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Brazil - Economic Briefing June 2003

Domestic Economy Slumping Amid High Interest Rates and Deteriorating Real Incomes

In order to stem the inflationary pass-through of last year’s currency deterioration, monetary officials had to keep the reins tight. High interest rates and diminished real incomes have sent domestic demand in a tailspin and the external sector currently remains the only driving force behind economic growth. However, uncertain prospects over the global economy threaten to choke off the only economic growth driver, unless the recent exchange rate appreciation helps lower inflationary expectations and enables monetary officials to adopt a more growth accommodating monetary policy.

Growth slows in the first quarter amid slump in domestic demand
In the first quarter, gross domestic product (GDP) expanded 2.0% over the same quarter last year. The first quarter figure represented a slowdown over the previous quarter when growth reached 3.4% and was on target with the Consensus figure of last month. Moreover, the first quarter reading was inflated by seasonal factors since this year’s first quarter counted more working days than last year’s. On a seasonally adjusted basis, economic activity declined 0.1% over the fourth quarter last year – the first such drop observed since the second quarter 2002.

External sector still favoured by more competitive exchange rate
The external sector represented the key driving force behind the first quarter growth, as the domestic economy slumped. Exports were up 20.2% in the first quarter over the same quarter last year, which was only slightly down from the 20.4% spike observed in the previous quarter. Imports remained in negative territory with a 4.7% contraction (Q4 02: -8.8%). The domestic side of the economy deteriorated notably compared to the fourth quarter. Investment declined 1.5% year-on-year (Q4 02: +4.2% yoy) and consumption dropped 1.8% (Q4 02: -0.2%), amid a notable decline in private consumption, which dropped off 2.3% over the same quarter last year (Q4 02: -0.4%). The current slump in domestic economic activity can be attributed to the current high interest rate setting and continued fallout from the real income deterioration associated with the exchange rate weakening last year.

Agriculture strongest sector as soy harvest boosted
The agricultural sector exhibited the strongest first quarter growth rate, with activity up 8.6% over the same quarter last year. The strong performance was attributed principally to favourable developments in soy output. In addition to agriculture, public utility services and mining activities registered strong expansions of 5.7% and 4.8% respectively over the first quarter 2002. On the downside, the transportation and construction sectors experienced drops in activity with output declining 5.1% and 1.7% respectively year-on-year.

Tight monetary policy and rising inflation key impediments to economic acceleration
High interest rates and tight credit are likely to remain key impediments to a rapid recovery in the domestic economy. The recent strengthening in the currency may serve to ease rising inflationary expectations, which could enable the Central Bank to ease the monetary reins to spur economic growth. However, a stronger currency also erases some of the competitiveness gained in the wake of the depreciation. Thus, an acceleration economic activity is unlikely to emerge with growth seen as slowing further throughout the year. Consensus Forecast panellists have lowered their projection for 2003 GDP growth a notch since last month. The moderate growth path is expected to be left behind next year, as lower interest rates and the external sector promise to drive economic activity upward. As a result, participants expect economic growth to accelerate to 3.0%.

 

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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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