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Corruption
scandal deepens and casts shadow over economy
The
corruption scandal that forced the resignation of President Lula’s
chief-of-staff José Dirceu in June is deepening. The scandal implicated
Dirceu as having coordinated a broad-scale corruption scheme to finance
political party campaigns of the ruling Worker’s Party (PT, Partido dos
Trabalhadores) and having knowingly tolerated the bribing of
legislators to buy votes. Since the political scandal comes on top of
additional charges of misconduct presented against the current Central
Bank president Henrique Meirelles and the Social Security Minister Romero
Jucá, the credibility of the existing political institutions has been
undermined significantly in the eyes of voters. The resulting
congressional investigation into the government’s misdeeds is likely to
stall any progress on economic policy for the time being and threatens to
further undermine the prospects for a Lula re-election in October 2006. A
further deepening of the political scandal is likely to be reflected in a
decline of domestic demand, particularly investment, a weakening of the
exchange rate, potentially higher inflation and a less accommodating
monetary policy from the Central Bank.
Private
consumption slowing amid high interest rates
In May,
national retail sales increased 2.7% over the same month last year, which
was below the 3.4% growth observed the prior month. Declining of sales in
supermarkets and household appliances accounted for the lion share of the
moderation, as activity in all other sub-sectors remained in positive
territory. However, a month-on-month comparison does not confirm the
deceleration implied by the annual figure, as seasonally adjusted activity
actually picked up 0.40% over April, when sales had dropped 0.25%.
Nevertheless, the downward trend in retail sales observed since January
persisted. The
annual average growth rate declined from 8.2% in April to 7.5% in May.
According to the joint survey of the Fundação Getúlio Vargas (FGV)
and Fecomercio, consumer confidence in São Paulo fell 0.8% in June
over the previous month from 134.1 in May to 133.1, on a scale between 0
and 200, where 100 is the dividing line between pessimism and optimism.
The June reading represented a modest recovery from two consecutive strong
declines in April and May.
Investment
remains healthy
Industrial
production data suggest investment activity remained healthy through the
end of the second quarter. In June, capital goods output increased 8.3%
over the same month last year, which was up notably from the 4.1%
expansion observed the prior month. A month-on-month comparison bears out
the healthy output growth observed in the annual figures. In seasonally
adjusted terms, capital goods output rose 4.16% over the prior month,
which was down moderately from the robust 5.18% increase registered the
prior month. Furthermore, more recent trade figures suggest that
investment activity, while moderating from resilient growth, remained
strong. In July, capital goods imports were up 24.1% over the same month
last year, which was down from 31.87% growth observed in June.
Government
revises outlook downward
On 27 July,
the Budget and Planning Ministry announced that the government had revised
the forecast for gross domestic product (GDP) growth for this year
downward from the previous 4.0% figure to 3.4%, which is now on par with
the Central Bank’s figure. Officials did not outline the specific
motivation of the adjustment but simply stated that the new forecast was
more in line with market expectations. Nevertheless, implicitly the
government acknowledges that higher interest rates, intended to subdue
inflationary pressures, have also driven down economic activity. The new
government estimate remains above the 3.1% expansion anticipated by
Consensus Forecast participants for this year. This month’s Consensus
Forecast figure has been revised downward by 0.2 percentage points from
last month’s estimate, the 4th consecutive downward revision. Next year,
Consensus Forecast panellists expect growth to accelerate moderately with
GDP seen to expand 3.4%.
Inflation
heading down amid declining economic activity
Repeated
Central Bank tightening measures are beginning to subdue inflation. The
mid-July consumer price index (IBGE-IPCA 15) that covers monthly price
increases up to the 15th of every month increased 0.11% over June. The
July figure was virtually unchanged from the 0.12% increase registered in
the preceding month and represented the lowest monthly variation observed
since July 2003. Higher communications costs resulting from a 7.72%
telephone tariff increase on 3 July accounted for the lion share of the
July increase, as most other consumer price increases remained subdued.
As a result of the July reading, the annual inflation rate dropped from
7.7% the prior month to 6.8% - the second consecutive decline. Consensus
Forecast participants expect inflation to moderate further this year to
5.8%, which is 0.1 percentage points below last month’s estimate but
remains well ahead of the Central Bank’s 4.5% inflation target but within
the +/- 2.5% tolerance margin. Thus, if confirmed, monetary officials
will overshoot the inflation target for the fifth consecutive year.
Furthermore, next year, Consensus Forecast panellists anticipate that the
Central Bank will overshoot again, as the 4.9% estimate is ahead of the
4.5% monetary policy target but also remains within the +/- 2.5% range
around the central target.
Monetary
tightening cycle comes to an end
Given the
improved inflation scenario, the Central Bank decided on 20 July to leave
the benchmark SELIC interest rate unchanged at 19.75% for the second
consecutive month. The stronger currency and the moderation in economic
activity are key factors behind the current moderation in inflationary
pressures, which has enabled the Central Bank to halt the tightening cycle
that had been in place since September last year. However, the potential
for any substantial easing in the second half has been undermined by the
current political crisis. Nevertheless, Consensus Forecast participants
expect that monetary authorities will begin to ease again in the third
quarter and further in the final quarter of the year, bringing down the
SELIC interest rate to 17.7% by year-end. Furthermore, interest rates are
anticipated to decline further next year to 15.5%.
Exchange
rate weakens amid political jitters
In July,
the currency depreciated 2.92% in nominal terms versus the US$ to close at
2.42 reais to the US$. The July weakening was the highest monthly
depreciation since March and was principally associated with rising
concerns that the political scandal could spill over to the economy.
Despite the depreciation observed in July, the currency was still 9.6%
stronger than at the end of last year. Nevertheless, Consensus Forecast
participants expect the depreciation to continue throughout the remainder
of the year with, amid concerns about the political uncertainty.
Therefore, the currency is expected to close at 2.60 reais to the
US$, which would represent a 6.8% nominal depreciation from current
levels. Next year, the depreciation trend is likely to persist with the
exchange rate anticipated to reach 2.74 reais to the US$ by
year-end – a 5.2% nominal annual depreciation.
Current
account surplus widens amid strong export performance
The current
account balance registered a surplus of US$ 2.6 billion in the second
quarter of this year. The surplus was just below the US$ 2.7 billion
surplus observed in the first quarter but virtually equal to the figure
registered in the second quarter last year. A notable widening in the
service balance deficit, which deteriorated from a US$ 7.2 billion deficit
in the second quarter last year to a US$ 9.6 billion deficit, was offset
by the substantial widening of the trade surplus. In the second quarter
the trade surplus reached US$ 11.4 billion, which was up from the US$ 8.9
billion figure of the second quarter 2004. The stronger currency and
moderating global demand have not had a notable impact on export growth.
In the second quarter exports grew 22.5% compared to the same quarter last
year, which was down only moderately from the 25.7% annual expansion
observed the previous quarter. The dampening effect of higher interest
rates on domestic demand is not reflected in a noteworthy decline in
imports, which rose 19.2% in the second quarter over the same quarter last
year. The second quarter reading was down just modestly from the 21.2%
growth observed in the first quarter. As a result of the second quarter
reading, the annual current account surplus dropped from US$ 12.8 billion
in the first quarter to US$ 12.6 billion in the second. Consensus
Forecast participants expect the current account to narrow further
throughout the second half of the year to reach US$ 11.1 billion by
year-end, which is up from last month’s US$ 9.2 billion Consensus Forecast
figure. Next year, the current account surplus is anticipated to narrow
significantly to US$ 5.6 billion, amid a further slowdown in export
growth. |
