Itaú BBA - Less pressure on the currency

Brazil Scenario Review

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Less pressure on the currency

octubre 4, 2013

We have revised our forecast for the end of 2013 to 2.35 reais per dollar from 2.45.

•           Delayed tapering in the U.S. and swap offers by Brazilian Central Bank helped to strengthen the local currency. These events provide some temporary relief to the exchange rate, and so we have changed our forecast to 2.35 reais per U.S. dollar from 2.45 by year-end, but we have maintained our estimate at 2.55 for the end of next year. 

•           A stronger currency and lower inflation in recent months led us to revise our forecast for the consumer price index IPCA in 2013 to 5.9% from 6.2%. Our forecast for 2014 remains at 6.0%. 

•           We expect GDP growth of 2.3% in 2013 and 1.7% in 2014. The balance of risks for growth has improved due to the recovery of some financial indicators. 

•           We forecast the Selic benchmark interest rate at 9.75% p.a. by the end of 2013 and 2014. Our estimates for the primary budget surplus hold steady at 1.7% of GDP in 2013 and 1.1% in 2014, although the outlook for revenues and expenses has changed.

U.S. monetary policy and actions by the Brazilian Central Bank strengthen the local currency

External and internal events helped to strengthen the Brazilian real; we have revised our forecast for the end of 2013 to 2.35 reais per dollar from 2.45. The decision by the U.S. Federal Reserve to maintain stimuli and more positive data from China contributed to boosting emerging-market currencies. Domestically, dollar sales by the central bank through swap transactions have also supported the real at a stronger level.

We have maintained our forecast for the exchange rate at 2.55 reais per dollar at the end of 2014. We believe that the Fed has just postponed the tapering to December. Therefore, our exchange rate forecast for year-end 2014 has been maintained at 2.55 reais per dollar, given that internal events (i.e., elections) and lower global liquidity could increase market volatility.

The current account deficit narrowed in August to USD 5.5 billion, as the trade balance was positive by USD 1.2 billion. Over 12 months, however, the deficit reached its widest level in recent history, 3.6% of GDP. We believe the current account gap will remain at this level until the end of this year, improving gradually to 2.7% of GDP at the end of 2014.

The trade balance was positive by USD 2.1 billion in September, showing a gradual recovery. The deficit year-to-date is USD 1.6 billion, in line with our expectation for a trade balance of zero this year. Imports ex-fuels started to retreat, falling 9% (seasonally adjusted) accumulated in the past three months due largely to the weakening move in the exchange rate seen mid-year. The net balance for crude oil also became more favorable, with a surplus of USD 1.6 billion in the last two months, helping to offset deficits from previous months. We maintain our forecast for the trade surplus in 2014 at USD 12 billion.

Less pressure on food prices and a less depreciated currency reduce inflation forecast 

The latest inflation figures were still tame, with some food prices falling more sharply than expected. With better supply conditions, fresh fruits and vegetables have contributed to the slowdown in consumer inflation, reversing their spike earlier in the year (33% between January and April). We estimate that prices for fresh fruits and vegetables fell by 18% in the past five months, with an impact of -0.40 pp on the IPCA.

We expect year-over-year inflation (IPCA) to recede to 5.86% in September, after peaking at 6.70% in June. This retreat in inflation (-0.84 pp) has been largely driven by the food group (-0.79 pp, incorporating our September estimate), particularly fresh fruits and vegetables (-0.51 pp). The relief in other groups was residual, given that non-food inflation remained around 4.8% during the period.

With a less depreciated currency at the margin, there will likely be less pressure on inflation in the next months. For 4Q13, we expect the IPCA to rise 2% (previous call: 2.2%). Higher inflation late in the year will be driven by seasonal factors (higher meat prices in particular), by the impact of exchange-rate depreciation in previous months and by the likely adjustment in fuel prices. Our scenario includes a 6% increase in gasoline and diesel oil prices at refineries in the final quarter of the year, with an impact of 0.16 pp on the IPCA. Though gaps in fuel prices have declined materially in the past month, the fact that current inflation is lower makes room for a moderate adjustment in gasoline prices.

As inflation at the margin is running below our estimate and the exchange rate is less depreciated, we revised downward our estimate for 2013 IPCA, to 5.9% from 6.2%. Inflation in market-set prices should reach 7.3%, while regulated prices are likely to increase only 1.5%. Our forecast for the IPCA in 2014 was maintained at 6.0%, with market-set prices rising 6.4% and regulated prices increasing 4.5%.

Our estimate for the general price index IGP-M in 2013 was reduced to 5.3% from 5.5%, while our 2014 forecast remains at 6.0%. Though our scenario incorporates less weakness in the exchange rate and somewhat-lower commodity prices, the revision in our forecast for the IGP-M in 2013 was small. A higher-than-expected reading in September cushioned the impact caused by other variables in our scenario.

After a weak 3Q13, GDP is expected to rebound late in the year

Current data still point to a slight contraction in the economy in 3Q13. Though some indicators surprised to the upside in July, such as retail sales, the data still point to contraction in economic activity in 3Q13. Crop data suggest a decline in agricultural and livestock. Even with growth in September, we forecast that industrial production ended the quarter in negative territory. Weakness in manufacturing affects transportation, services provided to companies and communication activities. In other words, it hurts the Service sector. Hence, we maintain our call that 3Q13 GDP will drop 0.5% qoq/sa, though downside risks to this estimate have receded in recent weeks.

Improved financial conditions suggest slightly higher growth in 4Q13, but higher inventories point the other way. During the past month, risk premiums declined, stock-market indexes advanced, exchange-rate volatility retreated and long-term yields fell. These are positive factors for the economy, particularly for investment decisions. We revised upward our call for 4Q13 GDP growth, to 0.6% from 0.3% qoq/sa. One factor holding back the rebound following a weak quarter is the increase in inventories. Surveys indicate an increase in excessive manufacturing inventories, which should prevent faster growth in the sector in 4Q13. We maintain our forecasts for GDP growth at 2.3% in 2013 and 1.7% in 2014.

Confidence remains at low levels, compatible with moderate expansion in the economy ahead. Indicators related to productive activity fell in September and are consolidating around lower levels than those seen a few months ago. Confidence slipped 1.0% mom/sa among industrial entrepreneurs and 0.2% in the Service sector, according to FGV. Consumer confidence advanced in September, but indexes for the Industrial and Service sectors are more closely correlated with economic activity. Given these confidence levels, economic expansion in the next quarters will likely be moderate.  

Notwithstanding a decline in the unemployment rate, there are evidences of a cool-down in the labor market. The unemployment rate was below expectation in August, going back to the lowest level in the series. The slide was driven by a fewer people searching for jobs, not by more jobs being created. The working population has expanded more slowly in recent months, but the labor force also decelerated, preventing an increase in the unemployment rate. Sluggish growth in the working population is just another indication of a cool-down in the labor market, along with the following factors: i) formal job creation (according to the Labor Ministry’s Caged registry) is at the lowest level since 2009; ii) consumers continue to see labor-market conditions as more difficult than in the recent past; and iii) the outlook for hiring in the industrial sector worsened to the lowest level since 2009.

Marginal improvement in credit conditions and in the delinquency of non-earmarked loans. The daily average for new non-earmarked loans expanded slightly by 1.3% in seasonally-adjusted real terms (rising 1.5% for consumers and 1.0% for companies). Hence, new loans continue to hover around a stable level. Growth in outstanding non-earmarked loans continues to slow down (to 2.5% yoy in August from 2.7% in July). Total delinquency in the system was stable, at 3.3%, falling 0.1 pp for non-earmarked loans to 5.1%. Though state-owned banks continue to widen their market share, there are signs that this process should lose momentum. Uncertainties surrounding the macro scenario and the sluggish economic recovery may hinder the rebound in new non-earmarked loans.

The first auctions provided mixed signs. Progress in concessions is important for economic expansion in 2014. Auctions involving two highways (BR-050 and BR-262) in September provided mixed signs. There was demand for BR-050, and the toll price had a discount of 42.4% in the auction. However, there was no demand for BR-262. Large investment needs in the first years and uncertainties about the execution of government projects during that stretch, among other reasons, were behind the lack of interest. The government has acted to change conditions, and the next auctions will likely be more attractive for private investors. It is a positive reaction, but upcoming auctions will consequently be delayed. Concessions will stimulate investment next year and tend to foster economic growth for longer periods.

Fiscal stance is still expansionary

In August, the public sector posted a primary deficit of BRL 432 million, or 0.1% of GDP. The result was worse than the average for the month in 2009-2012, which is a surplus of 1.4% of GDP. Over 12 months, the primary balance slid 0.1 pp, to 1.8% of GDP. The central government accounted for 1.5% of GDP, while regional governments contributed 0.4% (state-owned companies posted a deficit of 0.1%). The 12-month recurring surplus — which disregards atypical revenues and expenses — fell to 1.4% of GDP in August from 1.5% in July, confirming a declining trend in the fiscal effort.

Our estimates for the structural primary balance point to a still-expansionary bias in fiscal policy. According to our estimate, the consolidated primary surplus adjusted for the business cycle, asset prices and non-recurring budget transactions stood at 1.3% of GDP in the four quarters ended in 2Q13. Despite a slower drop recently, signaling a reduction in the fiscal momentum through the public budget and a more modest adoption of new stimuli, the structural fiscal result remains below its long-term equilibrium level. We define this equilibrium level as the primary surplus that is consistent with stability in public debt in the long run. We estimate this level around 2% of GDP. Hence, in absolute terms, there is still a considerable amount of fiscal stimulus in the economy.

Our budget forecasts are unchanged. We forecast the primary surplus at 1.7% of GDP in 2013 and at 1.1% of GDP in 2014. However, we have revised the breakdown of revenues and expenses by the central government.

We have incorporated larger outlays with subsidies for electricity bills, reflected in funds injected by the Treasury into the Electricity sector (CDE, RGR accounts). We estimate expenses of BRL 10 billion in 2013 and BRL 8 billion in 2014. As these expenses were not budgeted (in official calculations or in our previous forecasts), we revised upward the average real growth in central government expenses for these two years, to 5% from 4%.

But we now expect a larger volume of revenues in the period. We incorporated into our 2013 scenario around BRL 10 billion in revenues from installment payments or repayment of late taxes or taxes held up in legal proceedings, due to an incentive program. For 2014, recent signs (e.g., the decision to increase the IPI tax on the purchase of household appliances and furniture) indicate a smaller volume of tax breaks than we estimated. We thus increased our estimate for net federal revenues by BRL 11 billion.

The public sector’s net debt dropped 0.3 pp to 33.8% of GDP in August. Despite the primary deficit, the debt-to-GDP ratio declined in August. The U.S. dollar appreciation against the Brazilian real (up 3.6% in August) increased the local-currency value of international reserves, which are booked as public sector assets. This year, the exchange-rate move helped to reduce the debt-to-GDP ratio, which fell 1.4 pp from 35.2% in December 2012. We forecast that consolidated net debt will remain stable, at around 35% of GDP, until the end of 2014.

Inflation is still a source of concern for the Copom, but we maintain our Selic rate forecast at 9.75%

The monetary policy committee (Copom) has maintained its recent wording about inflationary risks, suggesting additional monetary tightening is still necessary. In its Inflation Report for 3Q13, the Copom expressed caution about the inflation outlook. The effect of a weaker exchange rate on consumer prices and a still-tight condition in factors market are sources of concern for the Copom.

Inflation forecasts remain high. Forecasts for 2014 and 2015 in the Inflation Report show just a gradual slowing trend, with still-high numbers, only slightly below those for 2013. In the reference scenario (Selic rate at 9% and the exchange rate at 2.35 reais per dollar), IPCA inflation reaches 5.8% in 2013, 5.7% in 2014 and 5.5% in 3Q15.

The inflation report outlines domestic and external buffers to inflationary risks. Domestically, labor market risks are likely to ease as the minimum wage increases more slowly in coming years. Also, in the committee’s view, the fiscal balance tends to shift to the neutral zone (vs. an expansive stance currently). Externally, the recovery in advanced economies and rising volatility in the markets are "opposing forces." The Copom also highlights "some accommodation" in international commodity prices.

Given moderate growth and recent stability in the exchange rate, we maintain our expectation of a hike in the benchmark rate to 9.75% by year-end. We forecast a 50-bp increase in the Selic rate at the next Copom meeting in October, followed by a 25-bp hike in the November meeting, ending the tightening cycle with the Selic rate at 9.75% p.a.

Forecast: Brazil

Source: IMF, IBGE, BCB, Haver and Itaú

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