Brazil - Economic Briefing September 2004

Economy Boosted by Rebound in Domestic Demand as Exports Skyrocket

The economy is currently experiencing a strong growth boost, as the export-led expansion is now being accompanied by a robust recovery in domestic demand.  Lower interest rates, declining unemployment and strong global demand are helping drive the rebound but inflationary fears are emerging and, if confirmed, could prompt the Central Bank to put on the monetary breaks.

Economic activity gains speed
Gross domestic product (GDP) expanded 5.7% in the second quarter of this year over the same quarter in 2003.  The second quarter reading was well ahead of market expectations and was more than double the 2.7% pace observed in the first quarter.  A quarter-on-quarter comparison does not bear out the strong expansion of the economy, as seasonally-adjusted economic growth reached 1.49% over the prior quarter, which was down from the robust 1.74% expansion observed in the first quarter.

Robust domestic demand drives growth engine
The acceleration over the first quarter was entirely due to the domestic side of the economy.  The contribution from the external sector, in contrast, dropped in the second quarter.  Domestic demand growth more than tripled from 1.5% observed in the first quarter to 5.5% in the second quarter over the same quarter last year, as both, consumption and investment, rebounded strongly from anaemic growth in the first quarter.  Consumption expanded a robust 4.1% in the second quarter, following on 1.3% growth in the first and investment more than quintupled the 2.2% pace observed in the first quarter to 11.6% in the second.  The contribution to economic growth from the external sector dropped compared to the first quarter, as exports grew at a slower pace whereas imports, which are a subtraction in the calculation of GDP, accelerated. Export growth remained strong with 16.5% over the same quarter last year but growth was down moderately from the 19.3% expansion in the previous quarter.  Imports, on the other hand, grew at 14.1%, which was up from the 11.7% pace observed in the first quarter.

Commerce and manufacturing propel economic activity and construction exits recession
With the exception of declines in mining and communications activity, all sectors experienced strong growth.  Commerce and manufacturing provided the strongest push behind the robust second quarter economic performance, as activity rose by 9.9% and 8.5% respectively over the same quarter last year.  Agriculture and transportation were the only sectors to experience a moderate slowdown, while the construction sector exhibited a growth acceleration of 8.9 percentage points.  As a result, the sector finally exited five consecutive quarters of declines and grew at a strong 6.7% pace over the same quarter last year.

Outlook favourable but looming interest rate hike could slow growth pace
Consensus Forecast participants expect the pace of economic activity to slow moderately in the second half of the year, with GDP growth decelerating to 3.9% in the third and 3.6% in the fourth quarter.  Nevertheless, for the full year, Consensus Forecast panellists revised their growth estimates upward by 0.4 percentage points from last month’s forecast with GDP expected to expand 4.1%.  The Consensus Forecast figure is now above the government’s 3.8% forecast, which was revised upward on 31 August from the previous 3.5% estimate.  Next year, growth is anticipated to decelerate only moderately, as economic activity is seen as rising 3.5%, which is unchanged from last month’s forecast and below the government’s 4.0% projection.

Inflation rising as economic activity and energy prices exert pressure
In August, consumer prices rose 0.69%, which was slightly above market expectations of 0.60% in the LatinFocus Consensus Forecast but represented moderation when compared with the prior month’s figure of 0.91%.  Higher fuel, energy, telephone and food prices were the key factors behind the August increase.  As a result of the August price increase, the annual inflation rate rose to 7.2% from 6.8% in July.  The annual variation in consumer prices remains well above the 5.5% central inflation target set by the Central Bank for this year but remains within its tolerance interval of +/-2.5%.  Consensus Forecast participants expect annual inflation to remain above the Central Bank’s inflation target at 7.2%, which is 0.2 percentage points above last month’s forecast.  Monetary authorities are confident that inflation will be reduced to 4.5% next year (with a +/-2.5% tolerance margin) and expect the same target and tolerance interval will be sustained for 2006.  Nevertheless, Consensus Forecast participants are not as optimistic about Central Bank monetary discipline and see annual inflation reaching 5.7% by the end of 2005 - still within the tolerance interval.

Central Bank maintains monetary policy unchanged amid economic pickup
In its monetary policy meeting on 18 August, the Central Bank’s monetary policy committee (COMPOM) decided to keep the benchmark SELIC interest rate at its previous month level of 16.0%.  Officials cited concerns about likely inflationary pressures from the acceleration in economic activity and higher oil prices as key factors behind the decision to maintain monetary policy unchanged.  Nevertheless, Consensus Forecast participants remain optimistic that the Central Bank will be able to cut interest rates further this year, as the SELIC rate is expected to drop to 15.4%.  However, participants appear to be anticipating a tighter monetary policy setting for this year than expected earlier.  This month’s 0._5 percentage point upward revision was the fourth consecutive upward revision.  Next year, interest rates should come down further, as inflationary pressures abate amid more moderate currency depreciation and slowing economic growth.