Mounting concerns over the increased prospects of global slowdown, a persistence of adverse international capital market conditions and continued unease about the downside effects of the domestic energy crisis as well as the emerging political cycle, have prompted substantial adjustments to growth forecasts for this and the coming year.  In addition, the continued deterioration in the exchange rate is prompting further monetary tightening and external balances remain a concern as the slowdown of the export engine is only partially compensated by lower imports.

Exchange rate in free fall.  Throughout this year the Real has suffered from persistent deterioration.  The contagion from Argentina, concerns about the growth impact of energy rationing, worries about the global downturn and increased apprehension about the domestic political cycle have served to weaken the Real significantly.  In September, the currency depreciation continued to accelerate with the Real losing an additional 5.7% in nominal terms, following the 4.7% and 5.2% depreciations in August and July respectively.  In total, the Real has now lost 26.8% of its value relative to the US$ this year.  As a result of the unrelenting currency deterioration, international reserve levels have continued to be drawn down as holders of local assets seek a safe haven in the US$.  The loss in international reserves, which dropped throughout most of September, prompted the Central Bank to issue some US$ 13 billion in dollar indexed government bonds and to reinstate the 10% compulsory bank reserve requirement on term deposits abolished two years ago.  This month’s Consensus Forecast reflects participants’ concern that what was initially expected to be an overshooting of the exchange rate may, in fact, be a more permanent weakening of the Real.  International reserve levels are expected to drop further this year, despite the US$ 4.7 billion boost received from the International Monetary Fund (IMF) on 28 September under the terms of the US$ 15.65 billion Stand-by Agreement.  Thus, the exchange rate forecast for this year has again been revised upward.  Currency pressures are expected to subside only marginally next year, given the new international scenario and the prospects for increased risk posed to economic policy by the political cycle.

Tighter credit and higher interest rates pose further challenge to economy.  The increase in Central Bank reserve requirements is expected to restrict credit availability further, which along with a higher probability that interest rates could be hiked to avert further currency depreciation, will dampen economic activity for the remainder of this and next year.  Even though the Central Bank decided to maintain the benchmark interest rate at 19% in its 19 September board meeting, officials are unlikely to ease this year, particularly if currency pressures persist and concerns over further inflation pass-through mount  The September consumer prices data indicates that annual inflation remains above the Central Bank target of 6% for this year.  According to Consensus Forecast data, inflation is likely to exceed the official target.

Banking on trade but global scenario not promising.  Despite the economic slowdown, the government is maintaining its economic growth forecast for next year, anticipating that the weaker currency will help spur export growth.  However, in September, exports grew only 0.7% over the same month last year, which was down from 3.8% in August.  Import growth is showing strong signs of a slowdown as well, as firms and consumers alike adjust to the weakening exchange rate.  In September, imports declined by 17.6%, the third monthly decline following the 5.9% and 0.6% drops in August and July respectively.  As a result of substantially lower imports, the monthly trade balance registered a surplus of US$ 594 million, the highest monthly surplus since October 1994.  The healthy August and September surpluses served to lower the annual trade deficit to just US$ 174 million in September, down from US$ 1.1 billion in August.  The government hopes that the increased likelihood of a notable decline in imports, when combined with a stronger export expansion, will serve to ease some of the pressure on the current account emerging from adverse international capital market conditions and declining FDI inflows.  According to government estimates, the current account will drop to US$ 24 billion, which remains well below figure anticipated by panellists for this year.  Furthermore, some participants remain sceptical about the ability of the economy to export its way out of the current slowdown, since global demand is likely to experience a major downturn and the accession of China to the World Trade Organisation (WTO) is expected to add increased competition for Brazilian exports. 

Growth forecast receives major downward adjustment.  Some panellists believe that the economy is already in or just entering a recession.  This month’s Consensus Forecast indicates that Brazil is likely to enter recession in the fourth quarter of this year, after meak growth in the third quarter.  The high prospects for a much weaker second half of this year will drive down annual growth.  Moreover, recession is expected to carry over to the first quarter of next year but the slowdown is likely to subside in the second quarter and pick up in the second half to boost the annual expansion.

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