Itaú BBA - Weak, But No Longer Weakening

Brazil Scenario Review

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Weak, But No Longer Weakening

enero 12, 2012

The economy remains weak. As interest rates fall and public spending picks up, growth will likely build up again and peak in the second half.

The economy remains weak and we have lowered our fourth-quarter GDP growth forecast to 0.2% (from 0.4%), even after incorporating better data from November and December. As a result, we lowered our 2011 GDP growth forecast to 2.7% (from 2.8%).

We kept our 2012 forecasts for GDP growth (3.5%), inflation (5.2%), and the year-end foreign exchange rate (1.75 reais to the dollar). But getting there will depend on policy boosters expected to be in place over the coming months.

The new minimum wage and a set of tax breaks will help in the first quarter. Lower interest rates and faster public spending will build strength gradually, causing the economy to peak in the second quarter.

Our monetary policy outlook remains unchanged: we expect the central bank to continue to lower rates toward 9.0%, with four additional 50-bp rate cuts along the first half of the year.

However, we acknowledge that the CB’s more cautious tone, and the possible use of other growth-promoting tools, may result in a shorter cycle.

Not All is Gloom: A Few Promising Signs

After sliding for three months, Brazil’s manufacturing industry held itself up in November, posting a 0.3% expansion. While the result for December is not yet known, other indicators point to a busy month. Auto production grew by more than 6%, electricity usage rose 0.9% and, according to a FGV survey, business confidence improved. In fact, industrial production may have risen more than 1% in December alone (all numbers are seasonally adjusted).

On the consumer side, things are also improving or at least not getting worse. In November and December, we expect to see a rebound in retail sales. The FGV consumer confidence index rose 0.5% in December. Since early December, consumers have enjoyed lower taxes on loans and on certain home-appliance purchases. A few weeks earlier, the central bank adjusted capital requirements on consumer loans; loans of up to five years now require slightly less capital.

Despite the still-low growth (tracking the third-quarter trend), the fourth quarter ended better than it started, no longer weakening.

It must be said that production continues to be held back by unusually high inventories. Another FGV survey reported a five-year high in the percentage of firms with excess stocks (not counting the post-Lehmann surge).

Despite these small improvements, we lowered our fourth-quarter GDP growth forecast to 0.2% qoq/sa (from 0.4%). We also reduced our 2011 growth estimate to 2.7% (from 2.8%).


Growth Pick Up in 2012

We continue to assume global weakness, not disruption, in 2012 (see our world outlook). In this scenario, Brazil’s GDP picks up the slack and grows towards a peak in the second half of the year.


Initial Stimuli: Minimum Wage and Tax Breaks

The new minimum wage of BRL 622 became effective in January, and the tax breaks on durables is scheduled to last until March. Both will be essential to growth in the first quarter. After that, the minimum wage will only have a residual impact, while the tax breaks will actually become negative (they raise sales now, and lower them after the benefit expires).

We estimate that the increase in the minimum wage (more precisely, the increase above last year’s increase) will add 0.4pp to the first quarter growth, and 0.6ppfor the whole of 2012.

Part of this will come directly from higher pensions and part will come from the minimum wage as a wage-setting benchmark. Around 25% of Brazilians – including workers and pensioners– earn a minimum wage, while the wages of many others are somehow linked to it.

We expect the tax breaks to add around 0.3pp to the first quarter growth. However, it will likely imply lower consumption after the benefit expires, having a final impact of slightly less than 0.1pp on growth in 2012.

On the other hand, the global slowdown has yet to be fully felt. Although it shows up in the form of lower confidence survey readings and a rise in unwanted inventories; it still hasn’t been felt in exports (volumes have, in fact, continued to rise). All told, we expect a quarterly growth of 0.8% in the first quarter of 2012.

Later Boosters: Monetary and Fiscal Policy

All along, low interest rates and higher public spending will also help boost growth. Both operate in longer cycles, gradually building strength over a few quarters, and both are also more powerful.

The central bank has been lowering the Selic rate since October, and will likely continue to do so in coming months. Public spending will likely pick up starting in the first quarter. The impact of these factors on growth will likely peak in the second half of the year; by then, the economy could easily be expanding at an annual rate of above 5%.

A loosening in fiscal policy is an important part of our 2012 growth outlook. Will it happen?

The government has been signaling a recovery in investment, and the new minimum wage will certainly push pensions and transfers. On the other hand, the government has been adamant about the full achievement of the 2012 primary target, which suggests that belts will be kept very tight elsewhere.

No doubt, the government will work in this direction. Pay raises for civil servants, for example, will probably be small this year. Still, the higher minimum wage will increase spending and transfers, leading to a rise in total spending that will be hard to avoid. We assume that federal spending will grow at a rate similar to the average for recent years of around 8.5%, instead of the 3.5% in 2011 (inflation-adjusted numbers).

In short, Brazil came to a halt in the second half of 2011. Barring a global disruption, the country will likely rev up throughout2012 and grow at a decent pace toward the end of the year. Our 2012 growth forecast remains at 3.5%.


Inflation will continue to ease as growth rises, partly due to the reweighting of the IPCA basket. Our inflation forecast remains at 5.2%.

Because of the changes ethanol supply, fuel prices may actually result in lower inflation and change its seasonal pattern this year.

Until now, producers typically carried small ethanol inventories between harvests, and imports were immaterial. As a result, ethanol prices would normally rise from January on, peak around April and fall sharply thereafter. This pattern was particularly strong in 2011.

Later in 2011, favorable market conditions enabled bulk imports for the first time.  According to our calculations based on official trade data, imports reached a total of 1.4 billion liters, or 7% of domestic production. The government also offered a subsidy to producers willing to carry inventories between harvests.

There are two effects here: Ethanol inventories will offer a smooth supply throughout the year and last year’s ethanol imports will improve supply conditions, possibly reducing fuel inflation in 2012.

Monetary Policy Outlook

Our growth and inflation forecasts for 2012 are unchanged, as is our monetary policy outlook. We continue to expect the central bank to lower the Selic rate to 9% through four additional 50-bp steps.

The local yield curve, however, now expects the CB to only cut the Selic rate to around 10% (less than a few weeks ago), reflecting a view that the central bank will be more alert to inflation risks.

The central bank’s December inflation report echoed its last policy statement: “By promptly mitigating the effects of a restrictive global environment, a moderate adjustment in the basic rate is consistent with inflation converging to the target in 2012.”

The CB’s “market” scenario assumes the market consensus Selic rate, which was then 9.5% for 2012 and 10.5% for 2013. In this scenario, the IPCA reaches 4.8% this year, but picks up to 5.3% in 2013. In the face of it, the CB could cut less than consensus in 2012, raise more in 2013, or live with higher inflation for a while and seek the target in 2014.

In a hawkish tone, the report emphasizes that the current monetary easing will be at its most stimulative later on and that these lags have been “taken into consideration.” The central bank estimates a GDP growth of 3.0% in 2011 and 3.5% in 2012.

If there is a bias in the report, it is a hawkish one. However, we believe that the global outlook may be more adverse than expected, with still weak growth in 2012. We therefore maintain our expectation of a Selic rate drop to 9% by mid-2012, ensuring a growth pick-up throughout the year and causing GDP to grow 3.5%. But the CB’s more cautious tone, and the possible use of other growth-promoting tools, may result in a shorter cycle.

Trade Balance and the Currency

Slightly higher commodity prices in 2012 will not help the trade balance much. We lowered our 2012 trade surplus forecast to USD 11 billion (from USD 15 billion), down from USD 29.7 billion in 2011. Foreign direct investment probably reached a sizable USD 65 billion in 2011, and we expect a similar volume this year, leading to adequate financing for a current account deficit of around 3.2% of GDP.

We kept our currency forecast at 1.75 reais to the dollar by year-end 2012, and expect the euro to lose some ground against both the dollar and the real.

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