Itaú BBA - GDP retreats 0.2% in 1Q19

Brazil Review

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GDP retreats 0.2% in 1Q19

junio 3, 2019

For 2Q19, our preliminary forecast is a modest GDP growth of 0.1% qoq/sa

The Brazilian economy in May 2019

GDP retreated 0.2% qoq/sa in 1Q19, confirming the weakness in economic activity early in the year. Formal job creation topped expectations in April, but current business confidence levels and the weaker activity pace imply downside to job creation in the coming months. Inflation dynamics remained benign, even if pressured by volatile items in the short term. On the political front, the month was market by the discussions in Congress regarding several provisional measures and the pension reform project that is being analyzed in the Lower House Special Committee.

GDP shows weak economic activity 

GDP receded 0.2% qoq/sa in 1Q19, in line with our forecast and the median of market expectations. Year-over-year, the indicator rose 0.5%. From a demand standpoint, household spending advanced 0.3%, government spending expanded 0.4% and imports increased somewhat, by 0.5% qoq/sa. On the other hand, investment and exports fell 1.7% and 1.9%, respectively. Importantly, investment is 27% below its pre-recession level (1Q14). In our view, sluggish investment, in spite of historically-low interest rates, is related to uncertainties surrounding fiscal reforms, but also reinforces our understanding that the fiscal adjustment and the reduction in credit subsidies have been contributing to a decline in the neutral interest rate. From a supply standpoint, the service component increased slightly in the quarter (0.2%), while agriculture and industry retreated 0.5% and 0.7%, respectively. For 2Q19, our preliminary forecast is modest GDP growth of 0.1% qoq/sa. Although preliminary, this expectation implies downside to our 1.0% growth estimate for 2019.

Confidence indicators fell further in May

FGV’s confidence indicators for May extended the correction seen in recent months. Consumer confidence fell for a fourth consecutive month, by 2.9 p.p., and its level is now consistent with household spending expanding around 0.4% during the quarter (1.4% in annualized terms). Confidence in the industrial sector declined 0.7 p.p. in the period, dragged by the expectations component (-1.5 p.p.), while the current situation component remained unchanged. Such confidence level is consistent with zero quarterly growth in the industrial sector. Furthermore, industrial capacity utilization (75.3% in May) continues to suggest slack in production factors, notwithstanding a 0.8% increase during the month. In the same direction, confidence among retail entrepreneurs dropped 5.4 p.p. in May, returning to the level seen in September 2018. Indicators for the construction and service sectors also declined during the month (-1.8 p.p. and -3.1 p.p., respectively). In our view, the recent performance of confidence indicators is consistent with weak activity at the margin.

Formal job creation beats expectations, but unemployment remains high in April 

According to the Ministry of Labor’s CAGED registry, a net 130k jobs were created in April, beating the median of market expectations by a wide margin (+80k). Seasonally-adjusted figures point to 50k jobs, lifting the quarterly moving average to 30k, from 20k in the previous month. Despite the strong reading in the month, business confidence levels suggest weakening economic activity early in the year, implying downside for job creation in the coming months. 

Also in April, the unemployment rate reached 12.5%, in line with the median of market expectations and slightly higher than our estimate (12.4%). According to our seasonal adjustment, unemployment fell 0.1 p.p. to 11.9% in the quarter ended in April vs. 1Q19. Notwithstanding the decline during the quarter, unemployment remains high by historical standards, driven particularly by the still-timid recovery in economic activity. The pace of formal jobs created in the private sector (as published by PNAD) is faster than the suggested by the CAGED registry. Such divergence is common, but not likely to last much longer.

Yearly inflation peaks in May 

The mid-month consumer price index IPCA-15 climbed 0.35% in May, printing close to our estimate (0.38%) and below the median of market expectations (0.41%). Deflation in the food at home component (-0.26%) took the spotlight, while auto fuels pressured the indicator again. The IPCA-15 is up 4.97% yoy, but our forecasts suggest that year-over-year inflation peaked in May. The IPCA rose 0.57% in April, and the year-over-year change accelerated to 4.94%, from 4.58% in March. We maintain our assessment that inflation dynamics remains benign, even if pressured by volatile items in the short term. Risk of demand-led inflationary pressures remains low. In addition, inflationary inertia remains well-behaved, inflation expectations are anchored and spare capacity in the economy is still substantial. We expect the IPCA to reach 3.6% by year-end in both 2019 and 2020.

Copom is still comfortable with Selic rate level

The Brazilian Central Bank’s Monetary Policy Committee (Copom) left the benchmark Selic rate unchanged at 6.5% pa, in a widely anticipated decision. The minutes of that meeting suggested that, despite the disappointing recovery pace, the Copom is still quite comfortable with the current level of the Selic. The committee indicated that, while 1Q19’s GDP could be negative (the minutes were published by the Central Bank before the GDP report was released), activity is likely to rebound hereafter, and added that it will need to see signs that the aftereffects of the 2018 shocks have passed before any reassessment. Moreover, the text hinted that the Copom will also need to gauge to what extent uncertainty about fiscal sustainability may be hindering activity. All in all, it seems authorities believe that the approval of the pension reform may be a sufficient condition to strongly accelerate growth. In our view, downside risks for the inflation path tend to prevail after the approval of the pension reform, leading authorities to resume monetary easing, but not before September.

Primary surplus of BRL 6.6 billion in April

The consolidated public sector posted a BRL 6.6 billion primary budget surplus in April, beating our call (2.8 bn) and in line with market consensus (6.6 bn). The consolidated primary deficit over 12 months remained at 1.4% of GDP, matching the March print. In our view, meeting the public sector’s annual primary deficit target of BRL 132 bn requires discipline, but shouldn’t be so challenging, especially in case of a successful oil auction from the transfer-of-rights area (“cessão onerosa”), expected in October, which could improve this year’s primary result by up to BRL 52 bn (0.7% of GDP). Finally, public debt dynamics remained unfavorable in the latest reading – the general government’s gross debt increased to 78.8% of GDP in April from 78.5% in March, while the public sector’s net debt declined at the margin to 54.2% of GDP from 54.3%.

Current account deficit of US$ 62 million in April

The current account posted a deficit of $62 million in April, well below our estimate ($600 million surplus) and market expectations ($500 million surplus). For the next years, we maintain our expectation of a gradual increase in the current account deficit, but not to the point of compromising the sustainability of Brazil’s external accounts, as the deficit remains low. Direct investment in the country is still the main source of financing for the current account deficit.  

Provisional measures are voted to avoid expiration

On the political front, May was marked by provisional measures (PM) advancing through Congress. PM 870, which addresses the federal administration restructuring that reduced the number of ministries to 22 from 29, was approved in the Lower House and the Senate and now moves on to be signed by the President. The proposal’s content went through changes during the process, such as the transfer of the Council of Financial Activities Control (Coaf) from the Ministry of Justice to the Ministry of Economy. The Lower House also approved PM 871, which seeks to prevent fraud and irregular benefits within the social security system (INSS) through the creation of a program to review benefits and require registration of rural workers. According to the government, the measure may produce about 10 billion reais in annual savings. The Senate will likely vote the measure today, the deadline before it loses legal validity. An important measure for the airline sector, PM 863, which allows 100% participation of foreign capital in Brazilian airlines, was approved by the Lower House and the Senate and was forwarded to the President’s desk. PM 868, which updates water and sewage legislation, will likely expire, but news reports indicate that a bill of similar content will be sent to Congress.

Pension reform still on the spotlight 

The pension reform is still the highlight, and is currently under assessment by the Lower House’s Special Committee. The deadline for representatives to present amendments to the proposal ended on Thursday, May 30, with 277 suggested changes to the text submitted by the government. The next step is that the rapporteur, Samuel Moreira (PSDB-SP), presents his report – according to news, this can happen until June 15. It is worth mentioning that Congress will enter into parliamentary recess between July 17 and August 1.

Financial assets

In May, the Ibovespa rose 0.7% in local currency and 0.8% in U.S. dollars. Country risk measured by the 5-year CDS increased 9bps and finished the month at 181bps. The exchange rate slightly appreciated 0.1% to 3.94 reais per dollar by the end of the month.

Upcoming events

In Brazil, all eyes remain on the pension reform process in the Lower House’s Special Committee.

Globally, trade tensions take the spotlight. On June 10, the U.S. should implement the announced 5% tariff on Mexican imports. U.S. and China presidents may meet during the G20 summit, to be held on June 28-29. The event can be a key step for trade negotiations, which remain tense between these two nations. In the U.K., Prime Minister Theresa May should resign on June 7. On June 10, the Conservative Party will start debates to choose a new leader, in a process that may take up to two months.

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