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Brazil - Economic Briefing April 2003

Tighter Monetary Policy May Stall Economic Rebound

Last year’s currency deterioration continues to pass-through to domestic prices. Inflation is currently on a trajectory that renders meeting the Central Bank target virtually impossible. As a result, monetary authorities have to maintain the monetary reins tight for the time being thwarting more pronounced economic growth.

Industrial activity remains robust as exports favoured
Industrial production rose 4.1% in February over the same month last year, which was up from the 2.7% rate observed in January. In seasonally adjusted terms industrial output rose 0.7% over January, which was up from 0.6% in the prior month. Robust growth in tobacco (+13.6% year-on-year), mechanical equipment (+11.9% yoy), transport equipment (+11.6% yoy) and leather goods production (+11.3% yoy) bolstered output in February. On the downside, pharmaceuticals output and textile production dropped 5.5% and 5.0% respectively over the same month last year. The government claimed that the healthy February rate was in part influenced by a weak comparison base last year but that stronger exports, amid the more competitive exchange rate, also served to drive up February output growth.

Domestic demand lagging amid high interest rates and weaker exchange rate
Last year’s deterioration in the exchange rate and the corresponding decline in real income, along with tight credit conditions and higher interest rates are beginning to show in domestic economic activity. Current domestic demand indicators do not point to a clear trend. According to the Economic Research Institute (FIPE, Fundação Instituto de Pesquisas Econômicas), the monthly indicator of economic activity (IMEC, Indicador de Movimentação Econômica), which monitors economic activity in São Paulo, declined 3.6% in February over the same month last year, following upon a 2.6% contraction in January. However, the data is distorted in part by seasonal factors. According to seasonally adjusted data, the economy added 1.7% over January, when monthly activity had dropped 0.1%. The key consumption-related indicator of the IMEC showed a similar pattern with activity dropping 3.6% over February last year but accelerating in seasonally adjusted terms to 1.7% over January (-3.8%).

However, investment does appear to be slowing. According to IBGE's industrial production data, capital goods production rose a moderate 0.1% in February over the same month last year, which was down from 2.3% in January. Similarly, trade data confirm a moderation in investment activity, as annualised capital goods imports in February were down 20.2% over the same month last year, a slight improvement over the 21.9% decline observed in January.

Participants anticipate the rate of economic activity to accelerate only moderately this year compared to 2002 amid the less favourable interest rate setting and uncertainty about the trajectory of the international economy. Furthermore, even though economic growth should gain speed next year, the expected growth rate is modest when compared with other countries in the region.

Currency strengthening resumes
The real resumed its strengthening trend in March, following a brief weakening in February. The currency appreciated 6.2% to the US$ in nominal terms over February, a substantial strengthening when compared with the 1.0% depreciation observed in the prior month. As a result, the currency closed at 3.35 reais to the US$ at the end of March – the strongest level observed in six months. Increased investor confidence about the likelihood of a short war in Iraq reversed the generalized sell-off in emerging market assets observed in February. In addition to the strengthening in the exchange rate, the stock market rebounded 9.7% in March, while the spread to US Treasuries of the benchmark composite J.P. Morgan EMBI+ Brazilian sovereign bond dropped to 1,059 - its lowest level observed since June of last year. The improvement in the foreign currency and capital markets reflects the fact that the feared investor flight to safe havens in the wake of a military conflict did not realize. The government has confirmed its commitment to the current floating exchange rate regime and promises to refrain from exerting pressure on monetary authorities to intervene in the currency markets if the strengthening threatens to choke off the current expansion in the export sector. Participants now actually anticipate that the real will appreciate this year over 2002, with the currency seen 1.9% stronger. Next year, however, the exchange rate is seen as encountering renewed pressures.


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Note:  The above text is an abridged version of the LatinFocus Consensus Forecast country briefing.  For more details please click here.


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