Itaú BBA - Less rainfall, greater risks

Brazil Review

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Less rainfall, greater risks

febrero 2, 2015

Rainfall levels were quite weak in January, at 64% of their historical average

The Brazilian economy in January 2015

Rainfall levels remained low in January, increasing the risk of water and electricity rationing. After announcing in December measures to curb spending (which have yet to be voted on by congress), the government announced actions to expand revenues. The central bank increased the benchmark interest rate again, while inflation topped the upper limit of its target range. Deficits in the public balance and in the current account kept widening. Consumer confidence fell in January, while the unemployment rate declined due to a shrinking labor force.  Eduardo Cunha was elected president of the Lower House and Renan Calheiros was elected president of the Senate.

Rainfall levels remained low in January, increasing the risk of rationing

Rainfall levels were quite weak in January, at 64% of their historical average. Aggregate reservoir levels stand at 21% capacity. The situation is worse in the Southeast and Northeast, where reservoirs for water supply and power generation are already low. In São Paulo, water volumes in the Cantareira system, the main supplier to the city, reached 5.1% capacity by the end of the month. The scenario increases risks of power rationing and water-supply restrictions, with possible impacts on economic activity.

The government announces increases in taxes and contributions

After announcing in December measures to curb spending (which have yet to be voted on by congress), the government announced actions to expand revenues: i) an increase in the CIDE tax on fuels; ii) an increase in the IOF tax on household credit transactions; iii) higher PIS/Cofins rates on imports; and iv) matching the IPI tax paid by manufacturers and wholesalers on cosmetics.

Central bank hikes the benchmark rate again 

The Monetary Policy Committee of the Brazilian Central Bank (Copom) increased the Selic benchmark interest rate by 50 bps to 12.25% p.a. in a unanimous decision that was in line with market expectations. The minutes released in the following week included elements which led the committee to conclude that the scenario of inflation convergence to 4.5% in 2016 “has been strengthening,” although the advances seen so far “are still insufficient.” Thus, we believe that the minutes are consistent with our scenario of a final 25-bp increase in the next Copom meeting, taking the benchmark Selic rate to 12.50%.

Year-over-year IPCA-15 accelerates to 6.7% 

The mid-month consumer price index (IPCA-15) climbed 0.89% in January, above our estimate and close to the median of market expectations. The year-over-year change picked up to 6.7%, topping the upper limit of the target range, of 6.5%. Food, housing, personal expenses and transportation provided the largest upward contributions during the month. Core inflation measures also accelerated, while service costs advanced less sharply than in the previous month.

A disappointing fiscal result in December 

The public sector’s primary deficit hit BRL 12.9 billion in December, way higher than our BRL 2.0 billion forecast. The biggest negative surprise came from regional governments (deficit of BRL 11.3 billion), but state-owned companies also saw a worse-than-expected result (deficit of BRL 2.3 billion). In 2014, the primary deficit stood at 0.6% of GDP, the weakest since 1997, while the nominal deficit reached 6.7% of GDP.

Current account deficit reaches 4.2% of GDP in December

In December, the current account deficit reached BRL 10.3 billion, wider than our call and market estimates. The deficit over 12 months stands at 4.2% of GDP, the highest since 2002. Foreign direct investment came at BRL 6.7 billion, sustaining the flow over 12 months at 2.9% of GDP. The current account deficit is relatively high and still on an upward trend, which is one of the reasons why we expect further depreciation of the Brazilian real this year. Our year-end estimate is 2.90 reais per U.S. dollar.

Consumer confidence continues to decline

In January, consumer confidence (FGV survey) dropped 7% on a seasonally-adjusted monthly basis, marking the sharpest decline since October 2008 and reaching an all-time low in the historical series started in 2005. The slide in confidence reflects higher interest rates and inflation and the perception of a weaker labor market. Low confidence points to sluggish consumer spending in 2015.

Unemployment rate falls in December

According to the Monthly Employment Survey (PME, by census bureau IBGE), the unemployment rate slid from 4.8% in November to 4.3% in December, close to our estimate but below market expectations. The seasonally-adjusted unemployment rate fell from 5.2% to 5.0%, as the labor force contracted more sharply than employment, meaning that fewer people were looking for jobs in December. The average unemployment rate in 2014 stood at 4.8%, down from 5.4% in 2013.

Currency weakened and stocks fell 

The exchange rate ended January at 2.66 reais per dollar, depreciating 0.2%, but it strengthened to 2.57 at one point during the month. The Ibovespa dropped 6.2% in local currency (-6.4% in dollars). The five-year Brazilian CDS rose 30 bps, to 227 bps.

Eduardo Cunha was elected president of the Lower House 

Eduardo Cunha, from the PMDB, was elected president of the Lower House, with 267 votes. PT’s candidate, Arlindo Chinaglia, was second, with 136 votes. In the election for the presidency of the Senate, Renan Calheiros, also from the PMDB, was elected. Both mandates are for two years.

What’s next?

Temporary decrees announced by the administration to cut spending will be sent to congress as new representatives take over on February 2. These decrees are valid for 60 days and renewable for another 60 days so that they can be voted on.


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