Itaú BBA - Still deteriorating

OrangeBook

< Back

Still deteriorating

February 17, 2016

In our view, weak economic activity data and fundamentals suggest that difficulties will continue ahead.

With information through February 16, 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                                             
Most consumption of goods and services sectors have reported a further slowdown in activity at the beginning of this year. 

Investment                                                                                                       
The domestic recession and uncertainties abroad –especially recent financial market volatility – generates an adverse environment for private investment.                                                                                                                                                        

Labor Market, Production Costs and Prices                                                           
Most sectors remain focused on cost cutting as they attempt to adapt to the new demand situation.

Real Estate                                                                                                       
The real estate market finds itself increasingly stressed. Sales remain sluggish, pressured by waning confidence and stricter credit terms.

Commodities                                                                                                
The recession should be less severe for the agricultural sector than the rest of the economy. Activity remains weak in the oil and the steel industry, where uncertainties still abound.

Our View
Data on economic activity reveal a continued recession, and the fundamentals suggest that difficulties will continue ahead. We now expect the recession this year to be at least as deep as it was in 2015.                                                                                                                                                                  


Summary

Most consumption of goods and services sectors have reported a further slowdown in activity at the beginning of this year. In many sectors, corporate debt levels remain high. Manufacturers and retailers have reported large inventories. There is little hope of a demand recovery in 2016, and there are growing concerns about delinquency. Some segments have indicated that recent budgets plans are unlikely to be met.  

The domestic recession and uncertainties abroad –especially recent financial market volatility –generates an adverse environment for private investment. Public investment levels also remain weak, as regional and central governments face an ongoing fiscal crisis.

This year, most sectors remain focused on cost cutting as they attempt to adapt to the new demand situation. This trend suggests that further job cuts are likely. Lower oil prices and frequent rainfall over the summer have eased concerns about electricity and fuel costs. However, many sectors are still suffering from the effects of currency depreciation on input prices.

Weak demand, however, limits the efforts to pass through costs to prices.

The real estate market finds itself increasingly stressed. Sales remain sluggish, pressured by waning confidence and stricter credit terms. Inventories remain high, pushing the industry to consider deeper discounts and more aggressive sales strategies.

The recession should be less severe for the agricultural sector than the rest of the economy, but there are concerns about sector debt and profitability.

The prolonged recession in the Manufacturing sector continues to put pressure on domestic sales for the steel industry

Activity remains weak in the oil industry, where uncertainties still abound.

Our view: Data on economic activity reveal a continued recession, and the fundamentals suggest that difficulties will continue ahead. Domestic demand is likely to remain weak. We now expect the recession this year to be at least as deep as it was in 2015. 

Consumption and Production of Goods and Services

Most consumption of goods and services sectors have reported a further slowdown in activity at the beginning of this year. In many sectors, corporate debt levels remain high. Manufacturers and retailers have reported large inventories. With rising unemployment, high interest rates and still-leveraged consumers, there is little hope of a demand recovery in 2016. Some segments have indicated that recent budget plans are unlikely to be met this year. 

Durable Goods sectors, which have been in recession for longer, seem better adjusted to the situation. Most firms have already taken steps to scale back output by closing plants, cutting staff or/and extending collective vacation time. Sales and output seem to be stabilizing after falling sharply in 2014 and 2015, but a continued downtrend remains a risk. If demand continues to fall this year, further cuts will have to be made.

The situation is different for the Semi- and Non-Durable Goods sectors such as apparel, office supplies, foodstuffs and cleaning materials. The further weakening in sales in recent months has been surprising, forcing businesses – particularly small and mid-size companies – to act decisively to reduce costs and production structures. Consumers are clearly migrating toward less value-added products. Many of these sectors are still assimilating the rise in imported input prices and energy prices. 

The Service sector is also suffering from cost issues and further demand contraction. Foot traffic in shopping malls, hotels and restaurants has been well below average in recent years. Most retail chains are planning store closures in Brazil, which has not occurred in several years. 

Delinquency remains a widespread concern for the Goods and Services sectors. More retailers are requesting longer payment terms from manufacturers, leading to heightened concerns about liquidity in the economy, particularly given the elevated financing costs. The number of companies filing for court-supervised restructuring is rising, particularly among small and mid-size companies. 

There is hope that the currency depreciation will benefit local manufacturers; however, low domestic demand limits this effect, which remains concentrated on high-income segments. In the long term, exports will also tend to support a recovery, but the reaction so far has been sluggish in most sectors - the Basic Food sector an exception.  

Investment

Business confidence is low, with marginal signs of stability. Our indicator, which is drawn from a wide base, has been reporting high monthly volatility, but the downward trend we observed through the middle of last year has softened. The indicator is 25% below the last quarter of 2014 and 10% lower than the first quarter of 2015.  Most sectors we surveyed report that inventories remain high.

Despite signs that confidence is stabilizing, there has been no resurgence in the willingness to invest. The domestic recession and uncertainties abroad - especially recent financial market volatility - generates an adverse environment for private investment.   There is significant spare capacity in many sectors. Public investment levels also remain weak, as regional and central governments face an ongoing fiscal crisis.

Demand remains suppressed in the capital-goods and heavy-vehicle industries because buyers anticipated purchases when subsidized credit was available. Many sectors of the economy have reported idle machines and vehicles. 

Exports are still an option for many companies in these segments, especially multinationals, which have better access to international markets. Both the Vehicle and Machinery sectors reported that Brazilian products became competitive due to the weaker exchange rate, particularly in Latin America. 

The weaker Brazilian real and the financial difficulties facing various sectors of the economy have drawn interest from companies (particularly multinationals) seeking new assets in Brazil to expand or diversify their businesses. The short-term risks have led many to maintain a cautious approach, but the number of deals is increasing.

Labor Market, Production Costs and Prices

This year, most sectors remain focused on cost-cutting as they attempt to adapt to the new demand situation. This trend suggests that further job cuts are likely, particularly in the Service sector and among small and mid-size companies. Additionally, the employment component of our client surveys has been on a downtrend since January 2014, with no signs of stabilizing. Most sectors have reached agreements to implement wage increases below the rate of inflation.

Lower oil prices and frequent rainfall over the summer have eased concerns about electricity and fuel costs. However, many sectors are still suffering from the effects of currency depreciation on costs, while some segments continue to worry that the government will raise taxes to boost revenue.

Weak demand, however, limits the efforts to pass through costs to prices. Supply chains continue to face significant pressure to absorb costs, which will, over time, improve efficiency. However, the stress of compressed margins on the economy is rising.

Real Estate

The real estate market finds itself increasingly stressed. Residential sales remain sluggish, pressured by waning consumer confidence and stricter credit terms. Inventories remain high, pushing the industry to consider deeper discounts and more aggressive sales strategies. There is, however, the risk of cancellations of property purchases by buyers, possibly hampering efforts to rebalance the market. Overall, the number of new development launches continues to be revised downward.

The commercial property market is even more unbalanced. Vacancy levels are high, particularly for commercial offices, and many developments are still under construction, especially in the Southeast. Prices and rents remain low, which has been a way out for companies to reduce costs.

In the shopping mall segment, activity remains weak, reflecting overall retail woes. Store owners are finding that cost management is becoming more complex, and the number of empty units remains high. As noted in our last Orange Book, only more mature malls have managed to maintain footfall, particularly those focusing on higher income brackets, benefitting from a switch in demand driven by the exchange rate depreciation.

Commodities

The recession should be less severe for the agricultural sector than the rest of the economy. We expect similar volumes to last year. But there are concerns about sector debt and profitability, as currency depreciation drives input costs up this year, while international grain prices have fallen. Some segments with a very clear comparative advantage in Brazil, like cellulose, are expected to be able to maintain higher profits.

Cash management is also a concern. There is less credit available, which limits investment capacity and hurts segments with a larger debt burden, such as the sugar and alcohol industry. 

The prolonged recession in the Manufacturing sector continues to put pressure on domestic sales for the steel industry. While local manufacturers have become more competitive as a result of the weaker exchange rate, it has also affected cash management due to the sector’s USD-denominated debt.  The mining industry is more concerned about external issues. Emerging economies, particularly China, continue to slow, creating a tougher outlook for prices and volumes.

Activity remains weak in the oil industry, where uncertainties still abound. Low prices and high debt levels continue to affect the supply chain. Oil companies are maintaining a wary eye on possible public asset sales and regulatory changes. However, we have yet to see any sign of changes.

Our View

Data on economic activity reveal a continued recession, and the fundamentals suggest that difficulties will continue ahead. Domestic demand is likely to remain weak.

Fundamentals indicate that the situation will remain difficult for the rest of the year. Uncertainties, production cost pressures and elevated idle capacity tend to further discourage investment. Last year’s downtrend in spending is likely to worsen. The deteriorating job market will continue to weigh on consumer decisions. As in 2015, exporters are likely to continue to make a positive contribution to the economy as the real slides against the US dollar; however, modest global growth is likely to limit the impact.

We now expect the recession this year to be at least as deep as it was in 2015. 

There are incipient signs that the economic-activity may stabilize during the second half of the year. The downtrend in business and consumer confidence has ended, posting a slight recovery in January. Inventories are high, but are being consistently adjusted. Other leading indicators, such as our diffusion index, continue to suggest a persistent – but less aggressive – economic slowdown.


 


 

 



< Back