Itaú BBA - Declining activity and rising inflation, but fiscal adjustments advance

Brazil Review

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Declining activity and rising inflation, but fiscal adjustments advance

marzo 2, 2015

Economic activity deteriorates and points to a scenario of negative GDP growth this year.

The Brazilian economy in February 2015

Economic activity deteriorates and points to a scenario of negative GDP growth this year. The labor market weakens further. Inflation remains pressured by public tariffs (especially electricity) and will likely run above the upper bound of the target range. Fiscal adjustments continue, with new measures, supporting the commitment to meet the primary surplus target. The exchange rate depreciated, reflecting external and domestic uncertainties. Amid the investigations of the "Lava Jato" operation, Petrobras lost its investment grade status. The government's approval rating fell.

Industrial production and retail sales are falling sharply...

Industrial production dropped 2.8% in January, reaching its lowest level since 2009. The contraction was widespread, with drops in 17 of 24 sectors during the month. Retail sales also posted a strong decline in the month, both in broad and core retail sales. The results underscore the intensifying deceleration trend of economic activity.

... while confidence indicators remain low

Indicators of business confidence in the industrial and trade sectors compiled by FGV dropped sharply once again in February, suggesting that economic activity in these sectors will likely remain weak. Consumer confidence also fell, reaching the lowest level of the historical series started in 2005.

We forecast a drop of 0.5% in GDP in 2015. There are additional risks.

We reduced our GDP forecast from 0.2% to -0.5% in 2015. Recent data show that economic activity has been deteriorating, and there will be investment cuts in the Oil and Infrastructure sectors. In addition, there are risks of water and energy rationing, which are not yet incorporated into our scenario. We estimate that rationing would have an additional negative effect of 0.6 percentage points on GDP growth, taking the forecast for the year to -1.1%.

Clearer signs of weakness in the labor market

The unemployment rate reached 5.3% in January, maintaining the upward trend of recent months. The Labor Ministry's Caged data indicated negative job creation in January (-81 thousand jobs). The weakness of economic activity will probably continue to weigh on the labor market in the coming months.

Fiscal adjustments advance, January result is favorable

The government issued a provisional measure increasing companies' social security contribution on gross sales. On the spending side, the government announced that it would limit ministries' administrative costs ("custeio") and investments to BRL 75.1 billion until April. The measures reaffirm the government's commitment to meet the fiscal surplus target of 1.2% of GDP this year. In addition, the year started at a good pace. In January, the consolidated primary surplus reached BRL 21.1 billion, above expectations. The main positive surprise came from regional governments.

High inflation pressured by public tariffs. IPCA will likely be above the upper bound of the target range in 2015

Current inflation remains high, pressured mainly by public tariffs. The IPCA-15 increased 1.33% in February, bringing the 12-month rate to 7.4%. The largest upward contributions came from residential electricity, fuel, used cars and public transportation. Based on the IPCA-15 and other information, we forecast the IPCA at 1.10% in February, with the 12-month rate reaching 7.6%. For the year, we forecast the IPCA at 7.4%, above the upper bound of the central bank's target range (6.5%). But we believe that inflation will retreat in 2016 to 5.5%.

Current account deficit accommodates, exchange rate depreciates again

A current account deficit of USD 10.7 billion was posted in January. Over 12 months, the deficit decreased to USD 90.4 billion from USD 91.3 billion, remaining stable at 4.2% of GDP. The exchange rate, however, depreciated again, reflecting the global strengthening of the dollar and domestic uncertainties. With high volatility, the exchange rate exceeded 2.90 reais to the dollar.

Government approval rating decreases from 42% to 23%, according to Datafolha

The Datafolha survey conducted between February 3 and 5 showed the government approval rating declining from 42% in December to 23%. The drop was widespread among the country's regions. This is the lowest level since 2001. For comparison purposes, during the popular protests of June 2013, Dilma's government approval fell to 30%. During the so-called "mensalão" scandal in 2005, government approval ratings reached 28%.

Petrobras has a new president and loses its investment grade status

The government announced Aldemir Bendini as the new president of Petrobras, replacing Graça Foster. Previously, Bendini was president of Banco do Brasil. Moody's downgraded the company's credit rating from Baa3 to Ba2. With the move, Petrobras lost its investment grade status. According to the agency, the action reflects concerns about the investigations of corruption, the delay in disclosing the company's audited financial statements and the company's increased indebtedness.

Brazilian real depreciated 8%

The exchange rate continued its depreciating trend. The real droped 8% from January to February, and ended the month at 2.88 reais per dollar. The Ibovespa increased 10% in reais and 1.7% in dollars. The five-year CDS increased 16 bps, to 243 bps.    

What’s next?

The Brazilian Prosecutor, Rodrigo Janot, will present the list of politicians involved in the "Lava Jato" scandal to the Supreme Court. The Congress may vote provisional measures ("medidas provisórias") related to the fiscal adjustment. Congressmen will also vote the fiscal budget for this year. The next Monetary Policy Committee meeting will be held on March 4. Due to the higher short-term inflation and weaker exchange rate, we now expect an interest rate hike of 0.50 pp (we previously expected a 25-bp hike). The 4Q14 GDP will be released on March 27. We expect a quarterly growth rate at zero, seasonally adjusted. IBGE will announce the GDP number together with a revised methodology, therefore there is more uncertainty regarding 4Q14 estimates.

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