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Brazil - Economic Briefing December 2002

Inflation Pressures Prompt Further Monetary Tightening

The politically induced currency weakening observed in the month prior to the October presidential elections and higher international oil prices are beginning to pass through to domestic prices, which have surged considerably. As a result, the Central Bank has acted to significantly tighten monetary reins, which could serve to choke off the economic rebound currently underway.

Economic activity accelerates in third quarter but improvement may be temporary
In the third quarter, gross domestic product (GDP) expanded 2.4% over the same quarter last year. The third quarter figure exceeded market expectations and represented a healthy improvement in economic activity compared to the second quarter, when growth reached just 1.0%. Furthermore, according to seasonally adjusted data, the Brazilian GDP increased by 0.9% over the second quarter this year, following on a 0.9% increase in the second quarter.

Agriculture leads growth
The agricultural sector grew at an annual rate of 7.2%, up from the 6.6% annual rate registered in the second quarter; while industry and services grew at a more moderate 3.0% and 1.8% pace respectively (Q2: industry: 0.1% year-on-year; services: 1.1% yoy). Within the industrial sector, mining activities experienced the strongest growth with a 10.8% expansion, while manufacturing activities accelerated further from modest growth in the second quarter (+0.8% yoy) to a 2.6% expansion over the same quarter last year. Meanwhile, the construction industry remained in negative territory, contracting 0.9% over the same period last year, after 2.5% annual growth registered in the second quarter.

Within the services sector, public utilities services experienced the strongest expansion, growing 9.8%, up from the 2.3% contraction in the previous quarter. The communications sector grew 6.8% over the second quarter last year (Q2: +6.0% yoy), while activities in the financial services sector expanded 4.1%.

Aggregate demand and supply data are not yet available. However, data indicate that consumption remains subdued and is not currently showing any signs of a recovery. According to the National Statistical Institute (IBGE), national retail sales rose 1.0% in the third quarter over the same quarter last year, which was barely an improvement from the 0.9% contraction observed in the second quarter. Moreover, stubbornly high unemployment will remain an impediment to sound consumption recovery this year - in October, open unemployment remained at a high 8.1% (Oct-01: 7.5%). 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) experienced a 5.95% increase in October compared to the preceding month. However, expectations about future conditions remain low at 81.2 points on a scale of 0 to 200, as perceptions about the current economic climate remain subdued.

Investment is likely to have remained in negative territory in the third quarter of this year. However, the third quarter reading showed some improvement in capital goods imports, with the annual contraction diminishing further from a 21.3% contraction in the second quarter to a 8.4% decline in the third quarter. Domestic capital goods production was also down 3.7% in the third quarter over the same quarter last year, a worsening from the 0.4% contraction in the second quarter.

The more adverse conditions for the exchange rate and increases in the benchmark interest rate are likely to exert downside pressure on domestic demand in the final quarter of the year. Nevertheless, participants remain optimistic that economic growth will accelerate further. The Consensus sees growth in the fourth quarter at 2.2%. For the year as a whole, participants now expect the economy to expand by 1.2%, up a notch from last month. A stabilized exchange rate is likely to enable the Central Bank to cut interest rates next year, which should facilitate a more pronounced economic expansion, lifting annual growth to 1.8% - up 0.3 percentage points from last month.

Currency induced adverse inflation scenario …
Businesses have begun to pass through the accelerated currency depreciation observed in the past four months to domestic prices, which have already experienced an upward push from the government’s decision to hike public services tariffs in October. The consumer price index (IBGE-IPCA) rose 3.02% in November – the highest monthly increase observed since 1994. The November number was more than double the 1.3% October increase and was more than three times the rate observed for the same period last year. As a result, the annual inflation rate mushroomed to 10.9% in November from 8.5% in the previous month. The accumulated inflation rate for this year of 9.65% is now well in excess of the Central Bank’s 6% target. Current wholesale price developments indicate that inflation may accelerate even further in the coming months. The Fundação Getúlio Vargas reports that monthly wholesale prices (IPA-DI) rose 6.0% in October, which was up from the 3.8% monthly increase registered in September. As a result, the annual wholesale price variation rose to 23.0% from 18.2% in September. As a result, the Consensus has revised the annual inflation forecast upward 1.2 percentage points from last month to 9.3%. This month’s Consensus exhibits strong variations in the year-end inflation forecast with a high of 11.7% versus the low of 7.0% expected for 2002. This variation may be the result of the fact that some panellists have not yet factored the November inflation figure into their forecasts. Hence, the final outcome is likely to be closer to the upper end of the forecast range. Despite a likely moderation in currency pressures next year, participants expect inflationary pressures to persist, as year-end inflation is anticipated to accelerate to 10.5%, which is 1.1 percentage points above last month’s forecast. Next year’s Consensus figure is now more than double monetary authorities’ central target of 4% and even exceeds the upper end of the +/- 2.5% target band.

… Prompts Central Bank interest rate hike
The strengthening in the currency in October and November - when the real appreciated 6.9% and 0.2% respectively – has not been sufficient to reverse the strong depreciation that the currency has experienced since the beginning of the year. At 3.63 reais to the US$ at the end of November, the currency remained 36.2% weaker than in January. The adverse combination of a weaker currency and higher oil prices has served to significantly raise inflationary pressures. As a result, the Central Bank has been forced to raise interest rates. In its 20 November meeting, the Central Bank board (COPOM) decided to raise the benchmark SELIC interest rate for the second consecutive month. The 100 basis point increase in the interest rate followed upon a 300 basis point hike in October. At 22.0% the SELIC is now at its highest level observed since June 1999. Therefore, participants have revised their year-end interest rate forecast upward to reflect the Central Bank move and now expect the SELIC to virtually remain at its current levels. According to the Consensus, an easing of currency pressures should enable monetary officials to ease next year and bring down the benchmark rate to 18.6%.


 

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