Itaú BBA - The rebound continues but doubts remain

Brazil Review

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The rebound continues but doubts remain

noviembre 1, 2012

Credit volumes are growing moderately and the Central Bank has completed the monetary easing cycle.

The Brazilian economy in October 2012

The economy continued to recover, but doubts about its sustainability remain. Credit volumes are growing moderately and the Central Bank has completed the monetary easing cycle. Fiscal results weakened, while external borrowing picked up. Asset prices declined. The PT won the municipal elections in São Paulo and the mensalão trial advanced with convictions. Attention will now be focused on whether the economic rebound proves to be sustainable; the third quarter GDP report is scheduled for November 30.

The economy continued to recover, but doubts about its sustainability remain

Indicators have confirmed that the production recovery is now under way. Itau’s monthly GDP posted a sharp 0.9% mom/sa rise in August, led by improved retail sales and industrial data. Manufacturing company surveys indicate that the inventory cycle is over, and that business confidence is rising. The upturn is becoming increasingly more widespread among the sectors. We forecast an acceleration in GDP growth, to 1.2% qoq/sa in the third quarter, from 0.4% in the second quarter. However, doubts about the speed of the recovery going forward remain, especially regarding the willingness of companies to step up their investment spending.

Credit volumes are growing moderately

Consumer loans rose by 0.7% mom/sa in September (in real terms), following an accumulated drop of 6.2% in the two previous months. Nonperforming loans remained stable, while interest rates and spreads were little changed. Over the last 12 months, the real average for new consumer loans rose 3.4%, a low growth rate relative to the performance of recent years.

Inflation still rising, but not for long…

October’s IPCA-15 inflation preview was above consensus, at 0.65%, boosted by a 1.56% increase in food prices. Yearly inflation reached 5.56%, up from 5.31% in the September IPCA-15. A decline in wholesale food prices, however, indicates that pressure will be less intense in coming months.

…and the Central Bank completed the monetary easing cycle.

The interest rate was cut by 25 bps, to 7.25%. For those members of the committee (five members) who voted for the drop in interest rates, uncertainties about the recovery of the domestic economy were still a concern, partly due to a worse-than-expected global environment. Additionally, they mentioned that the current high inflation is due to supply shocks, which tend to reverse in the medium term. The committee members also said it was the “last cut” and signaled the maintenance of the Selic rate at the current level for a "sufficiently prolonged" period.

Fiscal results weakened...

The consolidated primary fiscal surplus stood at 1.6 billion reais in September, shy of both market estimates (4.0 billion) and our call (3.0 billion). In 12 months, the primary surplus reached 2.33% of GDP, the lowest since April 2011. Given the levels that we project for the Selic and IPCA in coming years, we estimate that the annual interest burden on the public sector will gradually fall to below 4% of GDP by 2015. We maintain our view that structurally lower interest rates will result in a fiscal policy that favors a lower primary effort in coming years.

…while external borrowing picked up.

September’s balance of payments revealed a rapid pace of external borrowing and an outflow of foreign capital from the stock market. Medium- and long-term borrowing, such as bonds, notes, commercial papers, trade credits and loans reached $ 6.5 billion in September, the highest in more than a year. The equity market saw an outflow of $ 1.2 billion. Fixed income inflows rose slightly, to $736 million. Foreign direct investment reached $4.4 billion, or 2.8% of GDP, in the last twelve months. Intercompany loans came in at 35% of total FDI, down from 41% in August. The current account deficit stood at $2.6 billion, or 2.2% of GDP, in the latest twelve months. Weak profit remittances, caused by both a soft economy in past few quarters and a weak real, as well as a strong trade surplus are responsible for the result.

Asset prices declined

After two months of improvement, domestic markets worsened in October. The Ibovespa lost 3.4% in local currency and 3.6% in dollar terms. The five-year CDS rose slightly, to 113 bps from 112 a month ago. The exchange rate continued to trade within a tight range and closed at 2.03 reais per dollar, almost unchanged from the previous month.

The PT won the municipal elections in São Paulo

Fernando Haddad of the PT party won the runoff municipal elections in São Paulo against Jose Serra of the PSDB. The PMDB continues to have the highest number of mayors in the country, followed by the PSDB and the PT. However, when weighting the total mayorships in terms of their respective populations, the PT holds the lead on a national scale.

The mensalão trial, the largest ever in Brazil involving corruption charges, has advanced

In the latest round of the "mensalão" trials, José Dirceu, Chief of Staff between 2003 and 2005, was found guilty of misuse of public funds in a Supreme Court probe. The case involves 38 defendants, among them, legislators, public officials and go-betweens from the private sector. Most have been found guilty on one count or another. The case is setting new, more rigorous, jurisprudence precedents for corruption cases.

What’s next?

Attention will now be focused on whether the rebound in economic activity will prove to be sustainable, and acceleration in investment spending will play a key role. The most important data highlight is third quarter GDP report scheduled for November 30.

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