Itaú BBA - Recovery Disappoints, Real Depreciates

Brazil Review

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Recovery Disappoints, Real Depreciates

diciembre 3, 2012

The economic recovery disappointed in the third quarter, increasing the doubts about its sustainability.

The Brazilian economy in November 2012

The economic recovery disappointed in the third quarter, increasing the doubts about its sustainability. After four months of stability, the exchange rate has depreciated. The Central Bank kept the policy rate stable at the last meeting of the year. The focus will remain on whether the economic rebound proves to be sustainable.

The economic recovery disappointed in the third quarter, deepening the doubts about its sustainability

GDP grew a seasonally-adjusted 0.6% in the third quarter, versus expectations of a 1.2% increase. From the demand side, investment (-2.0%) and government spending (+0.1%) were the main surprises. Private consumption grew 0.9%. On the supply side, service activity stood flat in the quarter, while we expected a 1.0% gain. Agricultural activity rose 2.5% and industry grew 0.9%.  Our preliminary forecast for the October monthly GDP is a gain of 0.4% mom/sa, driven by stronger industrial production and retail sales. However, the first indications of vehicle sales, energy consumption and business confidence for November show a further weakening in activity. These ups and downs in economic activity are partly due to short-term stimulus measures, such as the IPI tax break, but also show that the recovery is not yet on a sustainable path.

New loans declined, but quality of credit improved

The volume of new loans to consumers fell a seasonally-adjusted 1.9% in October in real terms, implying a total drop of 7.4% since July. Delinquency rates remained stable, while expectations called for a decline. Credit conditions became less restrictive: consumer interest rates declined to 35.4% p.a. in October, from 35.8% in September. Meanwhile, the spread narrowed to 27.8% from 27.9%, while the average maturity expanded to 620 days from 616. As a share of GDP, total outstanding loans expanded 0.4 p.p., to 51.9%. From a capital control standpoint, state-owned institutions continued to increase their market share.

The real depreciated

After trading within the 2.00-2.05 range for about four months, the real started to depreciate again in early November, closing the month at 2.13 to the dollar and representing a 5.2% depreciation over the previous month. The Ibovespa gained 0.7% in local currency, but lost 3.8% in dollar terms. The five-year CDS closed at 111 bps, same level as in the previous month. Exchange-rate depreciation has been used as a tool to improve the industry’s competitiveness and boost economic growth, but a weaker real also raises inflation risk. The fact that the economic rebound remains fragile might prompt the government to seek a higher FX rate. However, given the possible deterioration impact on inflation, we do not see the FX rate rising much higher than the current levels in the short term.

Inflation still rising, but not for long…

November’s IPCA-15 consumer inflation preview came in at 0.54%. As expected, a surge in airline ticket prices (+11.8%) offset the decline in “food-at-home” inflation, which came in at 0.59%, from 1.98% in the October IPCA-15. A large number of holidays in November affected airline ticket prices. Yearly inflation rose to 5.64%, from 5.56% in the October IPCA-15. As food prices continue to lose steam and airline ticket prices stop rising, we expect a yearly inflation of 5.5% by the end of the year.

…and the Central Bank kept rates unchanged.

The Central Bank maintained the policy rate at 7.25%, in line with expectations. The decision statement was the same as in the previous meeting, which indicated that the monetary policy committee (Copom) should maintain the policy rate stable for a “sufficiently prolonged” period. This reveals confidence in a lower equilibrium real interest rate as well as the need to maintain economic stimulus. Given the soft recovery in activity, we believe that the Copom will maintain the Selic rate at the current level at least until the end of 2013. However, the recent disappointments in growth have increased the likelihood of additional rate cuts.

Fiscal results remain on a weakening trend…

The public sector posted a primary surplus of 12.4 billion reais (2.3% of monthly GDP) in October. Revenue continues to weaken. Over the last six months, net federal revenue decreased 1.2% relative to the previous year’s levels, reflecting the cyclical slowdown in tax collection and the impact of tax breaks to stimulate the economy. Real federal expenditures over the last six months have risen 6.0%, outpacing our estimate for potential GDP (3.7%). So far in 2012, the main contributors to the rise in public expenses are: pensions (accounting for nearly 45% of the increase), administrative costs (accounting for 30%), and public investment (18%). With capital expenditure growth largely concentrated in the Minha Casa Minha Vida home subsidy program, it seems that the increase in public spending this year is unlikely to produce any productivity gains ahead.

…while FDI remained very strong.

Foreign direct investment in the Brazilian economy reached 7.7 billion dollars in October, topping the most optimistic forecasts. The total FDI for the last twelve months is at 66 billion dollars, or 2.9% of GDP. An 89% share of the October FDI came from equity capital transactions, while only 11% came from intercompany loans. The current account deficit reached 5.4 billion dollars in the month (2.3% of GDP over the last twelve months).

What’s next?

Attention will remain focused on whether the rebound in economic activity will prove to be sustainable, and acceleration in investment spending will play a key role.

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