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Brazil - Economic Briefing December  2001

Entering Recession but Argentina-Induced Confidence Shock Easing

Higher interest rates, a more subdued global setting and domestic energy rationing have deepened the economic downturn, as both consumption and investment are showing further signs of deterioration.  The strong recovery of the Real shows that investors are eyeing Brazil more favourably and that market participants are likely to increasingly focus on domestic rather than Argentina related developments in their risk assessment, which should favour a more optimistic growth scenario.

Growth slows further in the third quarter on energy rationing and higher interest rates

In the third quarter, Gross Domestic Product (GDP) grew just 0.3% over the same quarter last year, down from 4.5% and 1.8% in the first and second quarters of this year respectively.  Nevertheless, the third quarter growth rate came in a notch above last month’s Consensus Forecast figure of 0.2%. 

Key behind the third quarter slowdown was the cutback in production that the domestic industry had to undergo in order to abide by the government-imposed energy rationing programme. The effects of the energy crisis were exacerbated by higher interest rates, resulting from the Central Bank's attempts to stem pressure on the Real since June.  Industrial activity fell for the first time in two years, shrinking by 1.3% year-on-year.  Within industry, public utilities and construction activity accounted for the lion share of the decline, experiencing a 12.1% and 2.1% contraction respectively. 

The 3.5% year-on-year growth in agricultural activity in the third quarter helped offset a more pronounced decline in GDP.  Services stayed in positive territory but the 1.5% expansion in the third quarter is well below the 2.7% growth rate registered in the second quarter.  The communications sector recovered from a contraction in the second quarter and expanded strongly (+10.5% year-on-year), thus, partially compensating for weaker commerce (-2.4% yoy) and financial services (-0.7%) activity.


Investment and consumption declining amidst tighter credit environment

Even though IBGE has not yet released aggregate supply and demand data recent indicators show that both consumption and investment are likely to have experienced downturns.  According to IBGE's industrial production data, annual growth in capital goods production slowed from 14.2% in August to just 3.5% in September over the same period last year.  Trade data confirm an investment slowdown, as imports of capital goods in September fell 10.4% over the same month last year, down from 4.4% growth in the prior month. 

Similarly, consumption is also likely to have slowed.  According to the Retail Federation of the State of São Paulo (FCESP, Federação e Centro do Comércio do Estado de São Paulo), retail sales dropped 10.0% in October over the same month last year, a slight improvement from the 11.8% contraction observed in September but, nevertheless, a confirmation that consumption remains very weak, due to the tighter credit environment.


Growth slump likely to persist through end of year

More recent data releases confirm that the slowdown is likely to persist into the final quarter of this year.  According to the Economic Research Institute (FIPE, Fundação Instituto de Pesquisas Econômicas), the monthly indicator of economic activity (IMEC), which monitors economic activity in São Paulo, dropped 2.5% in October over the same month last year, following upon a 0.1% contraction in September.  The October contraction was the second decline experienced since the end of 1999.  The key consumption-related indicator of the IMEC dropped 4.9%, while electricity consumption plummeted 22.3% over October last year.   

Even though the currency rebounded strongly in November, interest rates are unlikely to fall in the near future, as long as uncertainty in Argentina overshadows exchange rate stability and inflationary prospects.  Therefore, even if energy rationing is eased next year, tighter credit is likely to remain a strong impediment to a speedy rebound from the current growth slump.  Consensus Forecast participants have maintained their growth forecast for this year.  The current slowdown is anticipated to continue with the economy entering into recession in the current quarter and remaining in a slump through the first half of next year. 

Thereafter, the anticipated pick-up in the global economy, declining interest rates and prospects for an easing of current energy rationing in the latter half of 2002 should serve to boost the economy.  Nevertheless, the economic expansion for the year will remain subdued with growth reaching just 1.9%.  The prospects for an economic upswing are unlikely to depend heavily on Argentine developments, since market participants at this point have priced some form of Argentine collapse into their risk assessments and are likely to focus increasingly on domestic developments, such as the strengthening of fiscal balances and the execution of the remaining structural reforms.  The recent Real strengthening confirms that investors are increasingly viewing Brazil in a more favourable light.



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