Itaú BBA - Slower Growth and Lower Interest Rates

Brazil Scenario Review

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Slower Growth and Lower Interest Rates

noviembre 8, 2012

A slower rebound in investment worsens the GDP growth outlook and Selic rate will likely remain low for a longer period.

A slower rebound in investment worsens the GDP growth outlook and Selic rate will likely remain low for a longer period. 

We reduced our 2012 GDP growth forecast to 1.5%, from 1.7%. Our estimate for 2013 fell to 4.0% from 4.5%, given signs of a slow rebound in investments. In a more moderate growth scenario, we expect the Selic interest rate to end 2013 at 7.25% (from 8.50% previously). We raised our exchange-rate forecast for the end of 2013 to 2.02 reais per U.S. dollar (from 1.90 R$/US$). We also revised our call for the trade surplus in 2012, to US$20.5 billion from US$18 billion, and increased our estimate for 2013 to US$18 billion from US$13 billion. On the fiscal side, the recent results brought negative surprises. We expect the primary budget surplus to be lower this year. We revised our estimate for 2012 to 2.4% of GDP, from2.6%, and maintained 2.2% of GDP for next year. Our estimates for the consumer price index (IPCA) are 5.5% in 2012 and 5.3% in 2013.  

Slower Rebound in Activity, Despite Stimuli

Although the economy is expanding as expected, the pace ahead may be slower than previously envisaged. Consumer spending is stronger, while exports and investments are weaker. We expected lower growth contribution from the auto sector in 4Q12, but believed that this scenario might be offset by an increase in investments, pushing GDP growth to 1.3% in the final quarter of the year. We now believe that it will not be the case.

After avoiding economic stagnation in 2Q12 and boosting GDP in 3Q12, the auto sector has lost momentum. Recent data confirm a cool-down in auto sales and production. Furthermore, industrial production was weaker in September, deepening the downward revision of our Itaú Unibanco monthly GDP growth, to -0.3% from -0.1%, for the month. In order to grow at the previously expected pace in 4Q12, GDP would need to advance at higher monthly rates. But the latest data has proved to be worse, and 4Q12 growth is expected to be lower. 

The reaction of investments to stimuli may be slower than usual due to both the uncertainties in the international scenario and doubts regarding the consistency of the domestic rebound. Real interest rates dropped and business confidence is on the rise, but machinery and equipment purchases show no strength. Public investments are also below expectation. Without a pickup in investments, growth in 4Q12 is likely to be lower, but still enough to confirm the Brazilian economic recovery. Our 4Q12 GDP growth forecast was revised to 1.0% qoq/sa, from 1.3%. For 3Q12, our call stands at 1.2% qoq/sa.

Lower growth in the final quarter of the year tends to negatively affect expansion in the following year. A lower carry-over from 2012 will contribute to a downward revision in growth forecasts for 2013. We lowered our forecast for next year, to 4.0% from 4.5%, due to three factors: i) the carry-over effect from our revised 2012 growth forecast, to 1.5% from 1.7%; ii) the expectation of a slower recovery of investments; and iii) lower growth in the global economy.

Bank loans grew in September after two consecutive months of declines. Daily average for new consumer loans rose 0.7% (adjusted for inflation and seasonality), following an accumulated drop of 6.2% in the two previous months. Meanwhile, daily average for corporate loans advanced 4.0% in September, partially reversing the 5.9% decline registered in July and August. A strike by bank workers prevented a sharper recovery in consumer loans, and led to an increase in the most expensive credit modalities - overdraft facilities and interest-bearing credit cards - which are more readily available.

Interest rates and spreads rose slightly for consumers (largely due to a temporary change in the product mix) and fell moderately for companies. Seasonally-adjusted delinquency rates for loans 15 to 90 days past due posted a small increase, while delinquency rates for loans more than 90 days past due were stable remaining at a high level. The performance of new credit facilities suggests a future decline in delinquency. In terms of market share, state-owned banks continue to increase their presence.

Rising confidence indicators, a heated labor market, growing credit demand, as well as the expectation of a decline in delinquency and a rebound in domestic activity are compatible with moderate credit expansion in the coming months.

Growth and Inflation Should Support the Current Exchange Rate Level

Our scenario of more moderate economic activity and tamed inflation in 2013 opens room for maintenance of many of the economic stimuli adopted in 2012, including the current exchange rate. Although we continue to see a decoupling between the real and its peers and risk premiums, the exchange rate seems to have a prominent role in the current policy to boost manufacturing and exports. Considering this context and our own inflation scenario (which is unlikely to threaten the strategy of a weaker currency in the period), we expect the exchange rate to end both 2012 and 2013 at 2.02 reais per U.S. dollar (from 2 reais by year-end 2012 and 1.90 reais by year-end 2013, previously).

We raised our trade surplus forecasts. In October, the trade balance reached US$1.7 billion, accumulating US$17.4 billion year to date. The main driver behind the recent acceleration in surplus was the fact that imports remained at a lower level due to a weaker currency and lower growth (although the declining trend has been interrupted). For this reason, we adjusted our trade surplus estimate for 2012 to US$20.5 billion, from US$18 billion. For 2013, we incorporated the expectation of a plentiful agricultural harvest and our new scenario, in which the real is maintained at a weaker level and economic recovery is slower. We now forecast a trade surplus of US$18 billion next year (from US$13 billion previously).

Foreign direct investment (FDI) hit US$4.4 billion in September and, for the second consecutive month, intercompany loans were prominent in the mix (35%, after 41% in August). While these flows are more volatile, they add volume to the FDI, which accumulated US$47.6 billion in the first three quarters of 2012. We therefore slightly increased our FDI forecast for 2012 to US$63 billion (from US$61 billion). For 2013, we maintained our forecast at US$64 billion. Meanwhile, the current account deficit has been flat, ending September at 2.2% of GDP over the last 12 months, which remains our forecast for 2012 year-end. For 2013, we now expect a 2.3% gap (down from 2.5%), due to a revised trade balance estimate and other effects of a weaker currency, such as lower profit and dividend remittances.

Fiscal Results Remain on a Downtrend 

The public sector’s fiscal results continued to decline throughout the year. In September, the consolidated primary budget surplus stood at 1.6 billion reais. Year to date, the consolidated primary result is at 2.33% of GDP (January-September 2011: 3.43%), the third worst performance in the series since 2003. The federal government’s surplus between January and September 2012 narrowed to 1.7% of GDP, from 2.2% in the same period of 2011. The balance of regional governments retreated to 0.6% of GDP, from 0.8% one year earlier, showing a decline in the budget performance of areas with greater weight in the public sector.

The impact of the (adverse) economic cycle on the budget and the choice to stimulate the economy through tax cuts and higher spending are behind the drop in the primary budget surplus, which reached 2.30% of GDP in the 12 months through September - the lowest level since April 2011. Despite signs of a rebound in some tax categories (such as sales and personal income taxes), the trend in central government’s revenue remains weak, down by 1.4% from year-earlier levels in the six months through September. On other hand, while expenditures have apparently lost some steam in the very recent months, the pace of expansion remains considerable. The six-month moving average for federal spending points to an annual real increase of 6.3%, topping our estimate for potential GDP growth (3% to 4%).

Given this scenario, and following a sequence of below-expectation monthly results, we revised our estimate for the public sector primary budget surplus in 2012 down to 2.4% of GDP, from 2.6%. And we still see relevant downside risks to our revised forecast for the year. Our estimates account for a gradual recovery in tax revenue in 4Q12, reflecting the improvement in economic activity and a expenditure slowdown in the final months of the year. The adjustment in expenditures could possibly mean the postponement of certain outlays (investments, for instance) to 2013. We therefore revised our estimates for the real growth rate in central government expenses, to 5.0% from 7.0% in 2012, and to 8.5% from 7.0% in 2013.

For next year, we maintain our forecast for the consolidated primary budget surplus at 2.2% of GDP. On one hand, we look for a cyclical improvement in tax revenue (following the expected acceleration in activity) and a likely accommodation of government transfers (due to a lower increase in the minimum wage). On other hand, our scenario incorporates deep tax cuts (in the range of 50 billion to 70 billion reais in the year) and a strong pickup in public investments (to 95 billion reais in 2013, from 60 billion in 2012). We believe that the fiscal stance in 2013 will be clearly expansionary.

Falling Food Prices Provide Short-Term Inflation Relief

We maintain our forecasts for the consumer price index (IPCA) at 5.5% for this year and 5.3% for 2013. Current data indicates a slowdown in food prices, partly due to the drop in agricultural producer prices. Still, we maintain our average monthly IPCA forecast at around 0.55% in 4Q12. Market-set prices are expected to rise 6.2% this year, while regulated prices are likely to increase 3.2%. Among market-set prices, we expect a 4% advance in tradable goods and an 8.2% increase in non-tradable goods.

Our 2013 IPCA forecast remains at 5.3%. Less volatile inflation indicators (core measures and diffusion indexes) remain under pressure, suggesting that the IPCA will hover around current levels. The downward revision of our economic growth and commodity price forecasts for 2013 could suggest some decline in our inflation forecast, but our expectation of a weaker currency prevented such a change.

For the general price index (IGP-M), we revised this year’s forecast to 7.9%, from 8.3%, due to a steeper retreat in agricultural prices at the margin. The producer price index (IPA) is expected to rise 8.8%, with agricultural prices climbing 18% and industrial prices increasing 5.5%. For 2013, the expectation of lower prices for some agricultural commodities, amid more favorable weather conditions, led us to revise our IGP-M forecast to 4.2%, from 4.5%.

Stable Selic Rate for Longer

The Brazilian Central Bank cut the Selic rate to 7.25% in October, referring to the cut as "a last adjustment" in monetary conditions. Looking ahead, the monetary authority signaled that interest rates will remain at the current level for a "sufficiently prolonged" period.

We previously believed that with a steadier economic rebound, interest rates would bounce back in the second half of 2013. However, given that we now foresee a slower recovery next year, we believe that the Central Bank will choose to maintain interest rates unchanged at least until the end of 2013.

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