Itaú BBA - Brazil: Lower GDP Growth, More Fiscal Stimulus

Brazil Scenario Review

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Brazil: Lower GDP Growth, More Fiscal Stimulus

mayo 8, 2013

Recent decisions confirm the intention to promote a more accommodative fiscal stance (at least) in 2013.

  • We reduced our forecast for the fiscal primary surplus this year to 1.5% from 1.9% of GDP. For 2014, we maintained our forecast at 0.9% of GDP.

  • We reduced our GDP growth forecast for this year to 2.8% from 3.0%. The expansion in the first quarter was probably somewhat lower than we expected, and there are signs of further moderation at the beginning of the second quarter. For 2014, we reduced our GDP forecast to 3.3% from 3.5%. 

  • Inflation will likely slow down, but the scenario of high core inflation will probably remain unchanged. Our forecasts for the IPCA are at 5.6% this year and 6.0% in 2014.

  • We maintained the forecast of a 1 percentage point increase in the Selic rate in 2013. However, the existing stimulus and persistent inflation will likely lead some of the members of the Monetary Policy Committee (Copom) to vote for larger rate hikes.

  • We reduced our forecast for the trade balance in 2013 to 6 billion dollars from 10 billion dollars. We raised our forecast for the current account deficit to 3.0% from 2.9% of GDP in 2013. We expect the exchange rate at around 2.00 reais per dollar by the end of this year and 2014.

More fiscal stimulus in 2013

Recent decisions confirm the intention to promote a more accommodative fiscal stance (at least) in 2013. The data for March showed a worse fiscal performance, offsetting the unusually strong result posted in January. Year to date figures point to a lower primary surplus in 2013, mainly due to tax cuts. Signals of new tax cuts and lower budgetary contribution from regional governments suggest that the fiscal surplus will likely remain low and on a downward trend ahead.

Our calculations indicate that the recurring primary surplus (which excludes atypical or temporary revenue and expenditures from the conventional result) fell to 1.5% of GDP, the lowest reading since April 2011. In March, the public sector posted the second lowest fiscal result for the period since the beginning of the historical series (2002), reflecting tax cuts and administrative costs (“gastos de custeio”). The primary surplus in March stood at 3.5 billion dollars, or 0.9% of GDP. The 12-month rolling conventional primary surplus fell from 2.2% of GDP in February to 2.0% in March.

The National Treasury will no longer need to compensate for lower-than-expected fiscal results from regional governments. This change in rule proposed in the 2014 budget guidelines bill (PLDO) will be in force this year as well (following congressional approval of this amendment to the 2013 budget law). This change signals an attempt at greater flexibility for fiscal stimulus, and it creates new incentives to reduce the fiscal effort on regional and central governments.

 We lowered our forecast for the consolidated primary surplus in 2013 to 1.5% of GDP from 1.9%. We also reduced our primary surplus forecast for the central government, to 1.15% of GDP from 1.40%, with higher tax cuts and administrative costs (“gastos de custeio”). We still expect a sharper drop in the primary result of states and municipalities, which will likely reach 0.3% of GDP in 2013 (previous forecast: 0.4%), compared with 0.5% in 2012.

For 2014, we maintain our forecast for the consolidated primary balance at 0.9% of GDP, with a 0.9% result for the central government (exactly the target provided in the budget guidelines law) and a primary surplus for regional governments standing at practically zero. We believe that in the next year the central government will produce new tax cuts, which will likely amount to around R$90 billion (1.7% of GDP), against expectations of R$60 billion (1.2% of GDP) in 2013. Our estimate also assumes real-expenditure growth at a pace of 5% in 2014 (similar to our 2013 expectations). These fiscal actions will probably be part of an economic policy strategy designed to stimulate the resumption of activity growth.

Slightly lower GDP growth

We reduced our forecast for GDP growth in 1Q13 to 1.0% from 1.2% qoq/sa. Industrial production grew 0.7% mom/sa in March, below our 1.3% forecast. During 1Q13, industrial activity advanced 0.8% qoq/sa. The highlight was the weakness of the Mining sector, due to the decline in oil and iron ore production. While Mining fell 7.3% in the first quarter, Manufacturing grew by 1.5%. However, the first signs for April suggest a cool-down. The data point to a moderate growth of economic activity in the coming quarters. The expansion trend is still gradual and volatile. Furthermore, economic growth remains not very widespread. Exports are weak, and retail sales have slowed.

Strong investment in the first quarter, but weak ahead. On the demand side, the highlight in the 1Q13 GDP was probably investment. However, the decline in the confidence indices for the Industrial and Service sectors suggest a slowdown in gross fixed-capital formation ahead. This supports the scenario of moderate economic recovery throughout the year.

Credit market shows signs of recovery. Credit concessions, in real terms, grew 12.8% in March yoy. This pace exceeds the growth registered in the second half of last year. Delinquency in consumer loans more than 90 days past due fell slightly, to 5.35% in March from 5.42% in February, marking the sixth consecutive month of retreats. Delinquency in corporate loans dropped to 2.20% from 2.24%. Interest rates and spreads declined again.

The labor market conditions remain positive despite the slower pace of hirings and a slowdown in wages. The unemployment rate stood at 5.3% in March, and we expect it to hover around this level throughout the year. Both formal and informal hirings decelerated somewhat, but not enough to alter the unemployment rate. Furthermore, real wages slowed. Lower nominal increases and higher inflation reduced real gains. Despite the lower growth outlook for income, the labor market will still support consumption in 2013, along with the signs of credit expansion.

We reduced our forecast for GDP growth to 2.8% from 3.0% in 2013, and to 3.3% from 3.5% in 2014. The outlook of lower growth in the first quarter reduces the carry-over for the year. Moreover, recent data reinforce the slowdown scenario in the second quarter, which may be more intense than anticipated. For 2014, fiscal and quasi-fiscal incentives will probably be higher. Therefore, we expect stronger growth compared with this year. However, lower GDP growth in 2013 will likely lead to lower growth in investment in 2014.

Temporary relief in inflation, fundamentals unchanged

Inflation suffered continuous upward pressure early this year, ending the first quarter with a 1.9% gain, compared with 1.2% in the same period of 2012. This result drove the 12-month consumer price index (IPCA) to 6.6%, above the upper limit of the target range. The relief resulting from the 18% discount on electricity tariffs (-0.60 pp impact on IPCA) was not sufficient to compensate for the strong pressure of food prices, which rose 4.6% in 1Q13 (impact of 1.1 pp on IPCA).

The inflation outlook remains unfavorable; diffusion index and core measures remain high, despite some cool-down at the margin. Services inflation also remains under pressure, although increasing slightly less in the first quarter than in the same period of 2012 (2.5% versus 2.8%). Several changes in relative prices have affected the current inflation. On the one hand, there is the lift in food inflation due to supply shocks. On the other hand, there are the tax cuts, which likely reduced inflation by about 1 percentage point in the last 12 months. The smoothed trimmed means core is a measure of inflation that isolates an important part of such effects. This measure accumulated a gain of 6.2% in the 12 months through March, indicating that an upward trend is in fact occurring.

Despite the pickup early in the year, we expect inflation to retreat in the coming months, mainly due to the food group. Food prices will likely begin to reverse part of the increase posted in prior periods, due to remaining effects of the tax cut over the "cesta básica" and mainly due to the pass-through of falling agricultural prices. The recent sharp decline in grain prices already passed through to pork and chicken prices. Also, the normalization of the perishable food supply after the price hikes early in the year will probably bring major relief to inflation in the coming months. Between May and October, we expect inflation to range between 0.27% and 0.38% on a monthly basis.

The fundamentals, driven by the heated labor market and the persisting increase in inflation expectations, indicate an unfavorable balance of risk for inflation over longer periods. Thus, we don’t see a reversal of this outlook, given the fiscal and monetary stimulus in place. Our forecasts for the IPCA remain unchanged, at 5.6% for 2013 and 6% for 2014. Core inflation measures indicate that underlying inflation is slightly above 6%.

Divided Copom

Brazil’s central bank initiated a cautious adjustment in the monetary policy rate. The higher and more widespread inflation led the Copom to raise interest rates in April. Going forward, the Copom indicated that "internal and especially external uncertainties" warranted that monetary tightening be carried out with caution. In our view, the signal is consistent with our scenario of a 1.0 percentage point hike cycle in the Selic rate, at a pace of 0.25 percentage point hikes per meeting.

The global outlook in the short term reinforces the Copom’s cautious stance represented by a 0.25 percentage point rate increases per meeting. The latest figures show weaker growth in major world economic blocs. Commodity prices are stabilizing at a lower level compared with the end of last year. Internally, the recovery remains uncertain. There are signs of growth below expectation, and temporary relief to inflation in the coming months.

Persistent inflation, however, may lead to a split decision in the next Copom meeting. Although not the majority, some members of the Copom may argue that there is no alternative than more monetary policy tightening in order to keep inflation under control and bring it back to the target path.

We continue to forecast a hiking cycle of 1 percentage point in the Selic rate this year.

Oil negatively impacts trade balance and raises current account deficit

We reduced our forecast for the trade surplus this year to 6 billion dollars from 10 billion dollars. The trade balance in April was negative by 994 million dollars. On the positive side, the highlight was exports of 7.2 million tons of soybeans. On the other hand, delayed imports of refined fuels continue to negatively affect the trade balance. Moreover, the crude oil trade balance is negative by 1.5 billion dollars for the year. The significant drop in production of this commodity, along with the increase in refining, led us to estimate that crude oil will contribute about 3 billion dollars to the trade balance in 2013, down from a previous estimate of 7 billion dollars (equal to last year's contribution).

The trade balance revision increased our forecast for the current account deficit to 3.0% from 2.9% of GDP by the end of 2013. This deficit exceeds foreign direct investment (FDI). In March, the 12-month rolling current account deficit reached 67 billion dollars, while FDI reached 64 billion dollars. This is happening for the first time since 2010, reinforcing our expectation of deterioration in the balance of payments in 2013. With the current account deficit above the FDI, other sources of funding are needed. Otherwise, the exchange rate will depreciate or international reserves will fall.

We continue to expect the exchange rate at 2.00 reais to the dollar by the end of 2013 and 2014. Fiscal policy easing and the deterioration of the external accounts have contributed to an increase in the risk premium. This reflects fundamentals which are compatible with a more depreciated exchange rate than previously. Moreover, economic policy signs suggest that the desired exchange rate stands at around 2.00 reais per dollar.

Forecast: Brazil

Source: IMF, IBGE, BCB, Haver and Itaú


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