Economic growth will remain robust at Brazil

GDP growth is expected to remain robust in 2011 [3.6%] and 2012 [3.8%], driven by domestic demand, investments and exports, mainly to Asia.
Analisis Credito y Caución
Madrid - 11-jan-2012

After a convincing victory in the October 2010 presidential elections, on 1 January 2011 former Chief of Staff Dilma Roussef succeeded the popular Lula da Silva, who had been head of state for eight years and could therefore not run for a third term. Roussef leads a coalition of 10 parties that enjoys a large majority in Congress, but is also a fragile alliance of ideologically-diverse forces. As a result, as under Lulas leadership, this coalition will have to contend with low party discipline and coalition loyalty. Additionally since Roussef´s taking office in January 2011 six ministers had to resign due to corruption charges.

International relations are mainly stable, with a pragmatic attitude towards the US and South American states, including Bolivia and Venezuela. Brazil is increasingly seeking to bring its growing political and economic strength to bear on a global level: for instance, in its role as a member of the G20.

In 2009, Brazils economy experienced a mild recession [0.7% GDP contraction], due mainly to falling industrial output [-7.4% year-on-year] caused by a sharp drop in exports and investments [-10%]. However, since Q4 of 2009, the country has seen a strong and broad-based recovery, thanks to a rebound of exports to Asia, investments and buoyant consumer demand. Industrial output and exports grew 11.5% year-on-year in 2010 and retail sales generally were exceptionally strong last year,  increasing in volume by 10.9% year-on-year as a result of labour market improvements, with many new jobs both temporary and permanent being created. Credit conditions remained flexible and financing costs have reached historic low levels, providing a stimulus to household consumption, which increased 7.0% in 2010. While exports of goods and services increased 11.5% last year, imports rose substantially more: by 36.2%. For the whole of 2010 output grew 7.6% year-on-year.

2011: Slowdown of growth due to monetary measures

This strong rebound slowed down towards the end of last year and into 2011: After a 4.2% year-on-year growth in Q1, GDP grew 3.1% in Q2 of 2011. Growth of industrial production has markedly decelerated in H1 of 2011 compared to H1 of 2010, and even decreased 1.6% year-on-year in September and 0.6% in October 2011, reflecting deteriorated competiveness due to a stronger real and decreasing global demand.

According to the National Statistics Agency in Q3 of 2011 growth only expanded 2.1% year-on-year, and even contracted slightly [0.04%] on the previous quarter the first contraction since Q1 of 2009. Apart from agriculture all main contributors [industrial production, services, private consumption, and investments] recorded decreases.

However domestic demand is expected to remain rather robust in Q4, also sustained by a lower unemployment rate [5.8% in October 2011] and economic growth for the whole of 2011 will still be robust with 3.6%, despite a downward revision from the 4.3% forecast this summer.

The main reasons for the slowdown were cooling demand from developed economies and measures to avoid an economic overheating: In order to slow down credit growth [which grew 20% between April 2010 and April 2011], the central bank has imposed stricter reserve requirements for banks and the government increased taxes on consumer credit. There were signs that the credit cycle is building up pressure, leaving commercial banks with a rapidly rising proportion of disputable debts in their portfolios. At the same time the Central Bank raised the SELIC benchmark interest rate [its overnight lending rate] several times in the first half of 2011, to 12.50% in July 2011[3.75 basis points higher than in April 2010].

A surprising monetary policy turnaround since August 2011

One of the side-effects of the boom has been rising inflation, which has increased steadily since September 2010 and, with the strong domestic demand and higher food prices, rose to 7.3% year-on-year in September 2011, above the Central Banks target of 4.5%. In October 2011 inflation was still at 7%, and for the whole of 2011 consumer price inflation is forecast to increase 6.7% year-on-year.

Due to the still high inflation it came as a surprise that in August 2011 the Central Bank lowered the SELIC benchmark interest rate for the first time since two years. This was followed by two more decisions to cut the rate, which beginning of December 2011 was at 11%.

The Central bank probably lowered the SELIC rate because of signs that the economy was cooling off too much. Especially the two recent cuts in October and November 2011 are aimed to shield the economy from the deepening Eurozone crisis and the slowdown of global demand.

Another reason to start with interest rate cuts was to discourage foreign investors to buy assets/property in Brazil, in an effort to bring the exchange rate of the Real down. Before that step the higher interest rates attracted more short-term investment capital, and these capital inflows, coupled with higher inflation forced the real [R$] exchange rate to appreciate. Between mid-2009 and mid-2011 the R$ gained nearly 50% against the US$ over the past two years, favouring imports, while causing increasing worries for Brazilian exporters of manufactured goods due to their eroding competiveness. In that respect the monetary easing was successful so far, as since August 2011 the Real has lost some of its appreciation trend of 2010/2011.

A more expansive fiscal policy

The Central Banks monetary easing comes at a moment that fiscal policy is rather expansionary. Investments in exploiting the huge offshore oil fields and coming sport events [2014 World Cup, 2016 Olympics] fuel public sector spending. Early December 2011 the government introduced tax cuts worth 2.8 billion R$ [US$ 1.6 billion] on consumer credits, food staples, home appliances and foreigners´ stock purchases in order to spur 2012 growth in a more adverse global environment. Those stimulus measures will increase further the budget deficit.

In general Brazils budgetary policy is solid, but the primary surpluses [i.e. before interest payments] have been below the governments target rate of 3% of GDP. In view of the still high public debt [56%] the government should implement more public sector austerity measures to reduce the fiscal deficit and to prevent the public sector debt from rising further. Measures to do so could be a reform of the complicated tax and the generous pensions systems, but progress in those fields is rather unlikely.

On the whole, Brazils macroeconomic policy has so far been sound, but many structural deficiencies, such as a complex and burdensome tax regime, fiscal inflexibility, rigid labour laws and overregulation, remain untouched, although they massively hamper economic development in the long term. Shortfalls in Brazils overall political and party system [e.g. the lack of coalition and party discipline] are the main reason for the lack of effort towards structural reform.

In the past Brazil has reduced the level of public foreign debt considerably and improved its public sector debt profile by bond swaps, issues of real-denominated bonds to foreign investors, pre-payments [US$ 15.6 billon to the IMF and US$ 2.6 billion to the Paris Club] and debt buy-backs [Brady bonds worth US$ 6.6 billion]. As a result, there is a longer debt maturity and much less currency risk, as government debt is denominated mainly in real. Private sector [corporate/banking] debt now accounts for two-thirds of total foreign debt. However, heavy borrowing by Petrobras for its ambitious investment plans [see above] may strongly increase public foreign debt in the coming years.

Economic growth will remain robust

GDP growth is expected to remain robust in 2011 [3.6%] and 2012 [3.8%], although forecast has been revised downwards since this summer [from 4.3% for 2011 and 4.7% for next year]. Growth is still driven by domestic demand, investments and exports, mainly to Asia. Inflation is expected to slow down to 5.5% next year. However the inflation remaining above 4% and a rising number of overdue loans in the banking sector still point at some economic overheating.

The banking sector is in reasonable condition with strong regulation and supervision. However, the state-owned development bank BNDES is in a less comfortable financial position, which could turn into a major potential risk to public sector accounts.

The abundant capital inflow contributes to Brazils excellent international liquidity position of more than 20 months of import cover. Solvency is solid as well, giving rise to the stable investment ratings on the international markets. These are a guarantee that Brazils very large external financing requirements can be covered quite easily Exports from Brazils huge offshore oil reserves could underpin the external position in the longer-term.

The problems of fiscal tightening

Further fiscal tightening is necessary in the mid-term to reduce the public sector deficit, but the government faces the fact that less than 10% of the yearly budget consists of items that can be cut, while payroll, health care and education spending are fixed. One measure could be a reform of the complicated tax and the generous pensions systems, but this seems improbable due to the political circumstances.

Infrastructure improvement is essential for sustained long-term growth [the poor state of many roads, airports and harbours and overstretched power supply systems have already prevented additional growth]. To accomplish such improvements, however, the government would have to implement additional public sector investments.

Brazils oil wealth: Blessing or curse?

Exports from Brazils huge offshore oil reserves [see above] will underpin the external position in the longer term. However, the exploration also poses a challenge for the country: to manage these reserves skilfully without letting the competitive position of non-oil exports be overly weakened by a strong currency [a phenomenon often referred to as the `Dutch disease´].

`Bigger Brazil´: fiscal measures to protect textile, footwear, furniture, and IT

Textile, footwear, furniture and IT are those sectors whose international and domestic competitiveness has been severely hurt due to the real appreciation. Especially export performance has suffered as prices have become increasingly uncompetitive in international markets.

On August 2nd 2011 the government unveiled plans to prop up businesses in those sectors: The `Brasil Maior´ [Bigger Brazil] programme includes tax breaks worth R$ 25 billion [US$ 16 billion] over the next two years, including abolition of a 20% payroll tax for the labour-intensive industries mainly hurt by the stronger real. The State Development Bank BNDS will provide additional loans worth 7 billion R$ [US$ 4.4 billion] to the affected local producers. At the same time new export incentives [e.g. a new export financing facility] and tougher import controls and anti-dumping measures [mainly aimed at cheaper products from China] have been announced. At public procurement activities local suppliers will be preferred against [even up to 25% cheaper] foreign competition.

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