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Brazil Economy - July 2013

Source: OPEC 7/30/2013, Location: South America

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Brazilians‘ optimism about the state of their economy has shown a retreating trend since October 2012, as indicated by the consumer confidence index, which saw only a minor increase of 0.2 points in May from April‘s 111.8, its lowest reading since February 2010. This sentiment materialized in protesters taking their economic frustration out to the streets. Obviously, this does not suggest a sustained improvement in household spending, which forms the largest share of Brazil‘s economy, among other streams of output.

Along the same lines, the HSBC‘s purchasing managers’ index for manufacturing, seasonally adjusted (SA), was unchanged in June from 50.4 points in May, a sevenmonth low. The index has been experiencing a downward movement since February from its January 2013 21-month level high of 53.3. Despite this, it has continued to stay above 50. June‘s PMI shows only minor improvements in operating conditions.

Furthermore, the survey also signaled weaker foreign demand and higher rates of inflation, while the quickest growth was noted in the production of consumer goods. In the meantime, the national statistics agency of Brazil announced a fall in industrial production of 2% in May from the previous month. This figure, however, is 1.4% above that of the same month last year.

The decelerating pace of contraction in Brazil‘s exports to its top destination — China — which started in October 2012 reached growth of 18% y-o-y in April. This trend is questionable after total exports growth retreated to the negative again in May. Brazil‘s exports are suffering since April 2012, as the only expansion seen over the past 14-month period was in April of this year, which was not sustained, dropping by 6% in May. It is worthwhile to note in this context that starting in 2009, China overtook the United States as Brazil‘s top exporting destination. It is not a coincidence that Brazil‘s export of primary products — including iron ore and concentrates — became its main export, surpassing both semi-manufactured and manufactured products. In 2001, China imported around 18.3% of Brazil‘s entire exports, with iron ore and concentrates accounting for nearly 14.3% of total exports. Following months of a more than two-fold growth rally prior to 2012, Brazil‘s iron ore exports contracted every month since January 2012, with the first month of this year being an exception. Furthermore, iron ore prices have tumbled by around 24% since February of this year, prompted by the supply–demand mechanism. This price slide, combined with deteriorating volumes, is exerting a draining effect on export revenues. Nevertheless, the relatively slower decline in iron ore export revenue since the beginning of the year holds forth slim optimism for better performance in the coming months, though it will always be subject to demand increases from China.

Unemployment stood at 5.8% in May, its lowest May reading since at least 2001. Manufacturing capacity utilization was high and improved further over the first four months of 2013 to register 83%, higher than last year‘s average of 82.1%. These rates of unemployment and capacity utilization highlight that the economy is operating at nearly full capacity. Despite the fact that low unemployment is a prime macroeconomic objective and that high utilization rates generally reflect firm economic activity, in the case of Brazil, both put a cap on sought-after annual output growth. The low numbers of unemployed people together with tight rules on foreign labour left one channel for a possible output increase — enhancing productivity. This, in turn, requires investment in better education/training and new technology, which does not bear fruit in the short term. On the other hand, high capacity utilization means that more investment into less labour-intensive capital assets is the way towards an output increase.

Not surprisingly, inflation has continued to break the 6.5% upper boundary set by Brazil‘s monetary council (with a lower limit of 2.5% and a midpoint of 4.5%) since the beginning of this year. From 7.16% in April, inflation took a step down in May to 6.95%, and up compared to the same month in the previous year (based on y-o-y percentage changes in Brazil‘s national consumer price index). More attention placed on ramping up domestically-driven investment and encouraging household consumption has led to a long stream of rate cuts by the central bank of Brazil starting in July 2011 and concluding only two months ago when the key policy rate, the ?Selic‘ rate, was raised by half a percentage point to 8%. This loose monetary policy and climbing governmental spending, along with growing salaries and wages, have put more inflationary pressure on the demand side, while fading investment, a low unemployment rate and high capacity utilization have not helped ease pressure from the supply side.

The 1Q 2013 improvement in gross fixed capital formation (GFCF) after three quarters of contraction is a significant contributor to growth momentum this year, especially if it continues into the second quarter and does not retreat during the second half of the year. One important source of optimism in this regard is the undeniable contribution to government investment expected this year in World Cup-related infrastructure and preparation.

The Brazilian government — in its attempt to reverse the deceleration of output growth — has decided to make cuts to electricity rates and payroll taxes for many industries. Furthermore, the government is creating a credit line for low-income households of $8.7 billion. It also removed a tax, known as the IOF, on foreign investors who buy Brazilian bonds in the domestic market. In the monetary arena, while the central bank raised the ?Selic‘ interest rate in May by 50 basis points, the national monetary council has kept its inflation target unchanged through 2015, in addition to leaving the longterm lending rate at a record low of 5%.

Taking the above into account, Brazil‘s GDP estimate for 2013 has been revised down to 2.5% from an initial figure of 3.0%. Predictions for 2014 point to a growth rate of 2.8%. The range of economic risks is widening for Brazil. It remains to be seen and closely monitored how the government is going to act in coming weeks in response to recent public protests and their socioeconomic triggers.

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