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Brazil - Economic Briefing June 2002

Slow Growth in First Quarter May Prompt Rate Cuts

The economy remained in recession in the first quarter amid high interest rates and tight credit. However, concerns over inflation are easing, as the currency stabilizes, oil prices come down gradually and economic activity remains subdued. Therefore, the Central Bank may cut interest rates in the coming months. The improved interest rates setting combined with increased global demand are likely to boost economic activity in the months ahead.

First quarter growth data confirms that industry-induced recession as consumption remains subdued
Gross domestic product (GDP) shrunk 0.7% in the first quarter over the same quarter in 2001, which was on par with the 0.7% contraction observed in the fourth quarter of last year. Thus, the first recession since the 1999 devaluation continued unabated. Industry remained the key driver behind the first quarter slump with a 3.9% annual contraction. However, the reading marks an improvement when compared to a 5.5% year-on-year contraction in the preceding quarter. Within industry, the construction sector remained in recession with a 8.9% yoy decline in activity (Q4 2001: -8.3% yoy), followed by manufacturing, which registered a 2.0% drop (Q4 2001: -3.4% yoy). Services registered a slight deterioration, expanding 1.7% compared to 1.8% in the preceding quarter. The moderate growth experienced in the services sector reflected subdued consumption, as Brazil continued to suffer from tight credit and the weakening of the exchange rate. Activity in commerce dropped 4.0% over the first quarter last year (Q4 2001: -3.3% yoy). In addition, consumers and businesses alike have still not adjusted to the lifting of energy rationing. As a result, public utility services output was down 12.2% yoy.

Even though aggregate demand and supply data are not available, additional data indicate that although consumption remains subdued it is showing tentative signs of a recovery. According to IBGE, national retail sales rose 1.0% in March over the same month last year, which was up from the 1.5% annual contraction experienced in February. The Consensus expects consumption to have dropped 1.4% in the first quarter over the same period last year, which would be an improvement from the 1.9% contraction in the final quarter of 2001. After having reached a trough in March, consumption is likely to pick up towards the end of the year as credit conditions continue to improve. However, stubbornly high unemployment will remain an impediment to a sound recovery of consumption this year. In April, open unemployment rose to 8.2% from 7.8% in March. Consumer expectations also indicate that consumption is unlikely to experience a strong boost in the near term. The Index of Consumer Intentions (IIC), released by the São Paulo Retail Federation (Fecomércio), has experienced successive monthly growth rates since the beginning of the year but with rates declining. In May, the positive growth story was interrupted with the index experiencing a 0.9% decline, as both expectations about current and future conditions dropped. However, lower interest rates and currency stability may help bolster consumption this year. The Consensus sees consumption picking up at a moderate  pace this year.

Investment is also likely to have remained in negative territory in the first quarter of this year, as capital goods imports were down 5.2% in March over the same period last year. The March reading showed a worsening in capital good import flows as growth diminished further after having slowed from a 3.1% expansion in January to 1.1% growth in February. Similarly, industrial production data show that capital goods output dropped 1.8% in the first quarter over the same quarter last year. Continued high interest rates are considered a key impediment for a more notable investment expansion. Participants expect investment to have declined 4.8% in Q1, which would be an improvement over the 7.5% contraction observed in the final quarter of 2001. For the year as a whole, investment is seen as expanding slightly.

Consensus data indicate that the economy is likely to exit from the recession in the second quarter with GDP growth picking up. Despite electoral uncertainty, an improved inflation outlook is anticipated to give the Central Bank leeway to lower interest rates in the second half of the year, which will help accelerate growth and lift the annual GDP expansion.




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