Brazil - Economic Briefing September 2003

Subdued Domestic Demand Reduces Economic Activity

The economy is currently in recession, as the interest rate hikes, higher unemployment and deteriorating real incomes are stifling domestic demand. Nevertheless, the recent Central Bank interest rate cuts and the looser monetary policy promise to rekindle growth in the ailing domestic economy.

Economic downturn deepens in second quarter amid domestic demand slump
In the second quarter, gross domestic product (GDP) contracted 1.4% over the same quarter last year. The reading was in stark contrast to market expectations, which had seen the economy expanding 1.4%, and was down moderately from the 2.0% growth rate observed in the first quarter. Moreover, the second quarter was inflated by seasonal factors. In seasonally adjusted terms, economic activity declined an even more pronounced 1.6% over the preceding quarter, which also represented a sizable deterioration when compared to the 0.6% drop observed in the first quarter.

A strong decline in domestic demand was the principal factor behind the second quarter economic slowdown with the external sector supporting the economy. Total consumption dropped 5.2% in the second quarter over the same quarter last year, which was down from a 1.8% contraction observed in the first quarter. Within total consumption, public consumption offset a more pronounced decline in total consumption as activity within the public sector actually rose 0.9%, while private consumption declined a notable 7.1% over the same quarter last year. Similarly, investment activity contracted a strong 9.0% in the second quarter, which represented deterioration from the 1.5% decline in the first quarter. The external sector bolstered the economy from a stronger decline in activity, as exports rose 30.1% in the second quarter (Q1: +20.2%), compared to a 6.0% decline in imports (Q1: -4.7%).

With the exception of agriculture and government services, all sectors entered negative territory. The second quarter decline was most pronounced in construction, where activity dropped 11.1%. The construction sector decline was followed by notable drops in wholesale and retail commerce over the second quarter last year (Q2: -5.2% year-on-year; Q1: -0.1% yoy) and financial services (Q2: -2.6% yoy; Q1: 1.6% yoy).

The principal causes of the downturn in economic activity in the first half of the year were the persistently high interest rates, tight credit conditions, higher unemployment (13.0% at the end of June, up from 12.1% at the end of March) and last year’s strong currency depreciation, which continues to reduce real incomes. The Central Bank is confident that its recent monetary easing – officials have lowered the benchmark SELIC interest rate by 450 basis points since June and bank reserve requirements were lowered from 60% to 45% in August – will help to reactivate the ailing domestic economy in the second half of the year. Consensus Forecast participants appear to concur with monetary authorities’ optimism, as they anticipate the economy to grow again in the third quarter, with growth reaching a modest 0.8%. The favourable growth trend will persist in the fourth quarter with an economic expansion of 2.0%. Nevertheless, given the dismal second quarter reading, Consensus Forecast panellists have cut their full-year growth forecast 0.6 percentage points from last month’s estimate to just 1.1%. The current Consensus Forecast is thus well below the government’s 1.8% projection. However, the trend of accelerated growth in the fourth quarter is anticipated to persist into next year, as economic growth is seen reaching 3.2% - still below the government’s 3.5% growth figure.