Rapid-Growth Markets Forecast: October 2013

Brazil: buffeted by inflation and high interest rates

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The combination of a weaker exchange rate and the prospect of higher inflation have prompted Brazil’s monetary authorities to adopt a more aggressive response.

The outlook for Brazil is for relatively sluggish expansion.

The Brazilian real (BRL) has fallen more than 9% since the start of the year. The depreciating currency may generate some inflationary pressure and fuel the need for higher interest rates.

Although this may have an impact on growth, it must be taken into consideration that, in the past 10 years, Brazil grew significantly despite high interest rates.

One of the reasons why growth can be maintained in these conditions is that financing for investments is widely available at subsidized interest rates at the Brazilian Development Bank (BNDES).

However, some business investments could be affected because the price of imported capital goods may increase. On the positive side, a weaker exchange rate should start to make Brazilian firms more competitive. This may counteract the slowdown in consumption, but a significant boost to trade should not be expected.

A number of structural problems also need to be addressed, but with elections due by next October, the Government’s focus is likely to remain on the short term.

Brazil: exchange rate

EY – RGMF: Brazil exchange rate

Source: Haver Analytics.

Structural problems need to be addressed

Labor productivity in Brazil (GDP per worker) has grown by an average of only 1% a year for the past 15 years, compared with 1.6% in the US. Yet, despite the subdued pace of economic activity in the last two years, the jobless rate has remained close to all-time lows.

This is partly because Brazilian labor laws make it expensive to fire workers. Reforms to enhance productivity would, therefore, be more likely to promote an upturn in growth.

In addition to labor laws, businesses face obstacles such as:

  • High and complex taxes
  • Poor infrastructure
  • Excessive bureaucracy

These difficulties are so longstanding that they have their own name — the custo Brasil — or ‘Brazil cost.’ We believe that these structural factors are a key reason why manufacturing investment was so weak in 2012, despite record-low real interest rates.

Pace of reform remains slow

Consumer spending has benefited from helpful labor market conditions and better access to credit. But a prolonged period of an uncompetitive exchange rate and industrial inflexibility pushed much of this demand into imports, while local manufacturing stagnated. It will take some time for a more competitive BRL to reverse this.

The economic environment could be improved if the authorities were to implement reforms. Some changes have been made, but the Government’s current focus is on short-term adjustments to boost demand.

Medium-term outlook constrained

We expect:

  • The current account deficit to reduce somewhat in the medium term, as world demand picks up and the effects of the depreciation make Brazilian exports cheaper.
  • The real to trade between 2.20 and 2.40 to the US dollar in the final months of 2013, and at around 2.40 next year, in the run-up to the October presidential elections.
  • The CPI inflation to average 6.1% in 2014, well above the central bank’s official target of 4.5%. The weaker currency will increase the price of imports and raise inflation.
  • Annual GDP growth at just 3.2% for the next four years.

Brazil: private consumption

EY – RGMF: Brazil private consumption

Source: Oxford Economics.