú’s Macroeconomic Research team.

Contents

Consumption and Production of Goods and Services
The recent weakening trend in demand for consumer goods seems to have steepened in March and April.         

Investment  
The short-term effects of the economic adjustments and the Lava Jato Operation investigations and the ample spare capacity in many sectors have been restraining investment..     

Labor Market, Production Costs and Prices    
The slowdown in the real estate market has intensified in the first months of the year. Prices have been declining since last year.

Real Estate   
The number of sectors that have seen downsizing, or that have many companies intending to downsize, continues to increase. Electricity, taxes, FX depreciation put pressure on production costs.

Commodities         
Rainfall has improved since February, mitigating the negative impact of the earlier drought on agriculture.

Our View         
Recent data show contractions in various sectors of economic activity. In our base-case scenario, Brazil’s GDP performance in the second quarter will be the worst of the year.


Summary

The recent weakening trend in consumer goods demand seems to have steepened in March and April. The durable goods sectors remain the weakest, but the slowdown in the semi- and non-durable goods and services segments has been intensifying as well. There is growing concern about payment delays and rising defaults along production chains, which is causing liquidity problems.

Business confidence continues to decline, from a low level. The short-term effects of the economic adjustments and the Lava Jato Operation investigations, along with the ample spare capacity in many sectors have been restraining investment. On the other hand, the perception that the government will follow through on its economic adjustment plans, coupled with the recent currency depreciation and the prospect of easing production costs, is creating interest in longer-term investments.

The number of sectors that have seen downsizing, ​​or that have many companies intending to downsize, continues to increase. Most of the reported wage-increases are close to zero in real terms. However, since current inflation is high, nominal wage adjustments remain significant (around 8%). Increases in electricity prices and taxes as well as currency depreciation also put pressure on production costs.

The slowdown in the real estate market has intensified in the first months of the year. Prices have been declining since last year.

Rainfall has improved since February, mitigating the negative impact of the earlier drought on agriculture. In the steel sector, the slowdown in infrastructure investment and durable consumer goods production continues to hold back domestic sales. In mining, the outlook has become less favorable due to the downward trend in iron ore prices. In the oil sector, uncertainty remains high.

Our view: Recent data show contractions in various sectors of economic activity. Economic fundamentals, such as slowdown of the real wage bill, low consumer confidence and a worsening labor market, suggest that the economy will continue to weaken. In our base-case scenario, Brazil’s GDP performance in the second quarter will be the worst of the year.

Consumption and Production of Goods and Services

The trend of weakening demand seems to have steepened in the third and fourth months of the year. Most consumption-related sectors posted declines in sales volumes compared with last year and relative to the volumes planned for the first months of the year. Inventories of durable consumer goods remain high.

As in previous months, durable goods sectors such as automobiles, motorcycles, heavy appliances and electronics, remained the weakest of the consumption segments. Interest rate hikes, lower credit supply, the withdrawal of fiscal stimulus, accelerating inflation and the perceived weakening of the labor market are weighing on consumers’ decisions. There are signs of greater stability after the sharp declines of recent quarters, but as yet no signs of recovery.

In the semi- and non-durable goods segments such as clothing, office supplies, food and cleaning supplies, the slowdown has been steepening. Annual growth rates, generally still positive through the first two months of the year, are now moving toward zero or into negative territory. The same phenomenon is being seen in the service sector. Segments such as restaurants, carriers and hotels have been reporting declining demand and increased idle capacity. Only basic goods and services such as medicines, property security and education have shown resilience, although some have been affected by the government’s fiscal and parafiscal adjustments.

In sectors related to the production of consumer goods, there is growing concern about increases in late payments and defaults along production chains, which is causing liquidity problems.

Given the weak demand scenario, the limited availability of credit and these liquidity problems, producers of final consumer goods and producers of intermediate inputs have been considering resizing their production capacities, discontinuing non-essential outsourced services in order to survive the period of low activity.

On the positive side, a more depreciated currency is encouraging retailers to look for more local suppliers, thus boosting demand for domestic production in different areas of consumption. Producers of consumer goods with good export markets have also started to benefit from a more depreciated Brazilian real, posting increased sales in foreign markets.

The scenario is also more positive for sectors focused on low-cost operations, such as e commerce and other online services, which have been taking advantage of the more restrictive and selective demand scenario to gain market share.

Investment

Business confidence continues to decline, from a low level. Our indicator, which is built on a wide customer base, posted a significant decline in March. The indicator is about 20% below the level of the last quarter of 2014 and 40% lower than in March 2014.

External and domestic uncertainties and the short-term effects of the economic adjustments and the Lava Jato Operation investigations have been depressing confidence and restraining investment. At the same time, with the weakening of demand, many sectors are reporting high idle capacity, which reduces the urgency of capacity growth. Sectors such as heavy vehicles (trucks and agricultural vehicles) and capital goods (machinery, equipment) continue to post depressed sales and production, without any signs of recovery.

On the other hand, the perception that the government will follow through with the economic adjustments, coupled with the recent currency depreciation and the prospect of less pressure from production costs, has been arousing companies’ interest in Brazil (especially among multinationals). The long-term investment opportunities in Brazil remain attractive, especially when it is compared with other large emerging-market countries. However, caution still prevails, underscoring the importance of the economic adjustments in 2015 and the outcome of the corruption investigations now in progress.

Labor Market, Production Costs and Prices

The number of sectors that have seen downsizing, or that have many companies intending to downsize, continues to increase. Companies that need to hire are already reporting greater ease in finding labor, even specialized labor. Many sectors see the current weakening in the labor market as an opportunity to stimulate productivity gains among workers.

Most of the reported wage increases are close to zero in real terms. Businesses and outsourced labor suppliers are also agreeing to revise contracts and adapt to this new stage of the economic cycle. Even though, as current inflation is high, the nominal wage adjustments remain significant (around 8%).

Increases in electricity prices and taxes as well as currency depreciation also put pressure on production costs.in various sectors. As there is no prospect of a significant pass-through to consumers, the stress of absorbing the higher costs has been increasing along production chains. Sectors with higher shares of imported inputs are already redirecting their demand to domestic producers.

On the other hand, low growth and increased idleness in the economy have led to accommodation in some costs, such as rents, road freight, machinery and outsourced services.

Real Estate

The downturn in the real estate market has deepened in the first months of the year. In the residential segment, the pace of sales has been reported as being even weaker in March and April than it was in the first two months of the year. The drop in consumer confidence and the more conservative credit conditions have been holding back demand. Inventories remain high in the sector, and prices, on average, continue to accommodate.

In the commercial segment, the imbalance between supply and demand is more structural, generated by the combination of a slowdown in economic activity and an accelerating volume of launches (both actual and planned). The vacancy level is high, particularly in business offices, suggesting that the adjustment process may be long. Prices have been materially declining since last year, which opens a window of opportunity for companies to reduce costs, by renegotiating rental contracts or moving.

In the shopping-malls segment, consumer traffic continues to weaken, making cost management more difficult for tenants. The level of vacancy is still high, opening room for discounts on rent. Retailers in more defensive sectors such as medicines and food services for high-income consumers are seeing an opportunity in the current scenario to expand points of sale.

Commodities 

Rainfall has improved since February, mitigating the negative impact of the earlier drought on agriculture in southeastern Brazil. The risk of delays in soybean planting, which would have affected the winter corn crop (safrinha), has not materialized. On the price side, the currency depreciation is offsetting the drop in prices, preserving a portion of producers’ profits. In this scenario, expectations for Brazil’s grain harvest are positive.

The highlight of the agriculture sector, however, is sugarcane. The improved rainfall increased the productivity of the current crop. That, coupled with a more depreciated Brazilian real and the expected increase in the domestic ethanol market, has reduced pessimism. More structural financial difficulties remain, after years of unfavorable price policies and low investment. But the outlook is beginning to improve.

On the cost side, the decline in oil prices is offsetting the currency depreciation, averting increases in prices of pesticides and fertilizers. The perception of a gradually increasing supply of labor also benefits the sector.

In the steel sector, the slowdowns in infrastructure investment and durable consumer goods production continue to hold back domestic sales. However, exports continue to improve in response to the more depreciated currency and the resumption of growth in developed economies. In mining, the outlook has become less favorable due to the declining trend in iron ore prices in the international markets.

In the oil sector, uncertainty remains high. The sector is more cautious about short-term investments. Long-term interest in the sector has persisted, however, especially given the possibility that the private sector will gain more autonomy in the industry.

Our View

Recent data show contractions in various sectors of economic activity. Our diffusion index, which is based on a broad set of data, including business and consumer confidence, retail sales and demand for credit, ended February at a level similar to those seen during the 2008 financial crisis. In March, the indicator improved slightly, but it remains weak. Business and consumer confidence indicators for all the major sectors of economic activity (industry, services, construction and trade) continue to fall. Broad retail sales (including vehicle and construction materials) have remained at a low level over the last few months.

The economic fundamentals – a deceleration of the real wage bill, low consumer confidence and a worsening labor market – suggest that the economy will continue to weaken over the coming months. In our base-case scenario, Brazil’s GDP growth in the second quarter will be the worst of the year, down 1% from the previous quarter. We expect some stabilization in the second half of the year, but there are no signs of a recovery yet.



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