Itaú BBA - Confidence Declines in July

Brazil Review

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Confidence Declines in July

agosto 1, 2013

Business and consumer confidence fell in July because of economic and political uncertainty.

The Brazilian economy in July 2013

Business and consumer confidence fell in July because of economic and political uncertainty. The results point to a slowdown of economic activity in the second half of this year, after a moderate recovery in the first half. The seasonally-adjusted unemployment rate rose from 5.5% in May to 5.7% in June, which is still a low level relative to the historical series. A larger share of consumers, however, is reporting that jobs are harder to get. Meanwhile, the government announced the freezing of 10 billion reais of projected expenditures for this year as part of its effort to achieve this year’s primary surplus target of 2.3% of GDP. The Copom continued to increase the policy rate by 50 basis-points.

Business and consumer confidence declined…

Business confidence fell by 4.0% in the industrial sector and by 6.4% in the service sector from June to July. In the industrial sector, the business confidence index is now slightly below the threshold that separates confidence from lack of confidence (100 points). Political uncertainty, rising interest rates, higher volatility in the FX market and disappointment with the low rate of economic growth seem to be the main causes of the setback. Consumer confidence fell by 4.1%, and the percentage of respondents saying that jobs have been “hard to get” increased to 50.6% from 43.0%.

...and the unemployment rate increased.

The seasonally-adjusted unemployment rate increased to 5.7% (from 5.5%). The working population was stable, falling short of our estimate. Employment in education, healthcare and public administration continue to expand (6.0% yoy), while the number of people working in manufacturing and household services declined. Notwithstanding the slowdown in job market indicators, labor conditions remain favorable. The unemployment rate is still close to its all-time low and income is on the rise. However, risks related to the future direction of the labor market have increased. Data on formal jobs (tracked by the Labor Ministry’s Caged registry) in June showed improvement relative to the weak figures seen in May, but the numbers are still at a level that would be expected to lead to higher unemployment. If a scenario of lower economic growth materializes in the coming months, the unemployment rate could go up faster.

Ibope and CNT surveys confirm a drop in the government’s approval rate.

Similar to the Datafolha survey, the Ibope and CNT surveys also showed declines in the approval rate for President Dilma Rousseff’s government. The percentage of respondents who evaluate the government as “good” or “excellent” now stands at 30%, down from around 55% before the street protests in June. In a simulation of the second round of voting, the Ibope survey revealed a technical draw between Dilma (35% of voting intentions) and Marina Silva (34%).

Inflation slowed in July, but the depreciation of the Brazilian real adds upside risk for the medium term…

The mid-month consumer price index IPCA-15 went up 0.07% in July (vs. 0.38% in June). The drop from the previous month reflected a slowdown in inflation in several component categories, particularly transportation, food, clothing, healthcare and personal care. Core inflation measures also receded, with the average sliding to 0.3% from 0.5%. Service inflation remained under pressure, at 0.7%. Although inflation has slowed down, the depreciation of the Brazilian real, in the context of a still-tight job market, adds upside risk to the inflation outlook for the medium term. We forecast the IPCA at 6.1% at the end of this year and at 5.9% at the end of 2014.

The central bank hiked the SELIC rate to 8.50%...

The monetary policy committee (Copom) raised the benchmark interest rate (SELIC) by 50 bps in July, to 8.5% p.a., in a unanimous decision that reinforced its “commitment to ensure a declining trend of inflation”. As recorded in the minutes of the monetary policy meeting, the committee noted a number of risk factors that could justify further interest hikes in the months ahead, including the exchange-rate depreciation. But the committee also highlighted the risks to economic activity, such as the decline in consumer and business confidence. We believe that exchange-rate depreciation and supply limitations are still having an effect on the Brazilian economy, which means that inflation risks are the biggest problem for the central bank at the moment. In our view, the Copom will choose to continue the tightening cycle, maintaining the pace of interest rate hikes in order to curb inflation risks in 2014.

…and the government froze 10 billion reais.

The government announced the third bimonthly revision of the 2013 budget, which included the freezing of 10 billion reais of projected fiscal expenditures for the year. The announcement was broadly in line with what the press had been indicating in recent weeks. The financial markets, too, had been waiting for such an announcement as they searched for signs of a less expansionary fiscal stance going forward. The announcement signals an intention to soften the speed of fiscal stimulus, but there are budgetary and implementation risks ahead. We kept our projection for a primary fiscal balance of 1.7% of GDP this year.

The balance of payments was stronger than expected in June…

The balance of payments was better than expected in June: the current account deficit ($4.0 billion) was narrower than estimated, while foreign direct investment ($7.2 billion) was higher than expected. Foreign investment in the local fixed income market hit an all-time high of $7.2 billion after the IOF tax on such transactions was withdrawn in early June. The stock market, on the other hand, experienced outflows of $3.7 billion. In the first half of the year, foreign investment in the local capital market amounted to $17.4 billion, way up from $5 billion in the year-earlier period and $11 billion in 2012 as a whole.

…but the Brazilian real depreciated. Stocks declined and risk spreads widened.

The foreign exchange rate depreciated to 2.29 from 2.22 reais per U.S. dollar. The Central Bank sold dollars through currency swaps to contain the depreciation. After a substantial decline in June, the benchmark Ibovespa index edged up by 1.6% (-1.7% in dollar terms). The CDS spread remained broadly stable, at 186.6.

What’s next?

Economic activity data for the second half of the year have gained importance after the decline in business and consumer confidence in July. Markets will also continue to focus on the FX market, given the impact of the depreciation of the Brazilian real on inflation.

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