Brazil - Economic Briefing July 2004

Looming Inflation Risks Threaten to Derail Recovery Looms

Economic activity continues along a healthy recovery path, as consumption and investment alike are benefiting from the lower interest rates.  Furthermore, the external sector remains on a robust growth trajectory amid the continued acceleration of global demand.  Meanwhile, higher oil prices exert pressure on inflation; while rising US interest rates threaten weaken the exchange rate, which could force the Central Bank to postpone further rate cuts for the time being.

Economic recovery continues strengthening
Growth is proceeding along a more propitious trajectory.  Economic output in São Paulo rose 2.3% in April over the same month in 2003, as measured by the monthly indicator of economic activity (IMEC, Indicador de Movimentação Econômica) from the Economic Research Institute (FIPE, Fundação Instituto de Pesquisas Econômicas).  The April figure represented a modest deceleration when compared to the 2.7% expansion observed in the previous month.  A month-on-month comparison, however, shows that activity rose 0.8% in seasonally adjusted terms over March, which was up from the 0.3% drop observed the previous month.  Furthermore, the key consumption-related indicator of the IMEC registered a more pronounced 3.9% expansion.

Domestic demand recovering amid improved interest rate setting
Private consumption is showing clear signs of recovery from last year’s recession.  According to the most recent data from the National Statistical Institute (IBGE), national retail sales rose a robust 9.9% in April over the same month the prior year, which was below the 11.0% observed the prior month.  Similarly, more recent data confirm the improvement in consumption activity.  The São Paulo Retail Federation (Fecomercio, Federação do Comércio do Estado de São Paulo) reports that retail sales in São Paulo rose 5.8% in May over the same month last year, which was down moderately from the 6.7% growth observed in April but confirmed that consumption activity continued to accelerate in the second quarter.  Declining unemployment, lower interest rates and the improved credit setting are likely to bolster a consumption rebound in the coming months.  However, consumer confidence is wavering since the Central Bank is hesitant to continue to cut interest rates.  The joint survey by the Fundação Getúlio Vargas (FGV) and Fecomercio indicates that consumer confidence dropped 9.1% in June over the previous month, from 124.4 in May to 113.1, on a scale between 0 and 200, where 100 marks the line between pessimism and optimism.

Investment rebound driven by stronger domestic and international demand
Trade data indicate that investment activity also continued to grow in the second quarter of the year.  Capital goods imports were up 40.3% in June over the same month last year.  The June figure doubled the 19.9% growth figure observed the prior month and represented the fourth consecutive double-digit increase.

Outlook downgraded despite healthy rebound
Economic growth is likely to remain robust throughout the year.  However, Consensus Forecast participants have voiced concerns that the Central Bank may not be able to ease monetary reins sufficiently to provide for an even more propitious economic rebound.  The possibility that rising interest rates in the United States could generate pressures on the currency is raising concerns.  Furthermore, inflationary pressures from higher fuel prices could postpone further interest rate cuts.  Consensus Forecast panellists do not appear to have reflected these external risk factors and their likely impact on economic activity, preferring instead to maintain their forecast for the gross domestic product (GDP) growth this year 3.5%, which is in line with the government’s estimate.  The more robust pace of economic activity this year is also anticipated to carry over into 2005 when growth is seen reaching 3.4%, which is also unchanged from last month’s forecast.