Download Brazil Outlook 2008

Brazil Outlook 2008
“The economy is prepared to withstand the storm.”
By Alfredo Coutino, Senior Economist, Latin America
Moody’s Economy.com. West Chester, PA, USA.
April 24, 2008

The Brazilian economy continues to advance, with no signs of
deceleration yet.

An unnecessary monetary tightening was prompted by a
harmless inflation rebound.

The economy will moderate, but will be able to counteract the
external shock thanks to strong macroeconomics.
The Brazilian economy continues to accelerate, mainly stimulated by a
strong domestic market and dynamic exports of commodities. The
economic expansion is advancing in an environment of relatively
controlled prices. However, a mild inflation rebound has prompted an
unnecessary monetary tightening, which might have economic
implications ahead.
Brazilian financial markets remain among the most attractive to
foreign investors. In the foreign exchange market, the wider yield gap
is attracting more foreign investors, which, together with the
continuous flow of export revenues, keeps the Brazilian real
revaluating
The economy will be less subject to the negative effects of a U.S.
recession than will some countries. Brazil is less exposed to the
external shock because of its strong macroeconomic situation and
trade diversification. The economy will be able to counteract the
impact from abroad thanks to the strength of the domestic market.
Economic acceleration continues
Brazil's expansion accelerated at the end of last year, with the
economy posting its greatest growth in three years. The main propeller
was the domestic market, stimulated not only by a more relaxed
monetary policy but also by an improvement in employment and
controlled inflation. On the demand side, domestic absorption
continued to be stimulated by lower interest rates, flexible credit
conditions, and stable inflation. Consumption and investment were
also stimulated by the expansionary effects of capital inflows. Exports
of minerals and primary goods continued to benefit from favorable
conditions in the commodity market. On the production side, the
recovery was mainly supported by agriculture and services, followed
by industry. Thus, during the fourth quarter, GDP growth accelerated
to 6.2%, after 5.6% in the third quarter and 5.1% one year earlier.
During the whole year, the economy expanded at a rate of 5.4%,
compared with 3.8% in 2006.
Even during the first two months of this year, Brazilian industry
continued to expand at a solid pace. The economy keeps demanding
more production inputs, particularly capital and intermediate goods.
The production of consumption goods is supported by strong domestic
absorption, while investment is being stimulated by the private and
public sectors. Favorable credit conditions and lower interest rates are
propelling the consumption of durable goods. This way, Brazilian
industry continues to respond to the domestic market and also to the
still-positive external demand for manufactured goods. In February,
industrial production increased 9.7%, after 8.7% in January and only
3.0% one year before.
Inflationary panic in the central bank
Arguing the need to control a potential deterioration of expectations,
the Central Bank of Brazil tightened its monetary policy in April after a
timid inflation rebound. Since there is no real inflation problem, and
since monetary conditions were already restrictive, the central bank's
move seems to be in the wrong direction and designed only to
accommodate market pressures.
In the past few months, inflation has mildly increased, from 4.5% in
December to only 4.7% in March. The inflation rebound is practically
insignificant, particularly because inflation is still around the target of
4.5% and far below the upper limit established at 6.5%. This increase,
by itself, does not support the central bank’s decision.
Yet markets had been clamoring for a hike, fearing continuing,
demand-driven inflation. However, there is no excess demand in the
economy; on the contrary, there is excess supply. Therefore,
monetary policy will have no effect on this insignificant inflation
rebound. The monetary move not only introduces doubt and
uncertainty, it also indicates that the central bank got caught up in the
market’s unjustified panic. If the bank continues to hike rates, tighter
monetary conditions could have negative consequences for the
currency and external account, and even for economic growth.
Outlook
Despite the recessionary effects from the U.S., the Brazilian economy
will grow solidly this year, although activity will moderate because of
the slowdown in global demand. We continue to predict that the
economy will advance to a more sustainable growth path in the
medium term, mainly supported by the domestic market. The long-run
performance will depend on reforms, savings and investments. The
economy will grow at a speed consistent with its potential capacity in
order to preserve macroeconomic stability.
Even though the Southern Cone economy will be affected by the
external shock through trade and investment channels, the domestic
market will help compensate for the deceleration of external demand.
Since Brazilian trade is more diversified and its exports to the U.S.
represent only around 2.5% of its GDP, Brazil will likely be less
affected than in the past. Also, because the government will
strengthen domestic absorption through infrastructure and social
spending, the economy will be able not only to mitigate the impact
from abroad but also to expand solidly. Since Brazil enjoys a better
macroeconomic situation—fiscal and trade surpluses, record-high
international reserves, and stable inflation—the economy will be able
to weather the recessionary winds from the U.S.
This year’s growth will be based mostly on internal sources: private
consumption, investment and public spending. Government spending
is increasing according to the availability of fiscal revenues and without
incurring fiscal imbalances. Public investment in social programs and
infrastructure is also supporting the economy’s performance and
providing more social relief. Foreign resources will continue to
complement domestic investment, particularly in sectors related to
energy and other commodities. This will reinforce the economy’s
potential capacity in the medium term.
We expect GDP growth to moderate to 4.8% this year, after 5.4% last
year. Next year, we expect the economy to consolidate its growth
path, supported by additional economic reforms. GDP will grow by
5.2% in 2009, driven by domestic sources and complemented by stillpositive conditions in the commodity market.
No major inflation problems are expected in the short or medium term,
since monetary and fiscal discipline will be maintained. In fact, since
the economy will be growing around its potential rate, inflation will
stay close to the official target of 4.5% in the medium term. Despite
the recent monetary tightening, we expect interest rates to decline
later in the year and approach neutral. Particularly this year, the
economy will need to work without the monetary brake.
External accounts will benefit from commodities to a lesser degree,
given the expected moderation of international prices. As a result, the
trade surplus will continue to fall, inducing a gradual currency
correction and moving the Brazilian real toward a more competitive
position.
This commentary is produced by Moody's Economy.com, Inc. (MEDC), a subsidiary
of Moody's Corporation (MCO) engaged in economic research and analysis. MEDC's
commentary is independent and does not reflect the opinions of Moody's Investors
Service, Inc., the credit ratings agency which is also a subsidiary of MCO.
Moody's Economy.com (MEDC) is a subsidiary of Moody's Corporation, and is
headquartered in West Chester, Pennsylvania. MEDC is a leading independent
provider of economic, financial, country, and industry research.
Copyright © 2008 Moody's Economy.com, Inc.
Moody's Economy.com, 121 North Walnut Street, Suite 500, West Chester, PA 19380-3166