Itaú BBA - Adjustment scenario reinforces the slowdown

OrangeBook

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Adjustment scenario reinforces the slowdown

febrero 11, 2015

The weakening trend in consumption observed in the second half of 2014 seems to have worsened at the beginning of this year.

With information through February 09, 2014

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
The weakening trend in consumption observed in the second half of 2014 seems to have steepened at the beginning of this year. 

Investment  
The volatility of the external scenario, uncertainty about monetary and fiscal adjustments, and the risk of water and energy shortages have been constraining investment decisions.     

Labor Market, Production Costs and Prices    
The number of sectors that have made reductions in their workforce or that intend to do so continues to increase, contributing to the weakening of the labor market.

Real Estate   
One month into 2015, the real estate sector is even weaker than it was at the end of 2014. In the residential segment, the pace of sales in January was among the lowest recorded in recent years.

Commodities         
On commodities, the dry weather is negatively affecting agriculture in Brazil’s southeast. In the steel sector, concern is centering on the possibility of a slowdown in infrastructure investment and on the drop in production of durable consumer goods.

Our View         
Recent data show signs of a slowdown in economic activity in December, and the outlook for the first quarter of this year has deteriorated.


Summary

The weakening trend in consumption observed in the second half of 2014 seems to have worsened  at the beginning of this year. Business leaders in most of the consumption-related sectors are voicing  concern about the pace of sales growth, which has been surprisingly slow, even when the unfavorable seasonality is taken into account. Inventories of durable consumer goods are high throughout the chain, which will likely lead to lower production over the coming months. In the service sector, also, activity is surprisingly weak.

Business confidence remains low. The volatility of the external scenario, uncertainty about monetary and fiscal adjustments, and the risk of water and energy shortages have been constraining investment decisions. At the same time, weakening of demand and a high level of idle capacity reduces the need to invest.

The number of sectors that have made reductions in their workforce ​​or that intend to do so  continues to increase, contributing to the weakening of the labor market. Wage negotiations have been intense, but  most of the reported wage increases have been close to zero in real terms.

In addition to moderating the labor market, low growth also leads to accommodation in other production costs, such as rents, road freight and outsourced services. On the other hand, rising electricity prices and taxes (especially the CIDE tax on diesel) are driving up costs – which will likely add to the inflationary pressures this year.

One month into 2015, the real estate sector is even weaker than it was at the end of 2014. In the residential segment, the pace of sales in January was among the lowest recorded in recent years. The commercial segment is suffering from a more structural imbalance, generated by the combination of the slowdown in economic activity and the accelerated volume of launches in recent years.

On commodities, the dry weather is negatively affecting agriculture in Brazil’s southeast. Soybeans, sugarcane and fruit are among the affected crops. In the steel sector, concern is centering on the possibility of a slowdown in infrastructure investment and on the drop in production of durable consumer goods. In the oil sector, uncertainty has spiked in response to the “Lava Jato Operation” investigation and the steep drop in international oil prices.

Our view: Recent data show signs of a slowdown in economic activity in December, and the outlook for the first quarter of this year has deteriorated. Other factors, such as the possibility of water and energy rationing, are potential downside risks for the scenario. In this scenario, we expect negative GDP growth in 2015, with declines in both consumption and aggregate investment.

Consumption and Production of Goods and Services

The weakening trend in demand observed in the second half of 2014 seems to have worsened at the beginning of this year. Business leaders in most of the consumer-related sectors are voicing  concern about the pace of sales growth, which has been surprisingly slow, even when the unfavorable seasonality is taken into account. Inventories of durable consumer goods are high throughout the chain, which will likely lead to lower production over the coming months.

The durable goods segment – automobiles, motorcycles, heavy appliances, electronics – remains the weakest of the consumption segments. The further increase in interest rates and the perceived weakening of the labor market continue to influence consumers’ decisions. The ending of certain tax incentives (IPI, IOF on credit) has also made consumers more conservative, despite providing some temporary stimulus by triggering a wave of purchases in November and December, in advance of the incentives’ expiration. In this environment, many segments have decided to extend the mandatory “vacations” adopted at the end of 2014 into the first quarter.

In the semi-durable and non-durable segments, such as clothing, food and cosmetics, the slowdown is also significant, although yearly growth rates are still positive. The minimum wage increase, high temperatures and concern about water and energy supply have fueled demand for basic items such as food and beverages. In contrast, the water crisis is affecting demand for products and services related to general cleaning.

Service sector activity has also been surprisingly weak. Segments such as restaurants, carriers, general repairs and labor providers have seen a weaker-than-usual start to the year. Some businesses are reporting an increase in late payments and a rise in defaults along the chain, which is likely causing cash flow problems even in sectors that are relatively resistant to slowdowns in demand, such as hospitals and public transportation.

As we have emphasized in our last Orange Book, Brazilian consumers remain cautious, choosing to buy only the essentials. The government’s monetary and fiscal tightening announcements are seen as important, but are inconvenient in the short term. Potential shortages of water and energy add uncertainty to the scenario. In this environment, both producers of final consumer goods and producers of intermediate inputs have been considering whether to resize their production capacity and terminate non-essential outsourced services in order to survive the period of low activity.

Investment

Business confidence remains low. Our indicator, built ​​from a wide customer base, showed a notable decline in January, offsetting the improvement in November and December and taking the indicator back to the level posted in October – the lowest level in the series, which started in 2009. Confidence is 20% lower than in January 2014.

The volatility of the external scenario, uncertainty about monetary and fiscal adjustments, and the risk of water and energy shortages have been constraining investment decisions. At the same time, weakening of demand snd a high level of idle capacity reduces the need for investment.

The heavy vehicles (trucks, agricultural machinery) and capital goods (machinery, equipment) sectors continue to show low sales and production levels. The current reluctance to invest and the ending of the favorable conditions brought about by certain government funding programs suggest that activity will remain weak in these sectors throughout the year. In the specific case of agricultural machinery, losses in some crops are an additional factor in the drop of demand.

Among multinational companies, a long-term interest in Brazil persists across various sectors, but doubts about the economy’s recovery have been increasing. In this context, the importance of a sustained effort at macroeconomic adjustment in 2015 and of making progress on the reform agenda (especially with respect to taxes) becomes evident.

Labor Market, Production Costs and Prices

The number of sectors that have made ​​reductions in their workforce or that intend to do so continues to increase, contributing to the weakening of the labor market. Businesses in some labor-intensive sectors in which demand has been resilient – such as retail sales of non-durable consumer goods – report easier hiring. However, the labor market seems less tight only for less-qualified workers. Businesses in many sectors still report difficulty in hiring specialized professionals.

Wage negotiations have been intense, but  most of the reported wage increases have been close to zero in real terms. Intense negotiations are also taking place between companies and outsourced-labor providers, which have been agreeing to revise contracts and adapt to this new stage of the economic cycle.

In addition to moderating the labor market, low growth also leads to accommodation in other production costs, such as rents, road freight and outsourced services. The depreciation of the Brazilian real in recent months continues to push up prices. However, many retailers are indicating that there is already little room left for passing through cost increases to consumers, so most of the increase in costs has already been incorporated into the production chain.

On the other hand, rising electricity prices and taxes (especially the CIDE tax on diesel) are driving up costs and are a source of worry in many sectors; these factors will likely add to the inflationary pressures this year.   The impact of the drought on agriculture is also generating short-term cost pressure, even amid the economic slowdown.

Real Estate

One month into 2015, the real estate sector is even weaker than it was at the end of 2014. In the residential segment, the pace of sales in January was among the lowest recorded in recent years, even when the unfavorable seasonality is taken into account. The drop in consumer confidence and more conservative credit conditions are holding back demand. Inventories remain relatively high in the sector, and prices, on average, continue to moderate.

The commercial segment continues to suffer from a more structural imbalance, generated by the combination of the slowdown in economic activity and the accelerated volume of launches in recent years. The vacancy rate is high, particularly in business offices, suggesting that the adjustment process may be long. Prices have declined substantially since last year, which may help rebalance the sector.

In the shopping malls segment, activity in January was considered weak, making cost management more difficult for tenants. The vacancy rate is high and on an upward trend in many malls, making room for discounts on rent. However, uncertainty about the prospects for the retail sector in 2015 is making retail chains more reluctant to open new stores.

Commodities 

The dry weather is negatively affecting agriculture in Brazil’s southeast. Soybeans, sugarcane and fruit are among the affected crops. For the remainder of the year, there will be uncertainty as to how much the delay in soybean planting will affect the winter corn crop (safrinha). The forecast for the grain harvest is still considered high, but it is below market estimates. Expectations that grain prices on the international market will remain below the level of previous years further complicates the scenario for the agricultural sector this year.

On the more positive side, the depreciation of the Brazilian real and a decline in prices for pesticides and fertilizers (due to the oil price drop) are providing some relief. In the sugar and ethanol sector, the increase in the CIDE tax and the increase in the proportion of ethanol in gasoline are also helping to offset the losses caused by the weather and the lack of investment in recent years.

In the steel sector, concern is centering on the possibility of slowdown in infrastructure investment, and on the drop in production of durable consumer goods, especially cars and heavy appliances. The exchange-rate depreciation and the recovery in demand in the U.S. are helping, but are not enough to stimulate new investment in capacity expansion.

In the oil sector, uncertainty has spiked in response to the “Lava Jato Operation” investigation and the steep drop in international oil prices. The sector has become more cautious with short-term investments. Long-term interest in the sector, however, has been resilient.

Our View

Recent data signal a slowdown in economic activity in December and the outlook for 1Q15 has deteriorated. Other factors are also negative. In the oil sector, the cuts in capital expenditures and the reduction in our projection for output growth will impact economic activity. We also believe that difficulties involving some construction companies will impact the execution pace of their infrastructure projects in the short term. There is also risk of water shortages ahead, which have not been included in our scenario. Weak rainfall levels in January point may require additional cuts in water usage in important areas in the Southeast region. Moreover there is also risk of electricity rationing.

In this scenario, we expect negative GDP growth in 2015, with declines in both consumption and aggregate investment. The degree of these declines will depend primarily on the need for water and energy rationing and the eventual impact of the “Lava Jato” investigation.


 



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