Itaú BBA - Weak activity, slowdown in employment

OrangeBook

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Weak activity, slowdown in employment

noviembre 24, 2014

The recovery in consumption has been proving short-lived in most sectors.

With information through November 21, 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 recovery in consumption has been proving short-lived in most sectors, indicating a weak to moderate year-end.

Investment    
Investment decisions, in general, are still waiting for more clarity on the external and domestic economic scenarios.   
 
Labor Market, Production Costs and Prices    
Amid low economic growth and elevated idle capacity, an increasing number of sectors have reduced or intend to reduce their staff.

Real Estate    
The real estate sector continues to decelerate.

Commodities    
A good crop is expected in terms of volume, although profitability may be adversely affected by low international prices. In the steel sector, signs of improvement in global demand and the recent depreciation of the exchange rate bring optimism to the industry.

Our View    
In the short run, the fundamentals pose hurdles to a stronger rebound in economic activity. For next year, the challenge is to balance the economy, restore confidence and resume growth.


Summary

The recovery in consumption has been proving short-lived in most sectors. Sales posted some recovery after the significant drop observed between the end of the first half and the beginning of the second, but have again lost strength since October, indicating a weak to moderate year-end.

Business confidence remains low. Investment decisions, in general, are still waiting for more clarity on the external and domestic economic scenarios. The recent volatility in financial markets, especially in the exchange rate, adds uncertainty to the scenario.

With weakening demand, many sectors report low capacity utilization levels, which reduces the urgency for new investments.

The slowdown in the labor market persists. Amid low economic growth and elevated idle capacity, an increasing number of sectors have reduced or intend to reduce their staff.

The economic slowdown brings moderation to cost inflation. In contrast, the exchange-rate depreciation worries importer sectors. Most sectors report that current prices are consistent with the exchange rate between 2.20 and 2.40 reais per dollar.

The real estate sector continues to decelerate. In the residential segment, demand is weaker for both investment and own use properties, as interest rates are on the rise, and buyers are more cautious. In the commercial segment, the slowdown in the economy and the fast supply growth in recent years led to a structural imbalance, which will likely take more time to be corrected.

The planting of 2014/2015 grain crops progressed satisfactorily with the normalization of rain in October. A good crop is expected in terms of volume, although profitability may be adversely affected by low international prices.

In the steel sector, signs of improvement in global demand – especially in the U.S. – and the recent depreciation of the exchange rate bring optimism to the industry. Domestic demand, however, tends to remain restricted.

Our View: Recent data have demonstrated the fragility of growth. In the short run, the fundamentals pose hurdles to a stronger rebound in economic activity. For next year, the challenge is to balance the economy, restore confidence and resume growth. Our scenario comprises a set of minimum adjustments, including fiscal contraction, realignment of regulated prices and higher interest rates – just enough to avoid a deterioration of the economy.

Consumption and production of goods and services

The recovery in consumption has been proving short-lived in most sectors. Sales posted some reaction after the significant drop observed between the end of the first half and the beginning of the second, but have again lost strength since October, indicating a weak to moderate year-end.

The durable goods sectors, such as automobiles, motorcycles, heavy appliances and electronics, remain the weakest among consumption segments. Despite signs of stabilization since November, most of these sectors are posting production and sales significantly below the levels observed at the end of 2013. Semi-durable and non-durable goods such as clothing, foodstuffs and personal care report more resilient demand, but also feel the economic slowdown. Sales decelerated significantly in the second half, which brings concern for 2015.

In the services sector, activity has been losing steam. The sector is posting some growth compared to last year, but stands well below expectations at the beginning of the year. Demand decelerated, while costs – especially labor – are still high, narrowing margins.

As highlighted in our previous Orange Book, consumption-related sectors maintain confidence in the potential of the Brazilian domestic market. Multinational companies continue to demonstrate strategic interest in the country. But in the short term, expectations point to a modest Christmas and challenging 2015. Consumers are still careful, trying to buy only the essentials. Both producers of final consumer goods and producers of intermediate inputs have been considering downsizing production capacity and discontinuing nonessential outsourced services in order to survive the low activity period.

Investment

Business confidence remains low. Our indicator, built from a broad customer base, posted a slight increase in November compared with October (the month in which the indicator reached its lowest monthly level since the time series began in 2009), but is 3% below the average for the third quarter and 15% below the fourth quarter of 2013.

Investment decisions, in general, continue to wait for more clarity about the external and domestic economic scenarios. The recent volatility in financial markets, especially the exchange rate, adds uncertainty to the scenario. In any case, with the weakening demand, many sectors report high idle capacity, which reduces the urgency for new investments.

The heavy vehicles sector – trucks and agricultural machinery – continues to post sales and production at low levels, due to the low propensity to invest and the anticipation of sales.

Producers of capital goods also posted modest activity, limited by the postponement of investment decisions and the slowdown in the construction sector. The end of the government orders program for municipalities contributed to the weaker activity at the end of this year. In this sense, there is anxiety about fiscal and para-fiscal policy (financing provided by public banks) from 2015 onwards. On the positive side, sectors related to commodities (energy, mining) resumed orders.

Despite growing concerns, long-term interest in the country remains. The size and diversity of the consumer market and the potential to generate income from the production of commodities maintain Brazil as structurally attractive. However, concerns about growth recovery are mounting, highlighting the importance of macroeconomic adjustments in 2015 for the resumption of investments in the country.

Labor market, production costs and prices

The slowdown in the labor market continues. Due to low economic growth and elevated idle capacity, an increasing number of sectors have reduced or intend to reduce their staff. The size of adjustments depends on the sector, but on average, is not deep. However, they signal that new movements may occur if low growth and volatility of the economy continue in 2015. Sectors that seasonally increase hiring during the summer (retail, beverages) are reporting that extra hiring will not happen, or will be smaller than in previous years.

On the side of wages, negotiations are more intense, with companies making it clear that they are unable to accommodate significant wage increases. Most results have been close to zero in real terms.

In addition to moderating the labor market, the economic slowdown also brings the accommodation of other production costs, such as rents, road freight and outsourced services. In contrast, the exchange-rate depreciation worries importer sectors. Most sectors report that current prices are consistent with the exchange rate between 2.2 and 2.4 reais per dollar. Consumer durable goods segments such as electronics and heavy appliances indicate a transfer to the beginning of next year, regardless of demand conditions.

The exchange-rate depreciation and climatic factors will also likely add pressure on food prices over the short term, particularly grains, meats and perishable food items. In the case of beef, the international upward trend in prices continues, adding pressure to this category.

Real Estate

The real estate sector has delivered its weakest performance in the second half off the year in November. In the residential segment, the pace of sales remains below the first half, and significantly below previous years. With rising interest rates, real estate traditionally intended for investment, such as studio apartments, loses attractiveness. Final demand also moderated, as buyers await for better prices as consequence of the decelerating economy. The perception that the slowdown in the economy might bring better opportunities ahead also prompts real estate consumers to postpone decisions. In fact, inventories remain relatively high in the sector, and average prices continue to decline on a sequential basis.

In the commercial segment, the slowdown in the economy and the accelerated volume of releases over recent years resulted in a more structural imbalance in the sector. The level of vacancies continues to grow, suggesting that the adjustment process may take longer than in the residential segment.

In the shopping malls sector, indicators continue to suggest low investment over the next two to three years. Consumer traffic remains below expectation, especially in new malls. Many malls continue to post high vacancy rates, and have been offering discounts to attract tenants. The positive news is that, in response to discounts, retailers are beginning to identify opportunities. The movement, however, is cautious, due to the uncertainty about the performance of retail in 2015.

Commodities

The planting of 2014/2015 grain crops started late due to the dry weather in October, but improved sufficiently with the normalization of rain at the end of the same month. A good crop is expected in terms of volume, although profitability may be adversely affected by low international prices. The recent depreciation of the exchange rate partly offsets the drop in prices, but it also brings increased costs of inputs such as pesticides and fertilizers. The delay in soybean planting creates a risk for the winter corn crop (which may advance into the winter, and be damaged by low temperatures).

The harvest in the sugar and ethanol sector is almost over in the South-Central region. The sector expects better pricing policy for next year, although the lower-than-expected recent adjustment in fuel prices was not an encouraging sign.

In the steel sector, signs of improvement in global demand – especially in the U.S. – and the recent depreciation of the exchange rate bring optimism to the industry. Domestic demand, however, tends to be more restricted, due to the drop in the production of consumer durable goods, especially cars and heavy appliances.

Our view

Recent data have been demonstrating the fragility of growth. In the short run, the fundamentals pose hurdles to a stronger rebound in economic activity. Consumer and business confidence remain at low levels, despite a small improvement in confidence among industrial, service and retail entrepreneurs in October. Job creation has been sluggish in recent months, while industrial inventories remain high, suggesting that there will be further adjustments in supply over the next few months. On the demand side, the expansion in the real wage bill is cooling off and is likely to curb growth in consumer spending.

For the next year, the challenge is to balance the economy, restore confidence and resume growth. Our scenario comprises a set of minimum adjustments, including fiscal contraction, realignment of regulated prices and higher interest rates – just enough to avoid a deterioration of the economy. In 2015, growth will likely remain modest, inflation will likely remain close to the upper limit of the target range, and the exchange rate will probably continue to depreciate. Resumption of growth in subsequent years depends on the extent of the adjustments. The scenario of minimal adjustments is consistent with only limited growth ahead.



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