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Brazil - Economic Briefing May 2002

Rebound of Economic Activity on the Horizon but Inflation Worries

The economic slowdown is bottoming out and signs of improvement are emerging. However, a fuel price induced pickup in inflation is likely to cut short any efforts of the Central Bank to lower interest rates in the short-term to propel the economy forward, as declining exports to Argentina promise to keep industrial output more subdued than originally anticipated.

Economy remains in trough as consumption remains suppressed
In March, real retail sales declined 1.5% compared to the same period last year. The March figure represented an improvement compared to the 5.5% and 7.7% contractions observed in January and February respectively. According to the São Paulo Retail Federation (Fecomércio), high interest rates, a loss of consumer purchasing power resulting from currency depreciation, higher unemployment levels and increased insolvency are key elements behind the continued slump in consumption. The outlook for consumption, however, is improving. The Fecomércio Index of Consumer Intentions (IIC) rose by 0.6% in April, up from the 0.4% decrease registered in March. Monetary easing and an improved credit environment is likely to boost consumption later in the year. In fact, panellists expect growth to pick up at a faster pace in the second half of the year and to lift the consumption expansion to 2.1% for the year as a whole.

Industrial engine sputtering amidst tight credit and lower demand
According to seasonally adjusted data from the National Statistical Institute (IBGE), industrial production dropped 0.8% in March over February. The March reading represented the first monthly contraction observed since October 2001. On an annual basis, industrial output contracted 3.8% compared to 1.3% registered in February. Government officials attribute the continued slump in industrial activity to the drop in exports to Argentina. Last year, 8.0% of total Brazilian exports were directed to Argentina of which 92.5% were of industrial origin. Therefore, the industrial sector is likely to continue to grow below potential as long as the Argentine crisis persists. Nevertheless, the improved international setting may help offset some of the regional export growth constraints. In fact, Consensus participants are confident that industry is likely to begin entering positive growth territory in the second quarter, with growth picking up further in the second half amid lower interest rates.

Government lowers growth forecast as export prospects worsen
On 6 May, the government reduced its forecast for Gross Domestic Product (GDP) growth this year to 2.0% from 2.5% earlier. Officials claim that the persistence of the Argentina crisis is likely to slow the export engine this year, while concerns about higher inflation may stifle the Central Bank’s ability to lower interest rates as much as anticipated earlier in order to boost domestic economic activity. The Consensus remains more optimistic about growth prospects, expecting the economy to expand at a more favourable rate, as moderate growth in the first half is offset by a strong rebound in the second half when the anticipated rebound of the global economy is seen to compensate for plummeting demand of Argentina.

Central Bank raises inflation forecast as higher oil prices loom
In its 17 April meeting, the Central Bank board decided to raise its inflation forecast for this year, as concerns about higher oil prices and utility costs loom. The April consumer price index (IBGE-IPCA) increased 0.8% over March, when consumer prices rose 0.6%. The April increase was the strongest monthly uptick this year and raised the annual inflation rate to 7.8% from 7.5% in March. As a result of the less favourable inflation environment, monetary officials now expect inflation to reach 4.5% by the end of this year, which is up from the 3.7% targeted earlier this year. The new figure is at the upper end of the current inflation rate target between 4.0% and 4.5%. The decision to raise the official inflation forecast clearly indicates that monetary authorities are unlikely to lower interest rates for the time being. A surprise February lowering of the benchmark SELIC interest rate from 18.75% to 18.50% had raised optimism over more aggressive rate cuts this year. Participants have raised the inflation forecast for this year by 0.1 percentage points and have bumped up their year-end interest rate forecast accordingly by 0.2 percentage points since last month.




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