Itaú BBA - Adjustment continues, inflationary pressure recedes

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Adjustment continues, inflationary pressure recedes

mayo 2, 2016

Most consumer-related segments indicate that sales continued to shrink. Production costs are becoming less of a concern.

With information through April 29, 2016

This report, published six times per year, summarizes anecdotal information on current economic conditions received from key business contacts, economists, market experts, and other sources outside Itaú. Apart from the “our view” section, it is not a commentary on the views of Itaú’s Macroeconomic Research team.

Contents:

Consumption and Production of Goods and Services              
Most consumer-related segments indicate that sales continued to shrink throughout March and April. Retailers and producers continue to adapt to this new demand reality.

Investment      
Business confidence has stabilized, but remains low. The recession, significant idle capacity in many sectors and global uncertainties point toward an unfavorable environment for investment.       

Labor Market, Production Costs and Prices         
Production costs are still perceived to be high, but are gradually becoming less of a concern. Most sectors report that the cost-inflation period is now behind them.

Real Estate                                                                                                       
Residential home sales remain weak, limited by low consumer confidence and tighter credit conditions.

Commodities                                                                                                
The agricultural sector faces a weaker recession than the rest of the economy this year. In the steel industry, the prolonged manufacturing recession continues to squeeze sales.

Our View                                                                                                          

Activity data indicate that the economy is still in recession. An economic recovery will depend on the ability to push through adjustments and reforms, particularly in the fiscal area.


Summary

Most consumer-related segments indicate that sales continued to shrink throughout March and April. With rising unemployment, high interest rates and end-consumers still highly leveraged, there is little expectation of a recovery this year. Against this backdrop, retailers and producers continue to reduce inventories and resize as they adapt to this new demand reality.

Business confidence has stabilized, but remains low. Preliminary figures for April suggest an improvement in confidence, but it is early to say whether this represents a trend. The domestic recession, significant idle capacity in many sectors and global uncertainties point toward an unfavorable environment for private investment. Public investment is also constrained, given the fiscal crisis facing regional and central governments.

Production costs are still perceived to be high, but are gradually becoming less of a concern. The cost adjustment process that many sectors have implemented, allied with slight reductions in energy prices, rents and shipping costs, is leading to a more balanced economy. In this scenario, most sectors report that the cost-inflation period is now behind them and the outlook is for greater price stability.

Residential home sales remain weak, limited by low consumer confidence and tighter credit conditions. The commercial property sector faces a similar situation, but it is adjusting at a faster pace. Prices and rents have dropped significantly, becoming an opportunity for companies looking to cut costs.

The agricultural sector faces a weaker recession than the rest of the economy this year. The recent increase in grain prices has improved the prospects for sector profitability and has more than offset the effects of the recent exchange-rate appreciation.

In the steel industry, the prolonged manufacturing recession continues to squeeze sales. In mining, iron ore prices have risen recently, but doubts remain about how sustainable this trend might be.

Our View: Activity data indicate that the economy is still in recession. Unemployment is likely to remain high, which will keep a damper on spending. Greater stability in confidence indicators suggests that the recession’s grip may loosen in the second half. Going forward, an economic recovery will depend on the ability to push through adjustments and reforms, particularly in the fiscal area.

Consumption and Production of Goods and Services

Most consumer-related segments indicate that sales continued to shrink in March and April. Consumers are increasingly attracted by lower-added-value products at lower prices. With rising unemployment, high interest rates and end-consumers still highly leveraged, there is little outlook for a recovery over the coming months. Companies that supply the consumer goods industry, like packaging suppliers, have also confirmed that demand remains anemic, and report generally weak order books.

Against this backdrop, retailers and producers continue to reduce inventories and adjust their scale to this new demand reality. In most cases, the view is that this is still an ongoing process. As we reported in the previous edition of the Orange Book, there is a difference between sectors producing durable goods – vehicles, domestic appliances – which seem to have adapted better to the situation and started this process earlier, and the semi- and non-durable goods sectors, where the drop in demand has been more pronounced this year than last.

The services sector has also indicated a further drop in activity. Traffic at shopping malls, hotels and restaurants remains low, and there are growing concerns about the financial health of small and mid-size retailers and service providers, particularly in a high interest-rate environment. Most retail chains have been closing stores around the country.

Defaults remain a growing concern for the goods and services sectors. This trend has increased concerns about liquidity in the economy. The number of companies filing for court-organized reorganizations continues to grow.

On the other hand, 2015’s rising production costs are no longer a source of concern. The exchange rate has settled at a slightly higher level, price increases have been passed on and efforts have been made to adjust, leaving most sectors in a more balanced position. Few consumer-related segments are reporting that they intend to significantly increase prices.

Investment

Business confidence has stabilized, but remains low. Our indicator, which covers a wide client base, has shown some volatility but remains close to levels seen at the end of 2015. Preliminary figures for April suggest an improvement, but it seems too early to say whether this represents a trend. The ‘forecast investment’ indicator remains at its lowest-ever level.

The domestic recession, a significant amount of idle capacity in many sectors and global uncertainties all point toward an unfavorable environment for private investment. Public investment is also at low ebb, given the fiscal crisis facing regional and central governments.

In the heavy vehicle and capital goods sectors, domestic demand remains depressed, partly because purchases were brought forward when subsidized credit was available. Faced with this situation, vehicle manufacturers continue to adjust output, adapting their production lines and implementing collective vacations. There are worries about the sustainability of some suppliers and resellers of auto parts, which operate in very granular segments.

Exports have been an option for these sectors as they attempt to slim inventories. External demand continues to grow, albeit at a slower pace, and current exchange rates mean that Brazilian products are more competitive, especially in Latin America.

Turning to foreign investment, companies (especially multinationals) remain interested in acquiring new assets or expanding their current businesses in Brazil. The watchword is caution, given the various uncertainties that remain, but the number of transactions is rising.

Labor Market, Production Costs and Prices

This year, most sectors are focused on reducing costs to adapt to the new demand reality. This process is at different stages in different sectors of the economy, but the view is that many will continue to cut costs. This trend suggests that the job market will show further weakness ahead. Most sectors have agreed on below-inflation wage increases.

Production costs are still perceived to be high, but are gradually becoming less of a concern. The process of cost reduction that many sectors have implemented, allied with slight reductions in energy prices, rents and shipping costs, is leading to a more balanced economy. Generally, segments that are more dependent on imported inputs are more relieved, as the exchange rate has settled at a slightly lower level.

In this scenario, most sectors report that the cost-inflation period is now behind them and they expect to see greater price stability.

Real Estate

Residential home sales remain weak, limited by low consumer confidence and tighter credit conditions. As a result, inventories remain high. This is forcing the sector to consider larger discounts and more active sales strategies. As we reported in the previous edition of the Orange Book, there are concerns about the growing number of buyers cancelling purchases, which could make it even harder to rebalance the market. The number of new property launches is still falling.

The commercial real estate sector faces a similar situation. Vacancy levels are high, particularly in commercial offices, and there are still some projects under construction. However, the commercial sector is adapting much faster. Prices and rents have dropped significantly, becoming an option for companies looking to cut costs.

Crisis brings opportunity. Falling land and labor prices are encouraging companies with smaller debt burdens to invest. Another growth sector is real estate asset outsourcing, which is a more efficient and cheaper warehousing solution for companies.

Commodities

The farm sector faces a weaker recession than the rest of the economy this year. The outlook is for volumes similar to last year’s, with productivity for some crops, like soybeans, better than previous years. The recent jump in grain prices has improved the outlook for sector profitability and has more than offset any recent exchange-rate gains. With La Niña likely to affect the next crop, this is likely to sustain recent price rises.

Cash-flow management is a concern. Credit is tighter, limiting investment capacity and undermining more indebted segments like the sugar and ethanol industry.

In the steel industry, the prolonged manufacturing recession continues to squeeze sales. Brazilian products have become more competitive as the BRL has dropped in value, but this has also affected cash-flow management, because sector debt is denominated in dollars. In mining, higher prices in recent months have lessened the concerns seen at the start of the year, but doubts remain as to how sustainable this trend might be. Demand from China remains a dark cloud on the horizon.

Activity in the oil industry remains weak and uncertainties abound. Even following the recent recovery, relatively low prices and sector debt continue to affect the production chain. The possibility of public asset sales and regulatory changes are keeping companies on their toes.

Our View

Activity data indicate that the economy is still in recession. Unemployment is likely to remain high, reflecting the ongoing adjustment in the economy, which reinforces the consumption decline.

Recent stability in confidence indicators suggests that the recession’s grip may loosen in the second half.

As a consequence of the weaker currency, exporters have started to make a positive contribution. There is an import-substitution process that started last year and, more recently, there have been signs of an export revival.

Going forward, an economic recovery will depend on the ability to push through adjustments and reforms, particularly in the fiscal area.


 


 

 



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