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Economic Outlook Macro Research – Itaú Unibanco October 2013 Agenda International Five years after the financial crisis, the advanced economies are starting to grow again. The euro zone is out of recession. While developed countries improve, emerging markets are still facing deceleration. Growth in China has stabilized. Growth recovery in the U.S. means higher interest rates and a stronger dollar. Tapering postponement brings a relief for emergent markets in the short term. Fiscal debate is likely to be a temporary noise. Brazil Growth around 2% in this year and the next. Monetary policy in the U.S. and Central Bank interventions appreciate the BRL and bring a temporary relief to the exchange rate. Weaker price increases in the last months and less depreciated exchange rate bring our IPCA projection down to 5.9%. Inflation is still a source of concern for the Copom, but we maintain our Selic rate forecast at 9.75%. Fiscal policy remains expansionary, but there is limited room for additional stimuli. 2 U.S. Labor Market Improves, Despite the Fiscal Drag Payroll – Job Creation thousands Fiscal Drag Annualized, p.p. of GDP forecast 3,5% 2,8% 3,0% 2,5% 2,5% 2,5% 1,8% 2,0% 1,5% 1,5% 1,0% 0,5% 0,3% 0,0% -0,5% -1,0% -0,8% -0,8% -1,5% -1,3% -1,7% -2,0% -2,5% 2010 12-month moving average 2011 2012 Fiscal adjustment 2013 2014 GDP growth * Structural blance adjustjment (expenditure cuts + higher taxes) Source: Itaú Unibanco, BLS, Bloomberg, Haver Analytics, IMF 3 The Fed Signals Stimuli Reduction: Impact on the Emerging Markets Exchange Rates % change, May-to-date 5-year Nominal Rates p.p. change, May-to-Date US 0,8 1,2 7.2 Chile Colombia 0,6 9.8 Mexico 3,8 0,7 1,6 6.4 Colombia Peru Brazil 1,0 5,1 Peru 1,8 1,4 9.7 2,1 2,3 3,0 Current Prices Source: Itaú Unibanco, Bloomberg Mexico 8,0 22.2 10,0 5,9 Chile Brazil Maximum change 4 Europe: End of Recession, After Six Quarters of Contraction The euro-zone growth prospects remain positive. Indicators show a positive trend, reinforcing the confidence that the region has resumed growth, but at a moderate pace. Euro zone composite PMI Euro zone GDP QoQ change, seasonally adjusted 60 1,0% 0,5% 0,29% 55 0,0% 50 -0,5% 45 -1,0% 40 -1,5% -2,0% 2008 2009 2010 Source: Itaú Unibanco, Bloomber, Haver Analitics, IMF 2011 2012 2013 35 2007 2008 2009 2010 2011 2012 2013 5 China: Smaller Growth but no Hard Landing Policy signaling reflects less concern about short-term growth and more focus on structural reforms that can lead to sustainable growth. Government’s recent actions aim to avoid GDP growth volatility in the short-term. GDP – YoY Growth, % 15,0% 12,5% 10,0% 7,5% 5,0% 2007 Source: Itaú Unibanco, CEIC 2008 2009 2010 2011 2012 2013 2014 6 World: What Do We Expect for the Next Years? 2004-2007 2012 2013 2014 2015-2020 World 5.1 3.2 2.8 3.3 3.5 USA 2.9 2.8 1.5 2.5 2.5 Euro zone 2.5 -0.6 -0.3 0.9 1.4 Japan 1.9 2.0 1.9 1.4 1.0 China 12.1 7.8 7.7 7.3 6.8 Source: Itaú Unibanco, Haver Analytics 7 Commodities: Our Expectations for the Short Term Itaú Commodities Index 150 137,2 134,4 130 120,2 119,4 108,5 110 106,4 100,6 99,2 104,4 90 91,0 70 71,7 61,8 50 49,4 30 2004 Source: Itaú Unibanco 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 8 Deceleration in Latin America GDP – Growth, % 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% Argentina Chile Colombia 2010 Source: Itaú Unibanco, Haver Analytics 2011 Mexico 2012 Peru Brazil 2013 9 Slowdown of Economic Activity and Low Inflation Lead to Cuts in Interest Rates Peru Mexico 2013 2014 2013 2014 GDP - % 5.0 5.2 GDP - % 1.3 3.6 PEN / USD (YE) 2.70 2.80 PEN / USD (YE) 12.8 12.0 Int. Rate - (YE) - % 4.25 4.25 Int. Rate - (YE) - % 3.75 3.75 CPI - % 3.1 2.5 CPI - % 3.6 3.5 2013 2014 GDP - % 4.2 4.4 Colombia Chile 2013 2014 3.8 4.2 PEN / USD (YE) 1880 1900 PEN / USD (YE) 500 525 Int. Rate - (YE) - % 3.00 3.00 Int. Rate - (YE) - % 4.50 4.00 CPI - % 2.5 2.9 CPI - % 2.2 2.6 2013 2014 GDP - % 2.0 0.0 ARS / USD (YE) 6.1 8.2 BADLAR - (YE) - % 21.0 25.0 CPI - % (Priv. estimates) 28.0 35.0 GDP - % Argentina Source: Itaú Unibanco 10 Brazil: What do We Expect for the Short Term? 2012 2013 2014 0.9 2.3 1.7 5.8 5.9 6.0 7.25 9.75 9.75 2.4 1.7 1.1 Exchange Rate (eop) 2.08 2.35 2.55 Current Account (% GDP) -2.4 -3.6 -2.7 Economic Activity GDP % Inflation IPCA % Monetary Policy Selic Rate % Fiscal Primary Surplus (% GDP) Balance of Payments Source: Itaú Unibanco, BCB 11 Moderate Growth Ahead GDP (% Change) GDP (% Change, QoQ/as) (Seasonally Adjusted) 8% 2,0% 7,5% 7% 6,1% 6% 1,5% 1,5% 5,7% 5,2% 5% 1,0% 4,0% 4% 3,2% 0,6% 2,7% 3% 2,3% 0,6% 0,5% 0,5% 1,7% 2% 1,1% 0,9% 1% 0,0% 0% -0,3% -1% 2003 2005 Source: Itaú Unibanco, BCB 2007 2009 2011 2013 -0,5% 2010 Q1 2011 Q1 2012 Q1 2013 Q1 -0,5% 2014 Q1 12 Confidence Deterioration, but the Worst Is Past Index Selected Components Confidence Indexes Hard to get a job 160 140 Demand for capital goods 130 140 120 120 110 100 100 80 Services 90 Industry 60 Consumer 80 40 70 2008 2009 Source: Itaú Unibanco, FGV 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 13 Diffusion Points to Weak GDP Growth Ahead Broad Data Set - Diffusion GDP vs. Diffusion Index 75% 10% 90% 8% 80% 6% 70% 4% 60% 2% 50% 0% 40% -2% 30% -4% 20% 2009 65% 55% 45% 35% 1995 1998 2001 2004 Data diffusion (-2) Source: Itaú Unibanco 2007 2010 2013 GDP 4Q (RHS) month 2010 2011 3MMA 2012 2013 historical average 14 Jobs Creation Slowing Down, Wages Still Rising Offered Nominal Wages – New Jobs (Fipe/Catho) annual change Occupied Population annual change 25% 9% 8% 20% 7% 6% 15% 5% 4% 10% 3% 7,5% 2% 5% 1% 0% 0% -1% -2% 2005 -5% 2007 2009 2011 2013 2011 2012 2013 Caged Source: Itaú Unibanco, Ministério do Trabalho e Emprego, Fipe/Catho 15 Moderate Growth of Wages and Consumption Ahead Retail Sales Real Wages Bill 180 130 170 120 160 110 150 100 140 90 Annual Change 130 2011 120 110 100 2006 2008 2010 2012 4.8% 2012 6.3% 2013 2.2% 2014 2.4% 2015 2.8% 2016 3.2% 2014 2016 Source: Itaú Unibanco, Ministério do Trabalho e Emprego, Fipe/Catho Annual Change 80 70 60 2006 2008 2010 2012 2011 6.6% 2012 8.4% 2013 3.3% 2014 2.8% 2015 3.1% 2016 2.5% 2014 2016 16 After Temporary Relief, Pressure on Inflation Is Likely to Return in the Next Months IPCA – Consumer Price Index Monthly 12-month 0,90% 7,0% 0,75% 6,5% 0,60% 6,0% 0,45% 5,5% 0,30% 5,0% 0,15% 0,00% 4,5% Jan-12 Apr-12 Jul-12 Oct-12 Monthly Source: Itaú Unibanco , IBGE Jan-13 Apr-13 Jul-13 Jan/13 0.86% 6.2% Feb/13 0.60% 6.3% Mar/13 0.47% 6.6% Apr/13 0.55% 6.5% May/13 0.37% 6.5% Jun/13 0.26% 6.7% Jul/13 0.03% 6.3% Aug/13 0.24% 6.1% Sep/13 0.35% 5.9% Oct/13 0.53% 5.8% Nov/13 0.71% 5.9% Dec/13 0.78% 5.9% Oct-13 12-month (rhs) 17 What Is the Exchange-Rate Impact on Inflation? Exchange Rate Pass-Through Simulations BRL = Base Case 10% deval. 20% deval. Recent sample models (2004-13) Pass-through: 8% IPCA 2013 5.9% 6.1% 6.2% IPCA 2014 6.0% 6.7% 7.4% Full sample models (2001-13) Pass-through: 11% Source: Itaú Unibanco IPCA 2013 5.9% 6.2% 6.4% IPCA 2014 6.2% 7.2% 8.2% 18 Intervention on the BRL due to Impact on Inflation Exchange Rate BCB Position in Swaps (in billions of dollars) 20 10 0 -10 -20 -30 -40 -50 -60 2011 Source: Itaú Unibanco, BCB 2012 2013 19 What Is the Equilibrium Exchange Rate? Three Different Views Equilibrium 1: Purchasing power parity (PPP): with competitive markets and no transportation costs or other kinds of friction, homogeneous goods should trade at the same price in all countries. Equilibrium rate = BRL 2.63 (Big Mac Index); BRL 3.02 (average real exchange rate 1982-2012). Equilibrium 2: “Current rate”: assumes that the exchange rate reacts to several cyclical variables (net external liabilities, CDS, terms of trade). Equilibrium rate = BRL 2.24. Equilibrium 3: Current-account equilibrium approach: exchange rate clears savings and investment market. Equilibrium rate = BRL 2.30 (assuming external financing = 1.5% of GDP). Equilibrium Exchange Rate (BRL/USD) Source: Itaú Unibanco Big Mac Index 2.63 PPP (average real exchange rate) 3.02 “Current rate” 2.24 Current account equilibrium (1.5% of GDP) 2.30 20 More Depreciated Exchange Rate Reduces the CurrentAccount Deficit Current Account (% of GDP) 3% 2% 1% 0% -1% -1,5% -2% -3% -4% -5% 2000 2002 Source: Itaú Unibanco, BCB 2004 2006 2008 2010 2012 2014 2016 2018 2020 21 Less Room for Counter-Cyclical Monetary Policy… Yield-Curve Pricing of Selic Rate Correlation Between Exchange Rate and Prefixed Market Interest Rates 1,0 14% 0,89 0,8 13% 0,6 12% 11,6% 0,4 0,2 11% 0,0 10% 9,75% -0,2 9% -0,4 8% -0,6 -0,34 -0,85 -0,8 7% -0,93 -1,0 6% 2008 2010 2011 2013 2014 -1,2 2010 2011 2012 2013 Projeção Itaú Unibanco Itaú Unibanco forecast Apreçamento da SELIC implícito na curva de DI futuro Yield curve pricing Source: Itaú Unibanco, Bloomberg 22 …and Counter-Cyclical Fiscal Policy Primary Surplus - % GDP Net Debt - % GDP 3,5 40 39,1 3,1 3,0 38 2,7 2,5 36,4 2,4 36 35,2 35,1 34,7 2,0 1,7 34 1,5 1,1 32 1,0 0,5 30 2010 Source: Itaú Unibanco, BCB 2011 2012 2013 2014 2010 2011 2012 2013 2014 23 Brazil Needs to Become More Competitive Competitiveness Ranking (World Economic Forum, 2013) Switzerland Singapore Finland China Chile Turkey South Africa Mexico Brazil India Peru Russia Argentina Venezuela Chade Source: World Economic Forum 1 2 3 29 34 44 53 55 56 60 61 64 104 134 148 24 Prices in Brazil Are High Currency Appreciation (+) or Depreciation (-) Measures Prices relative to the U.S. (PPP) in 2012 Emerging Effective real exchange Big Mac Index rate (against 04-11 average) (nominal exchange rate vs. Jul/2013 PPP) Jul/2013 South Africa -34.0% -14.9% -60.0% South Korea -28.0% -7.6% -24.6% India -61.0% -7.2% -67.1% Mexico -33.0% -2.0% -37.3% Chile -16.0% 4.4% -13.6% Brazil 2.0% 4.6% 16.0% Colombia -27.0% 13.7% -1.8% Russia -20.0% 16.5% -42.0% China -34.0% 26.0% -42.8% Japan 29.0% -18.3% -29.8% United Kingdom 4.0% -11.3% -11.8% Euro zone 9.0% -6.8% 2.3% Australia 59.0% 7.6% 1.4% Developed Source: Itaú Unibanco, FMI, The Economist, BIS 25 High Costs Relative to Productivity Level Wages thousand U.S. dollars per year Wages + Labor Benefits thousand U.S. dollars per year current prices current prices India India 2012 prices 2012 prices China China Mexico Mexico Russia Russia Brazil Brazil 0 10 20 0 30 Productivity, 2012 (% of U.S.) India China China Brazil Brazil Mexico Mexico Russia Russia 10% 20% Source: Itaú Unibanco, KPMG, FMI, Penn World Table 20 30 40 50 60 GDP Per Capita, 2012 (PPP) India 0% 10 30% 40% 0% 5% 10% 15% 20% 26 Where Does Brazil Need to Improve? Ranking: Ease of Doing Business (World Bank, 2012) Most Problematic Factors for Doing Business % of answers (World Economic Forum, 2013) Infrastructure Chile 19,7 37 Tax regulations Peru Colombia Mexico 43 45 16,8 Tax rates 15,1 Government bureaucracy 14,9 Labor regulations 48 11,7 Corruption Uruguay 7,3 89 Workforce quality Paraguay Argentina Brazil 103 124 130 Policy instability 2,7 Access to financing 2,6 Capacity to innovate Others Source: World Economic Forum 5,8 1,2 2,2 27 Challenges: Need for Better Infrastructure Overall Quality of Transportation Infrastructure Grading: 0 - 7 (World Economic Forum, 2013) 7 6 5 114th place, among 148 4 3 2 1 Source: Itaú Unibanco, World Economic Forum 28 Challenges: Heavy Tax Burden Tax Burden – % of GDP 60% 50% 40% 34% 30% 20% 10% 0% Source: Itaú Unibanco, Heritage Foundation 29 Challenges: Public Expediture Needs to Be more Efficient Public Expenditure Quality Rate from 0 to 7 (World Economic Forum, 2013) Tax Burden vs. Expenditure Quality (World Economic Forum, 2013) Total tax burden, % of profits 100% 6 90% 80% 5 Brazil 70% 60% 4 50% 132nd place, among148 3 40% 30% 20% 2 10% 0% Singapore Switzerland Chile Canada China Panama Japan Australia USA South Africa South Korea Mexico India Peru Russia Colombia Angola Brazil Argentina Venezuela 1 Source: Itaú Unibanco, World Economic Forum 1 2 3 4 5 Public expenditure quality, rate from 0 to 7 30 Challenges: PISA Scores in Brazil Are Below Average PISA 2009 – Average Test Score (math, science, reading) 550 500 496 450 408 400 350 Source: Itaú Unibanco, OECD, Hanushek & Woessmann (2010) 31 Challenges: Less Labor, Need More Investment Labor contribution decreases in the years to come. Growth depends on increasing investments and productivity. GDP Growth Decreasing Labor Contribution 8% 2,0% Labor Capital Productivity 7% 1,5% 6% 5% 4% 1,0% 2,7% 3% 2,3% 2% 0,5% 1,7% 0,9% 1% 0% 0,0% 2010 2012 Source: IBGE, Itaú Unibanco 2014 2016 2018 2020 2008-2011 2012-2015 2016-2020 32 Challenges: Lack of Domestic Savings Public Spending on Social Security Source: Itaú Unibanco, IBGE 33 Source: Itaú Unibanco, UNCTAD South Korea Germany Poland Israel Chile Mexico UK Canada France South Africa Turkey India China Russia Peru Indonesia Venezuela Colombia Brazil Challenges: Market Openess Sum of imports and exports (%GDP) 120 100 80 60 40 20 0 34 Opportunities: Infrastructure Auctions, an Important Step Total estimated investments: around USD 100 billion Investment values Characteristics Follow up BRL 42 billion • Auction through lowest toll fee • Concession term of 25 years • Subsided credit (BNDES + CEF): 25 years (5 years grace period) at TJLP + 2% p.a. (currently representing 7% p.a.) • Real unleveraged IRR of up to 7.2% (with the highest allowed toll fee) • Equity support by public banks or pension funds • Two highways (BR-050 and BR-2562) already auctioned. • BR-262 without bids • 3 further highways to be auctioned in 2013 Railways • 10 Railroads • 12,000 km BRL 91 billion • Operator sells 100% of transport capacity to Valec (EBF, state-owned company), which manages transport fees to final costumer • Concession term of 30 years • Subsided credit (BNDES + CEF), 30 years (5 y grace period) at TJLP+ 1% p.a. • Real unleveraged IRR of up to 8.5% (subject to changes) • Equity support by public banks or pension funds • Guidelines (“Edital”) still under evaluation of TCU (Federal Court of Auditors) • Auctions should begin in early 2014 Airports • Galeão (RJ) • Confins (MG) • Regional Airports BRL 18.6 billion (for Galeão and Confins) • Auction winner subscribes 51% of equity into SPE. 49% is subscribed by Infraero (public airport manager) • Concession term of 25 years • Unleveraged real IRR of up to 6.63% • Financing of about 14 years (2 years grace period) at about TJLP + 1.5% p.a. • Auctions scheduled for November, 22 Ports • 16 states • First tranch in Santos and Pará BRL 54.7 billion • Concession either through lowest tariff or highest investment • 25-year term, renewable once • Uncertainties regarding the details of this program. Auctions should begin in 2014 High-speed train • Rio to Campinas (through São Paulo) BRL 35.7 billion • • • • Concession Highways • 9 Federal Highways • 7,500 km Source: Itaú Unibanco Conditions subject to change 40-year term, not renewable Real unleveraged IRR of 7.0% Government to bear occasional losses, if they exist • Auction postponed for late 2014 35 Conclusion World: Prospect of recovery in the U.S. and higher interest rate hikes hasn’t changed (despite the recent postponement). Brazil: Fundamentals point to a growth around 2% in 2013 and 2014. Equilibrium exchange rate is around its current values; in PPP it is more depreciated. Short term pressure may come back. Given moderate growth and recent stability in the exchange rate, we maintain our expectation of a hike in the benchmark rate to 9.75% by year-end. Long-term growth depends on investments, infrastructure, education and bureaucracy reduction, among others. 36 Long-Term Scenario Source: Itaú Unibanco 37 Our Economic Analysis Online 38