By- Udit Kumar & Rutuja Morankar
Brazil went into a recession, in 2014. During the early part of this phase, incidence of high inflation, capital outflows and unsustainable fiscal deficit tied its government’s hands in dealing with the recession. More recently, fall in inflation has enabled its Central Bank to reduce interest rates and some of the economic data are suggesting that the economy may be emerging out of the woods. However, structural challenges and political uncertainty are likely to cast a shadow on Brazil’s recovery.
The GDP declined by 3.8% (YoY) in 2015 and 3.6% in 2016. In Q1 2017, the GDP expanded by 1.1% (QoQ), after recording negative growth for eight consecutive quarters. (On an annualised basis, GDP fell 0.4% in the same period compared to a decline of 2.5% in Q4 2016). The IMF downgraded the growth forecast for Brazil following subdued activity in the last quarter of 2016 and emerging political uncertainty. According to its latest outlook, the economy is expected to grow by 0.2% in 2017, compared to the earlier forecast of 0.5%. Brazil—an export oriented economy—went into a recession in 2014 following a decline in non-energy commodity prices such as iron ore and sugar. Prior to the recession, Brazil received huge capital inflows which supported the Real’s appreciation, making exports less competitive. While the expansionary monetary policy led to a historically low interest rate of 7.25% in October 2012, expansionary fiscal policy led to a sharp increase in fiscal deficit.
In 2013, the Fed’s move to reduce liquidity resulted in capital outflows from Brazil. Even though there were signs of recession, monetary and fiscal policies were tightened to restrict capital outflows. This resulted in Brazil’s central bank raising the interest rate to a high of 14.25% by mid-2015. The rise in interest rates raised the gross public debt to historically high levels (63% of GDP). In late 2016, the Central bank of Brazil started gradually reducing the benchmark Selic interest rate—with the latest cut in May 2017—to rejuvenate the economy. The bank has reduced interest rate by 400 bps since October 2016 to 10.25% till date. A steady decline in inflation is expected to pave the way for further rate cuts.
The headline inflation continued to decline and fell from a 12-year high of 10.7% in January 2016 (YoY) to a 10-year low of 3.6% in May 2017—due to weak consumer demand and declining food prices. This is below the central bank’s official mid-point target of 4.5% (There is some flexibility, with a margin of 1.5%). Meanwhile, core inflation, which excludes food and energy, is also on a downward trajectory sliding to 5% in April 2017 from an average of 7.6% in 2016. The Central bank has projected the headline inflation to average around 4.1% in 2017 and move up to 4.5% in 2018. Unemployment rate which accelerated sharply to a record high of 13.6% in May 2017, continues to plague the economy. Industrial production recorded negative growth since early 2014 till the end of 2016. Output recovered briefly in the beginning of 2017 but went back into the negative territory in April 2017. The latest decline was led by a downturn in key sectors such as automobiles, pharmaceuticals and oil refineries.
However, select growth indicators are showing signs of reversal in trend. The manufacturing sector PMI expanded for the second consecutive month to the highest level since February 2013 to 52.0 in May 2017, suggesting further improvement.
Trade balance has remained largely positive in the last five years. There has been steady decline in Brazilian exports from pre-crisis level of $242 bn in 2013 to $185 bn in 2016, due to slow economic growth. In the same period, imports fell gradually from $240 bn to $137 bn. Brazil’s primary exports include Iron ore and Soybean. During the same period, Iron Ore exports were hit due to weak prices. While minor decline was also evident in Soybean exports.
Despite a decline in the trade activity, things seem to be turning around for both exports and imports in 2017. A bumper harvest is expected to boost agricultural production and exports. Brazil recorded a trade surplus of $7.7 bn in May 2017—highest monthly surplus since 1989. Reflecting the recovery, the total balance in the first five months of 2017 amounting to $29 bn is the highest in history for the period. Brazilian Real has remained fairly range-bound since the start of the year till date. However, the currency depreciated by 9% following the corruption charges on President Michel Temer.
In the same period, Brazilian financial and bond markets also reacted strongly. Brazil’s Bovespa stock index declined by 10% to 61597 in over two days—its biggest decline since the 2008. Meanwhile, the 10-year government bonds yields rose by 185 bps to 11.77. The Brazilian government has approved an austerity measure to cap public spending to the rate of inflation for 20 years along with social security reforms to gradually reduce Brazil’s high budget deficit—at $49.6 bn in 2016. Spending cuts will be largely on social and welfare services. The pension expenditures are seen as a burden on government finances. Structural problems continue to pose challenges to growth in Brazil. The uncertainty surrounding the President’s political future coupled with opposition from the masses could paralyse Brazil’s ongoing effort to enact fiscal reforms. It would be crucial for Brazil to address the inherent structural issues in order to bring the economy back on track.