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Brazil - Economic Briefing October 2003

Economic Doldrums Prompt Outlook Revision

The unexpected depth of the recession plaguing the economy has impelled a significant revision to the economic outlook for this year. The external sector continues to thrive but domestic economic activity remains subdued. Nevertheless, the recent moderation in inflation and successive interest rate cuts by the Central Bank may provide the domestic economy with the necessary push to exit the recession.

Central Bank eases monetary policy further amid subdued growth
On 17 September, the Central Bank decided to lower the benchmark SELIC interest rate by 200 basis points to 20.0%. The September easing represented the fourth consecutive cut in the SELIC rate, which has dropped 650 basis points since May. Monetary officials cited the declining trend in inflationary expectations observed in recent months and the appreciation in the currency, along with optimism about continued fiscal discipline and a more subdued economic setting, as key drivers behind the decision to ease monetary policy. Authorities claim that the inter-harvest period and readjustments of regulated prices are likely to put some pressure on consumer prices in the coming months. Also, the price increases earlier this year may feed through to higher wage adjustments at the end of the year, which could exert some upward pressure on prices. Nevertheless, the Central Bank is optimistic that inflation will remain contained and continue to decline, as the inflationary pass through of accelerated currency depreciation from last year is anticipated to have come to an end and prices are expected to moderate, particularly amid the less favourable economic setting. The Central Bank’s optimism over continued deceleration in inflation this year is likely to be reflected in monetary policy measures. In fact, Consensus participants see the benchmark SELIC interest rate declining further from its current level to 18.3% by the end of the year, which is down 1.4 percentage points over last month. In addition, the pick up in economic activity next year is not anticipated to significantly accelerate inflation and should help the Central Bank bring down interest rates further to 15.0%, which is down 0.6 percentage points from last month.

Inflation abates on growth slowdown and currency strengthening
In September, consumer prices rose 0.78%. The September figure exceeded the 0.34% monthly increase observed in August and was above market expectations of 0.60%. As a result, the annual inflation rate remained unchanged over August at 15.1%. Wholesale prices, as measured by producer price index (FGV-IPA-DI), experienced a 1.29% increase, reversing the declining trend observed since April. Nevertheless, while the annual wholesale price growth rate continued to drop from 25.9% in August to 22.8% in September, the figure remains well above the consumer price variation. The current divergence in wholesale and consumer prices may, in part, reflect wholesaler’s inability to transfer higher prices to retailers amid subdued domestic demand. Furthermore, this year’s currency strengthening is subduing inflationary pressures. In September, the exchange rate appreciated 1.5% in nominal terms versus the US$, virtually offsetting the 1.7% depreciation observed in the previous month. At 2.92 reais to the US$ at the end of September, the currency was 20.9% stronger than at the end of last year. Inflation still remains at almost double the 8.5% year-end inflation target and the Consensus remains sceptical about the Central Bank’s ability to meet its target, expecting 9.5% year-end inflation. However, this month’s the annual Consensus inflation estimate has been lowered for the fourth consecutive month and is now within the +/- 2.5% tolerance margin set for the inflation target. Next year’s inflation rate, which Consensus Forecast panellists see to reach 6.7%, will also be above monetary officials’ central target rate of 5.5% but just as foreseen for 2003, still within the +/- 2.5% tolerance.

Growth pattern erratic and economic activity still subdued
Following the release of the sombre second quarter gross domestic product (GDP) data, the Central Bank decided to lower the growth forecast for this year to 0.6% from 1.5% officially expected before the revision on 30 September. According to the government, the combination of high interest rates, deteriorating real incomes resulting from higher inflation, rising unemployment and tight credit conditions drove the economy into recession in the first half of the year. Even though the improved inflationary setting observed at the beginning of the second half and the aggressive lowering of interest rates should help spur on economic activity, growth is unlikely to be sufficient to lift the economy to a more propitious growth pace.



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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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