Itaú BBA - Global deceleration, local reaction

Brazil Scenario Review

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Global deceleration, local reaction

diciembre 8, 2011

The economy has weakened, but a mix of low interest rates, more public spending, tax breaks and credit stimulus will rekindle growth in 2012

The Brazilian economy continues to shift into lower gear. After a peak in the first quarter of 2011, quarterly growth cranked to a standstill in the third quarter: a 0.0% reading.

The slowdown still reflects policies adopted since the end of 2010. First, higher capital and reserve requirements raised the cost of borrowing. Then, along the first half of the year, the Selic rate went from 10.75% to 12.50%. Fiscal spending stayed subdued, and the BNDES went back to a more normal pace of lending after a busy 2010.

More recently, that trend was compounded by global woes and their impact on confidence. By now, the economy seems headed to grow 2.8% in 2011 (see our report "We forecast 2.8% for GDP growth in 2011").

The third quarter of 2011 was probably the weakest in this cycle. From now on, growth will likely rise, possibly peak in the fourth quarter, and then recede (see graph). The first quarter of 2012 will be in the grip of opposing forces: the effects from a waning global economy, and the one-shot impact of the new minimum wage and IPI tax breaks. We are keeping our 2012 growth forecast at 3.5%.

In other words, we expect a pickup as the economy responds to a mix of stimulus. First among them, lower interest rates. The Central Bank has been cutting the Selic since August and, given the weakness at home and global risks, more cuts will probably come.

With the Selic falling faster than inflation, the real interest rate will look very low in coming quarters: around 3 to 4%, depending on how we calculate it. That’s unusually low for Brazil, and lower than in the post-Lehman recovery. Even against a difficult global environment, monetary policy will be helping growth, again.

Other levers will be used. Last week, the government announced a tax break for certain home appliances, as well as lower taxes for consumer loans. A 2% tax on foreign equity investment was thrashed, along with a 6% tax on foreign purchases of local debentures. A few weeks earlier, the CB eased capital requirements on consumer loans, and called off an increase in the minimum payment on credit card bills scheduled to happen in December.

Long list, small impact, ready to do more

Together, those measures could add perhaps one quarter of a percentage point to GDP growth in 2012 – most of it from easier lending terms (lower tax on loans, lower capital requirements).

The tax breaks will help too, and more so if, as in 2008, they stay around for longer. The relief window is set to expire in March 2012.

Beyond their direct impact, these measures reveal concern with growth and – as in 2008-9 – an intention to use many options. It makes sense to expect more to come if growth weakens further. Should we expect less rate cuts? So far, the impact of additional measures seems too small to replace monetary policy. If anything, they are offsetting a slightly worse global outlook. In our base scenario, we still expect the Selic rate to reach 9% next year.

Fiscal policy will probably be less restrained, and not only because of this last batch of tax relief. In January, the new minimum wage will raise spending on pensions and pressure public sector wages. Public investment will likely be back, after a dry 2011. We expect the primary surplus to fall towards 2.5% of GDP in 2012.

The weight of inflation

Protecting growth amid a global slowdown means keeping inflation broadly unchanged – and letting pass an opportunity to converge to the 4.5% mid-target in 2012.

A reweighting of the IPCA inflation index – scheduled for January – will, however, lead to lower inflation next year.

The new weights reflect spending habits captured in a 2008-9 household survey. Consumers now spend a larger share of their income on electronics and new cars, and that is basically why the weight of manufactured goods went up. The weight of services fell, mostly because of a relative drop in spending on education and health services.

We expect the new weights to trim 50 bps off from next year’s IPCA, a bigger impact than the 14 bps we had assumed before the new weights became known. Our 2012 forecast was revised to 5.25%. Lower inflation certainly adds comfort as the central bank and the finance ministry move to protect growth.

Exchange rate

We still expect the real to be at 1.75 to the dollar by year-end 2012. Commodity prices have trended lower, and could lead to smaller trade surplus in 2012. However, prices have been volatile and we chose to keep our forecast for the 2012 trade balance at USD 15 billion, for now.

At the same time (and despite global uncertainty), foreign capital inflows continue to be a part of Brazil’s high-investment, low-savings macro story. While there will be volatility, these capital inflows will probably keep the Real at around its current value, in real terms.

Brazil and our global scenarios

How does Brazil relate to the global scenarios in our World outlook?

In our base scenario (“Muddle-through”), strong stimuli offset the negative impact from abroad, and generate a rebound in the second half of next year.

In the “Disruption” story, in which the euro monetary system breaks up, Brazil would probably be hit faster than macro policies could react. Like in 2008, we’d expect to see a recession, with the usual levers propping up growth in subsequent quarters: interest rates, reserve requirements, fiscal policy, BNDES. Again as in 2008, we’d expect the currency to spike to well above 2.0 reais to the dollar, and gradually move back to the levels of our base scenario.

In a scenario in which the ECB acts more aggressively, preventing a worsening of the crisis in the euro zone (“Revamped-ECB”), the recovery in 2012 would be faster. In that case, it will be central bank’s and the finance ministry’s task to calibrate policies and avoid a pickup in inflation in 2013.

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