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Growth decelerates amid
declining exports and moderated investments
In the second quarter,
gross domestic product (GDP) expanded a paltry 1.2% over the same quarter
last year, which is the lowest growth rate registered in the last three
quarters. The second quarter reading was below both the first quarter
3.3% growth (previously reported: +3.4% year-on-year) and market
expectations of a 2.0% expansion. Weaker domestic demand and declining
exports were behind the second quarter slowdown. On the domestic side of
the economy, investment growth registered a pronounced deceleration
(Q1 2006: +9.0% yoy; Q2
2006: +2.9% yoy); while private consumption accelerated slightly and
government consumption continued growing at virtually the same pace as in
the first quarter. Meanwhile, in the external sector, exports declined
for the first time since the third quarter of 2003, fuelling concerns
about the impact of the stronger currency on exports. Imports also
decelerated (Q1 2006: +15.9% yoy; Q2 2006: +12.1% yoy), but not
sufficiently to offset the impact of slower exports (Q1 2006: +9.3% yoy;
Q2 2006: -0.6% yoy).
On a sectoral basis,
all sectors, except for agriculture, decelerated compared to first quarter
figures. That said, the industrial sector accounted for the lion share of
the overall slowdown.
A
quarter-on-quarter comparison corroborates the deceleration suggested by
the annual figures. According to seasonally adjusted data, economic
activity grew 0.45% over the first quarter, which is the lowest growth
rate of the last three quarters.
Government
still optimistic despite second quarter deceleration
Since
August last year, the Central Bank has been easing monetary policy, trying
to create a more favourable backdrop for domestic demand. However, in
spite of the lower interest rates, investment decelerated sharply in the
second quarter. Moreover, as a result of the appreciation of the
currency, the volume of exports declined in the second quarter for the
first time since the third quarter of 2003. The second quarter slowdown
in investment and exports is already affecting the labour market. In
July, the unemployment rate rose to 10.7% from 10.4% registered in June.
The July figure constitutes the highest unemployment level observed since
April last year. Higher unemployment levels could hamper private
consumption in the months ahead, which is the only component of GDP that
remains healthy. In spite of the less propitious developments, on 31
August, international credit agency Moody's Investors Service upgraded the
country’s long-term foreign currency rating from “Ba3“ to “Ba2”, two
levels below investment grade status. The agency stated that the country
has improved its ability to deal with adverse economic conditions thanks
to a diversified export structure. Moreover, lower interest rates and
external debt stocks have improved the government debt ratios. However,
if the government does not implement actions to curb the rising trend in
primary spending and to reduce the public debt even more, the upgrade to
investment grade will take some time. That said, the government has
proposed a 9.5% nominal increase in budget spending for next year
in order to finance higher public sector wages, health care as well as
road and ports projects. In July, the moving annual public sector deficit
had already reached 3.6% of GDP, which is the highest level of the last 3
months and is also above the full-year deficit of the last two years. The
government remains optimistic about this year’s outlook. On 4 September,
Deputy Finance Minister Bernard Appy stated that the economy will pick up
in the third quarter and that a 4.0% growth is still possible this year.
Consensus Forecast participants do not share the government’s optimism and
expect the economy to rebound in the third quarter but to grow only 3.5%
for the full-year, which is down 0.1 percentage points from last month’s
figure. Next year, the pace of economic activity should accelerate
somewhat with growth reaching 3.6%, which is unchanged from last month’s
estimate.
Lula
continues leading opinion polls less than one month prior to the elections
Presidential and parliamentary elections will take place on 1 October.
Recent surveys show that President Luiz Inácio Lula da Silva continues to
lead in polls. According to a survey conducted from 4-5 September by
pollster company Datafolha, support for Lula increased 1 percentage
point to 51%. Simultaneously, support for the main opposition candidate,
Geraldo Alckmin, from the Social Democracy Party (PSDB, Partido da
Social Democracia Brasileira) remained at 28% of the votes, widening
the gap to the front running president. In contrast, candidate Heloísa
Helena from the left-leaning Socialism and Freedom Party (P-SOL,
Partido Socialismo e Liberdade) lost 1 percentage point in September,
to 9%. According to Datafolha, considering these results, Lula
would win the election with 57% of the valid votes, with no need to go to
a run-off election.
Central Bank cuts interest rates again as inflation reaches lowest level
in seven years
In August, consumer prices increased 0.05%, which was down
from the 0.19% increase registered in July and well below market
expectations of 0.20%. Higher recreation, healthcare and housing prices
were almost offset by declining transportation, communication and
household equipment prices. As a result of the subdued August price rise,
annual headline inflation dropped from 4.0% in July to 3.8%, continuing a
downward trend that has been in place since May last year, with only
temporary interruptions. In fact, the August inflation rate constitutes
the lowest inflation level registered since June 1999. Consequently,
annual inflation remains below the 4.5% Central Bank target for this year
but within the ±2.5% tolerance margin. As a result of the favourable
price developments observed in recent months, the Central Bank continued
to loosen monetary policy. On 30 August, the Central Bank lowered the
benchmark SELIC interest rate for the tenth consecutive time from 14.75%
to 14.25%, the lowest rate in 20 years. Moreover, given the benign
inflationary environment, monetary authorities are likely to continue to
loosen the reins. Consensus Forecast participants expect inflation to
reach 3.9% by the end of the year, which is down 0.2 percentage points
from last month’s forecast figure. Next year, inflation is likely to
accelerate, as Consensus Forecast participants expect consumer prices to
rise 4.4%, which is unchanged from last month’s figure.
Currency resumes
appreciating trend
In August, the exchange
rate appreciated 1.75% in nominal terms to reach 2.14 reais to the
US$. The August strengthening contrasted with the 0.55% depreciation
observed in July and resumes the virtually uninterrupted appreciating
trend set in place since the end of 2004. As a result of the August
developments, the currency is now trading 10.5% stronger than in August
last year, compared to the 9.8% year-on-year appreciation observed in July.
The Central Bank has continually intervened
in foreign
exchange markets to weaken the currency. Moreover, on 26 July, Finance
Minister Guido
Mantega announced a change to the current exchange rate regime. Exporters
are now allowed to keep 30% of their export earnings abroad. Companies
had been required to repatriate US$ earned through exports and convert
them into reais no later than 210 days following export. The
measure is not intended to weaken the currency, but rather to
lessen its appreciation. Markets had expected a more significant change
in foreign exchange rules. In June, President Luiz Inacio Lula da Silva
had announced that, if re-elected in October, the government will strive
to weaken the currency by further tweaking foreign currency market rules.
Consensus Forecast participants expect the currency to depreciate to 2.23
reais to the US$ by year-end, which would reduce the annual
appreciation from the current 10.5% to 5.1% by the end of the year. Next
year, Consensus Forecast panelists expect the exchange rate to depreciate
3.6% to close at 2.31 reais to the US$. |
