Brazil - Economic Briefing January 2002

Currency Skirts Contagion and Continues Recovery

The deterioration experienced by the Real during most of last year began to subside by year-end. In fact, the currency recovered strongly in the last two months. A more favourable exchange rate outlook is likely to lower inflationary expectations, which should enable the Central Bank to bring down interest rates and help foster an economic rebound as energy rationing concerns subside.

Currency continues rebound as Argentina contagion eases

Despite default and devaluation in Argentina, the Real continued to appreciate strongly at the end of last year.  In September, the deteriorating investor confidence spillover from Argentina had caused the currency to weaken by an annual rate of up to 30% against the US$ and had driven the Real to 2.80 to the US$.  However, in October the Brazilian economy appears to have decoupled from the Argentine contagion and the currency rebounded strongly in the last two months of the year, appreciating 6.1% and 9.0% in November and December respectively.  As a result, the Real closed 2001 at 2.32 Real to the US$.  The strengthening of the Real has prompted participants to expect a stronger currency this year with the Real closing at a level, which is 5.6% stronger than the forecast last month.

Lower interest rates and easing of energy rationing to spur growth

A continued strengthening of the exchange rate is likely to give the Central Bank leeway to ease monetary policy this year.  In its meeting on 19 December, the Central Bank board decided to leave the benchmark SELIC interest rate unchanged at 19.0%.  Monetary authorities cited the favourable trend of a strengthened currency and the likelihood of lower oil prices this year as key factors behind a more favourable inflationary outlook for 2002.  The prospects of declining price pressures this year should enable the Central Bank to lower interest rates, which would help to foment a pickup in economic activity.  Participants expect the monetary authority to lower interest rates in the first quarter of this year and to continue easing throughout the year, with the SELIC rate dropping further by year-end.

Growth to begin recovery in second quarter of this year amidst improved credit environment

Aggregate supply and demand data for the third quarter of last year indicate that the slowdown in economic activity – GDP growth dropped to just 0.3% over the same quarter in 2000 – was prompted by an abrupt deceleration in consumption.  Private consumption suffered the consequences of a deteriorating currency, higher interest rates and energy rationing and dropped 3.3% over the third quarter 2000, which represents a strong deceleration from 3.0% growth in the second quarter.  Imports declined a staggering 15.6%, down from a 14.9% expansion in the second quarter.  Additionally, the softening in the global and regional economy also served to undermine export growth, which declined 5.3%, after having grown a healthy 18.5% in the second quarter.  Only investment managed to exhibit positive results with 1.7% growth over the same quarter in 2000, compared to 2.8% in the second quarter.

Participants expect the economy to have entered a recession in the fourth quarter 2001.  The meagre growth recorded in the final two quarters of the year helped lower the annual growth rate, which is seen to have reached much less than the 4.3% in 2000.  Economic activity is expected to remain subdued in the first quarter of this year but should begin recovering in the second quarter, if energy rationing subsides and the exchange rate remains stable enough to enable the Central Bank to ease monetary policy.  Participants expect the economy to rebound strongly in the second half of the year and to boost the annual growth rate to 2.1%.

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