Itaú BBA - Weak Activity With Few Signs of Recovery

OrangeBook

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Weak Activity With Few Signs of Recovery

septiembre 16, 2014

The weakening of consumption in Brazil during the first half sharpened between June and August.

With information through September 12, 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 of consumption in Brazil during the first half sharpened between June and August.  

Investment    
Global uncertainties, low growth and doubts about the time demand will take to recover have been leading to postponement of investment decisions.    


Real Estate    
The slowdown in real estate has become more intense in recent months.


Commodities    
Agricultural producers have been facing an unfavorable combination of low volumes and falling prices. In the steel sector, there are signs of improvement in global demand – especially in the US.


Labor Market, Production Costs and Prices    
The slowdown in the labor market is becoming clearer. There are no signs of significant inflationary pressures for the coming months.


Our View    
Business and consumer confidence levels remain low and industrial inventories are high,suggesting limited growth in the near future.


 


Summary

The weakening of consumption in Brazil during the first half sharpened between June and August. Part of the movement was caused by the smaller number of working days due to the World Cup (which kept consumers away from stores), while another part is attributed to the fundamentals of the economy. Activity has been stabilizing since mid-August, but only a few sectors posted recovery. The durable goods segments – automobiles, heavy appliances, electronics – remains the most affected by the decline in demand. Sales are considered weak, and producers report high inventories at retailers.

The business confidence indicator has not recovered from the declines of the second quarter, which have held back investment. Global uncertainties, low growth and doubts about how long demand will take to recover have led to postponement of investment decisions. Costs are still a concern, but they do not seem to be the cause of lower confidence. In fact, some sectors already see moderation in production costs inflation, especially with regards to labor and transportation.

The slowdown in real estate has become more intense in recent months. In the residential segment, sales fell sharply during the World Cup, recovering only partially since then. Inventories remain relatively high and prices are falling. In the commercial segment, the decline in activity remains more pronounced. The economic slowdown and the large volume of releases in recent years in some capitals have led to a loss of balance in the sector.

In terms of commodities, the 2013-2014 grain harvest may be characterized as good, but the weather has damaged some crops. Producers have been facing an unfavorable combination of low volumes and falling prices. The same is observed in the sugar and ethanol sector. Coffee crops, on the other hand, have suffered significant decline, but the increase in international prices cushions the losses for the sector.

In the steel sector, the stable exchange rate at a level considered by the industry as appreciated continues to limit exports, although there are signs of improvement in global demand – especially in the US.

The slowdown in the labor market is becoming clearer. Real wage adjustments have been declining. In some sectors, the real wage adjustments are already close to zero in recent months. With the weaker economy, there is strong competition in many sectors connected to consumption and those affected by the more stable exchange rate. There are no signs of significant inflationary pressures for the coming months.

Our View: We recently reduced our forecast for GDP growth in 2014 (to 0.1%) due to the weaker-than-expected 2Q14 result and the sluggish pace of economic recovery post-World Cup. Business and consumer confidence levels remain low and industrial inventories are high, suggesting limited growth in the near future. The labor market has been affected by the weakening economy and appears to be losing momentum.

Consumption and Production of Goods and Services

The weakening of consumption during the first half sharpened between June and August. Part of the movement was caused by the holidays and the World Cup (which kept consumers away from stores), while another part is attributed to the fundamentals of the economy.

The durable goods segments, such as automobiles, heavy appliances and electronics, remain the most affected by the decline in demand. Sales are considered weak, and producers report high inventories at retailers. However, semi and non-durable goods segments, such as clothing, food and cosmetics, have also started to suffer weaker sales and declining orders. In the service sector, many segments have also been growing below expectations, including entertainment, labor outsourcing, property security and food away from home.

The slowdown has been stabilizing since mid-August, but only a few sectors have posted recovery to pre-World Cup levels. Among the sectors in recovery, we highlight construction, passenger transport (air and ground) and business hospitality. Still, the stance is cautious.

Looking ahead, the sectors connected to consumption remain confident about the potential of the Brazilian domestic market. But the perception is that the cyclical adjustment of demand will continue in the short term. Consumers are more discerning, seeking to buy only the essentials. Producers of both final consumer goods and intermediate inputs have been adopting measures such as lay-offs, mandatory vacations and discontinuing contracts for non-essential services in order to survive the period marked by low activity. 

Investment

The business confidence indicator has not recovered from the decline seen throughout the second quarter. Our indicator, built from a broad customer base, was stable in July and August, but the current level is 14% below the level at the beginning of the year and 18% below August 2013.

Global uncertainties, low growth and doubts about how long demand will take to recover have led to postponement of investment decisions. Supply-side factors such as high production costs and fiscal complexity are also mentioned as factors of concern, but they do not seem to be the cause of lower confidence. In fact, some sectors are already observing moderation in production costs inflation, especially labor and transportation.

In the heavy vehicles sector – trucks and agricultural machinery – production and sales remain subdued. Activity has not reacted since the drop in June. In addition to the low propensity to invest, the anticipation of sales in recent years and the lack of manpower (drivers) remain among the factors that limit the demand for trucks.

In terms of production of capital goods, besides the slowdown generated by the postponement of investment decisions in general, there is a negative effect caused by the end of government orders for municipalities. Going forward, the expectation is more positive, driven by the lack of infrastructure in the country and the government concessions program. There has been some anxiety over this particular area for the coming years, depending on the evolution of the domestic scenario. The sector has been voicing some concern regarding the ability of BNDES to fund projects and equipment purchases.

As mentioned in previous editions of the Orange Book, despite the cautious climate, interest in investing in the country still remains. The size and diversity of the consumer market, and the potential for income-generation and investment driven by the production of commodities, are factors that help Brazil stay structurally attractive.

Real Estate

The slowdown in the real estate sector has become more intense in recent months. In the residential segment, sales fell sharply during the World Cup, recovering only partially since then. But the current pace of sales is still substantially below sector projections from the beginning of the year. The weakening demand is noticed particularly in real estate traditionally intended for investment, such as compact studios and small apartments. Inventories remain relatively high and prices are falling, except for properties in prime areas of major cities, a segment whose demand is more solid and supply is very tight.

In the commercial segment, the decline in activity remains more pronounced. The economic slowdown and the accelerated volume of releases in recent years have led to an imbalance in the sector. The vacancy level is high, especially in large capitals.

In the shopping malls segment, signs point to low investment over the next two to three years. With the slowdown in retail, traffic inside malls declined and retailers’ willingness to invest is lower. New malls report high vacancy and are offering discounts to attract tenants. Only the most traditional (and well established) malls have been able to sustain high demand.

Commodities

The 2013-2014 grain harvest may be characterized as good, but the weather has damaged some crops. At the same time, the harvest is quite strong in the United States. Thus, local producers have been facing a combination of lower volumes and falling prices.

In the case of coffee, the effect of unfavorable weather is still causing downward revisions in harvest forecasts. The decline will likely stand between 10% and 15%. Unlike other grains, however, the international price is high, offsetting much of the decline for local producers. 

In the sugar and ethanol industry, the production of sugarcane has been good so far, but the harvest of part of the crop that was less affected by drought earlier in the year has already happened. Going forward, the crop tends to post a drop in volume and quality. Thus, this year's crop as a whole will likely be smaller than originally forecasted. Declines in productivity add pressure to the average cost, which, combined with low price, results in a difficult situation for the sector.

In the steel sector, the stable exchange rate at a level considered by the industry as appreciated continues to limit exports, although there are signs of improvement in global demand – especially in the US. On the side of domestic demand, the expected acceleration of infrastructure concessions helps, but the drop in the production of consumer durables, especially cars and heavy appliances, makes for a cautious stance in the sector.

Labor Market, Production Costs and Prices

The slowdown in the labor market is becoming clearer. Real wage adjustments have been declining. In some sectors, the adjustments made in recent months are already close to zero. Negotiations are still intense, but it is becoming clear that companies are not able to accommodate significant salary increases, especially amid weak demand. Many sectors have been adopting measures such as lay-offs and mandatory vacations.

In addition to moderating the labor market, the economic downturn also leads to accommodation of other production costs such as rent, road freight and outsourced services. In contrast, the possibility of increases in electricity, fuel and tax burdens ahead is a cause for concern.

With the weaker economy, there is strong competition in many sectors connected to consumption and those affected by more stable exchange rates, but without any signs of significant inflationary pressures for the coming months. There is some pressure coming from beef, a sector undergoing a global upward trend in prices. Consumers, in turn, have responded by replacing beef with chicken and pork – whose prices have dropped due to the reduction in international grain prices.

Our View

The 2Q14 GDP and indicators for recent months revealed a significant slowdown in domestic demand throughout the year. We recently reduced our forecast for GDP growth in 2014 to 0.1% (0.6% previously) due to the weaker-than-expected 2Q14 result and the sluggish pace of economic recovery post-World Cup. Business and consumer confidence levels remain low and industrial inventories are high, suggesting limited growth in the near future. Thus, despite some indicators showing positive growth in July and August (such as industrial production and retail sales), we expect activity to remain weak over the coming months. The labor market has been affected by the weakening economy and appears to be losing momentum, especially in the pace of job creation, although the unemployment rate remains at low levels.



 



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