Brazil: economy slowing to regain balance?
Published 6 June 2014
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0.1 Detail
In 2011 and 2012 the Government stimulated demand through expansionary fiscal policy and simultaneously relaxed monetary policy. Tax incentives were focused on consumption of consumer durables and cars. The SELIC interest rate was cut from 12.5% in August 2011 to 7.25% in October 2012, when, with inflation at over 5%, the real interest rate reached a historic low of 1.8%.
Supply did not respond as hoped, instead inflation rose, aggravated by weather-related food price inflation shocks. Unemployment in economically (and politically) important regions fell to historic lows and real wages rose rapidly. Key logistic bottlenecks remained though some progress is being made in addressing these. The Government introduced no major reforms to reduce the costs of tax compliance and navigating bureaucracy.
The Government reduced inflation pressure in part by holding down regulated prices throughout 2012 and 2013. However, that temporary salve imposed losses in the oil and gas and electricity sectors, which have since cut planned investment in oil refining and electricity generation. Regulated prices will have to rise. However, to keep below the 6.5% upper inflation target band, inflation in non-regulated prices must fall.
As a result, in April 2013, the Central Bank began to tighten monetary policy to tackle inflation. Nine interest rate increases from 7.25% to 11% are now curbing demand growth. Inflation should moderate as a result. Credit growth in April 2014 fell to its lowest level since 2007. Households and firms are cutting saving (very low at 13.7% of GDP in Q1), and now spending less, to pay off loans. Encouragingly, loan defaults are falling.
Consumer purchasing power is not only being squeezed by rising interest payments but also by higher prices. In the first half of 2013 inflation rose from 6% in to 6.7% and consumer spending grew only very slowly. However, as inflation slowed to 5.6% by January 2014 consumer spending picked up smartly (growing 0.8% in Q3 and 0.9% in Q4). In 2014, however, inflation again increased to 6.3% in April, as food prices rose, and consumer spending declined.
At its 28 May meeting, the Central Bank paused the cycle of interest rate rises. This was a unanimous decision. But, if inflation does not moderate, the Bank indicated they are ready to act. The pause responds to the fact that a) consumer demand has fallen and b) the full effects of the past rate rises will be felt only in the months ahead.
Lack of demand and higher interest rates have also had knock on effects. Investment fell in Q1 (-2.1%) as did industrial output (-0.8%). Supply is now outstripping demand for new cars and trucks. Tax breaks on buying new cars crowded car purchases into previous years and demand is slacker now. In addition, BNDES, the vast state development bank, raised the interest rates it charges on loans to buy new machinery.
That monetary policy is reducing demand is good news. Lower inflation, and a better balance between demand and supply, should lead to more sustainable economic growth in Brazil, from which the UK can benefit. The price to pay is lower growth now. In other positive news, the agriculture sector, an area of expanding commercial opportunity for the UK, continued to outperform both industry and services. It grew by 3.6% in Q1. Also 2013 growth, at 2.5%, was stronger than the previous 2.3% estimate.
Despite lower near term growth, Brazil’s challenges are our opportunity. A new government, of whatever hue, must match future demand growth with tricky structural reforms to boost supply. Our Business Environment Campaign is focused on tax and trade reforms to cut costs and increase competition. Education and infrastructure investment in Brazil will grow and boost supply, hence our Campaign and HVO in Infrastructure and our Campaign in Education. We aim to contribute to the supply side reforms that will increase Brazil’s growth trajectory.
0.2 Disclaimer
The purpose of the FCO Country Update(s) for Business (”the Report”) prepared by UK Trade & Investment (UKTI) is to provide information and related comment to help recipients form their own judgments about making business decisions as to whether to invest or operate in a particular country. The Report’s contents were believed (at the time that the Report was prepared) to be reliable, but no representations or warranties, express or implied, are made or given by UKTI or its parent Departments (the Foreign and Commonwealth Office (FCO) and the Department for Business, Innovation and Skills (BIS)) as to the accuracy of the Report, its completeness or its suitability for any purpose. In particular, none of the Report’s contents should be construed as advice or solicitation to purchase or sell securities, commodities or any other form of financial instrument. No liability is accepted by UKTI, the FCO or BIS for any loss or damage (whether consequential or otherwise) which may arise out of or in connection with the Report.