Brazil - Economic Briefing April 2006

Central Bank Policy Easing Supports Economy

Industry is exhibiting clear signs of a recovery, which is likely to bolster overall economic growth. Moreover, even though export growth is beginning to moderate due to the strong comparison base of last year, the Central Bank is likely to continue to cut interest rates to boost economic growth.

Industrial sector rebounds

The incipient recovery in the industrial sector first registered in October and November last year has begun to consolidate.  In February, industrial production increased 5.4% over the same month last year, which was well ahead of market expectations and exceeded the 3.1% increase registered in January.  Within industry, the mining sector registered the most robust growth followed by manufacturing.  The mining sector benefited from strong oil and gas as well as metals output, while the manufacturing sector experienced healthy expansions in home appliance and electronics production.  Furthermore, capital and consumer goods production helped to bolster the February reading notably.  A month-on-month comparison confirms the February acceleration in production, as output grew 1.17% over the preceding month in seasonally adjusted terms.  Furthermore, as a result of the healthy reading, the annual average growth rate rose from 2.9% in January to 3.0%.  Consensus Forecast participants expect the recovery in industrial production to persist throughout the year, with full-year growth reaching 4.1%, which is unchanged from last month.  Next year, Consensus Forecast panellists anticipate that industrial production growth will remain healthy with the expansion reaching 4.3%, which is also unchanged from last month.

New finance minister addresses the lowering of interest rates to reach sustainable growth

Clear signs of a recovery in the industrial sector shed a favourable light on this year’s growth prospects.  Furthermore, even though the export sector is likely to moderate due to the strong comparison base of last year, a probable continuation of Central Bank monetary policy easing should bolster domestic demand, which will boost economic growth.  Recent political changes also point to a government determination to reduce interest rates.  On 27 March, finance minister Antonio Palocci resigned amid corruption allegations.  During his tenure as finance minister, Palocci effectively curbed inflation and reduced the public deficit.  President Lula appointed Guido Mantega, the former president of the state development bank, as the new finance minister.  Mantega has stated that the government intends to ensure that interest rates continue to decline in order to ensure more sustainable growth.  The new finance minister is also expected to push for an easing of fiscal policy to further stimulate the domestic economy.  According to the Retail Federation of  São Paulo (Fecomércio SP), the consumer confidence index reached 138.1 in March, only slightly down from the 138.2 reading registered in February.  At the current level, the index is well above the 100 point mark between pessimism and optimism.  Except for the slightly stronger February figure, the March reading marks the highest level of consumer confidence since April last year.  The Consensus Forecast panel anticipates economic activity to accelerate throughout this year, with full-year growth in gross domestic product (GDP) reaching 3.5%, which is up 0.1 percentage points from last month’s Consensus Forecast figure and below the 4.0% Central Bank estimate.  Next year, the pace of economic activity should accelerate more moderately with growth reaching 3.6%.

Inflationary pressures moderate further

In March, consumer prices increased 0.43%, which exceeded market expectations of a 0.33% rise and was modestly above the 0.41% increase in February.  Fuel prices continued to exert notable upward pressure on the overall price level.  However, declining food prices mitigated the overall March rise, while most other price categories experienced only modest increases.  Despite the fact that the monthly prices variation was a notch higher, the annual inflation rate dropped from 5.5% in February to 5.3% in March.  At the current level, annual inflation exceeds the 4.5% Central Bank monetary policy target but is within the +/- 2.5% tolerance margin around the central target.  As a result of the improved inflationary environment, the Central Bank decided to lower the benchmark SELIC interest rate for the sixth consecutive month on 1 March from 17.25% to 16.50%.  Consensus Forecast panellists anticipate that inflation will decline further throughout this year to 4.6%, which is unchanged from last month’s Consensus Forecast figure.  Next year, Consensus Forecast participants expect inflation to drop only moderately to 4.4%, which is below the Central Bank target of 4.5%.

Trade surplus narrows amid import growth surge

In the first quarter of this year, the trade balance registered a US$ 9.3 billion surplus, which was well below the US$ 12.1 billion surplus registered in the fourth quarter but exceeded the US$ 8.3 billion surplus observed in the first quarter of last year.  Both export and import growth remained in double-digit year-on-year growth territory.  However, import growth more than doubled to a 24.1% annual pace (Q4: +10.6% year-on-year), while the export expansion remained virtually unchanged at 20.2% (Q4: +20.6% yoy).  Robust double-digit growth in capital and durable consumer goods imports provided the lion share of the push to the healthy March reading.  Primary and manufactured good exports helped sustain the strong export growth pace.  As a result of the first quarter reading, the annual trade surplus reached US$ 45.8 billion, which was up from the US$ 44.8 billion surplus registered in the previous quarter.  This year, Consensus Forecast participants expect the trade surplus to narrow to reach US$ 39.2 billion amid healthy export growth.

Central Bank intervention and political events prompt currency weakening

In March, the exchange rate depreciated 1.71% in nominal terms to reach 2.17 reais to the US$, which contrasted the 3.57% appreciation registered in February.  The March figure represents the first weakening in the currency since December last year and constitutes an exception in a virtually uninterrupted appreciation trend observed since the end of 2004.  Despite the March depreciation, the currency is trading 22.7% stronger than during the same month last year.  The appreciation has continued virtually unabated despite Central Bank and government efforts to weaken the exchange rate.  In March, monetary authorities purchased US$ 3.1 billion on the spot foreign exchange market, bringing the total amount purchased this year to US$ 7.9 billion.  In March, active Central Bank intervention raised international reserves by US$ 2.4 billion – lifting the balance to US$ 59.8 billion.  However, apart from Central Bank intervention, political events affected the currency in March, as markets reacted to the resignation of Finance Minister Antonio Palocci.  The deterioration in the currency, however, appeared short-lived, as the exchange rate appreciated 1.5% by 7 April to reach 2.14 reais to the US$.  Consensus Forecast participants expect the current appreciation trend to reverse this year with the currency depreciating 5.6% from its current level to reach 2.27 reais to the US$ by year-end.  Next year, Consensus Forecast panelists expect the exchange rate to depreciate 4.3% to close at 2.37 reais to the US$.