Download At a Glance – Outlook and key Brazil themes for 2014

At a Glance
Brazil – Outlook and key
themes for 2014
Italo Lombardi, Mike Moran
Brazil – Outlook and key themes for 2014
What happened to growth in Brazil?
3
Brazil’s growth outlook
11
Balance of payments to improve gradually
24
Inflation – Any relief?
27
Fiscal policy – A course adjustment?
29
Monetary policy – BCB on hold for now
32
FX – Positioning signals
35
2
What happened to growth in Brazil?
8
7
6
5
Average 4.2%
4
Average 2.7%
3
2
1
0
-1
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: Standard Chartered Research
3
What happened to growth? Short-term explanations
Exports of basic goods from Brazil to China are more than 35% currently from 5%
in the early 2000s:
 Brazil’s exposure to China’s growth has increased.
 China’s growth is down to 7.5-8.0% more recently, from 9.5-10% prior to 2011.
 Commodity prices are down by nearly 20% since their peak in 2011.
Latin America, Brazil’s second-largest export destination, is also highly exposed to
China:
 Chile and Peru are important exporters of metals.
 There are second-round effects.
 Argentina is the recipient of 20% of Brazil’s exports – 50% of Brazil’s manufactured
exports.
Monetary policy hikes in early 2011 led to a slowdown in investment.
There is a ‘Hangover effect’ from the fast pace of growth of 7.5% in 2010.
Source: Standard Chartered Research
4
What happened to growth? Long-term explanations
The 1994 stabilisation program may have succeeded.
In the 2000s, the economy seemed unable to grow for an extended period of time
without having an ‘inflation issue’.
Potential growth, productivity and competitiveness:




Regardless of growth performance, unemployment continued to trend lower.
Measures of labour productivity show a mismatch with real wage growth.
Total Factor Productivity (TFP) and the production function.
Potential growth and output gap.
Explanations:
 Lack of capital investment
 Low education level
 Need for a better tax code and labour laws, among many other things
Source: Standard Chartered Research
5
What happened to growth? Long-term explanations
Supply and demand mismatch
RS, IBC-Br and IP levels SA
210
Retail sales
Clearly, the services sector, measured by the
performance of retail sales, did much better than
the industrial sector
 Uneven demand for labour
 The role of the exchange rate
 Most productive labour lost leverage as the currency
190
appreciated
170
150
IBC-Br
Labour productivity by sector
%
15
130
Agriculture
10
IP
5
0
110
-5
Industry
-10
90
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Jan-13
-15
Mar-97
Mar-00
Mar-03
Mar-06
Mar-09
Services
Mar-12
Source: BCB, Standard Chartered Research
6
The labour market – A puzzling picture
Unemployment rate on a secular downward trend
IBGE UR seasonally adjusted
Employed population is decreasing
Total employed population (’000s)
14
23,500
13
23,000
12
22,500
11
10
22,000
9
21,500
8
7
21,000
6
20,500
5
4
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Mar-12
20,000
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Source: Standard Chartered Research
7
What happened to growth? Long-term explanations
TFP also collapsed over recent years
TFP versus labour productivity (y/y %)
Output gap already positive by our calculations
H-P versus production function output gap (%)
8%
8
6%
6
Labour
productivity
4%
2%
2
0%
0
-2%
-2
TFP production
function
-4%
-6%
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
Mar-09
Mar-11
Mar-13
Production
function gap
4
H-P filter gap
-4
-6
Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Mar-12
Mar-14
Source: Standard Chartered Research
8
What happened to growth? Long-term explanations
Potential growth is much lower than 5 years ago
Potential growth using production function
Potential growth of around 2.5% is a
concern for the monetary authority
3.6
3.4
 Any pick-up in growth could have implications
for inflation
3.2
 Economy overheats very easily
 Interest rates remain elevated
3.0
 High interest rates inhibit fixed investment
 A vicious cycle is established
2.8
2.6
2.4
2.2
2.0
Mar-01
Mar-03
Mar-05
Mar-07
Mar-09
Mar-11
Mar-13
Source: Standard Chartered Research
9
What happened to growth? Long-term explanations
Relative price of capital is stable in Brazil
Brazil vs. US relative price of fixed capital
110
100
Brazil
90
80
70
US
60
50
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Source: Standard Chartered Research
10
Growth outlook – Short term versus long term
Macroeconomic adjustment:







The adjustment is already in progress
Monetary policy adjustment initiated in April 2013
Fiscal adjustment has already started, but will be more gradual
We expect the current fiscal tightening to last through 2015
The dismal situation in Argentina will not help in the short term
Monetary and fiscal adjustments will be essential for a recovery in confidence
The next step (2015-18) will be a pick-up in investment, mainly driven by
infrastructure projects – PPP and concessions
 Stronger global growth will help in the transition
Source: Standard Chartered Research
11
Growth – Another year of poor performance
BCB’s Focus GDP growth median, max and min on April of each year versus actual
Historically, there have been plenty of GDP growth surprises; too early to call for a bad year? (%)
8
7.53
Actual
7
6.10
5.71
6
Mean (march)
5.17
5
4
Max.
3.96
3
2.66
2.73
3.16
2
1
1.31
2.28
Min.
1.15
1.80
1.03
0
-0.33
-1
-2
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: BCB, Standard Chartered Research
12
Brazil – FIFA World Cup 2014
 Studies show that, on average, economic growth in countries hosting big sports events
increases two years after the events. Out of 14 events, 9 resulted in higher growth following
the events.
 Irons (2006) shows that among EM countries, economic growth averages 3.1% in the two
years prior to the event, slows down to 1.3% on average in the year of the event, to
accelerate on average to 4.1% in the two years after the event.
 Hosting countries whose national teams win the event experience even greater acceleration
in economic growth.
 In Brazil, a total of BRL 22.7bn is expected to be invested in infrastructure for the World Cup.
This compares with c. BRL 30bn in Germany in 2006, and BRL 15bn in South Africa in 2010.
 Some of the intangible benefits: Increased interest in the country, increased tourism after the
event, improved quality of services, and improved domestic sentiment.
 Some of the intangible costs: Increased traffic, possible increased violence, and reduced
business/productive tourism.
Source: Standard Chartered Research
13
Brazil – The electricity sector under pressure
 Risk of electricity rationing is 24% (PSR estimate), gradually rising since early 2014. Risk is
mainly concentrated in the southeast and midwest systems, which are responsible for 70% of
the hydroelectric energy reserves  Thermoelectric plants running close to full capacity.
 First two months of 2014 were the hottest since 2002. Energy consumption jumped 11% y/y.
Q2 temperatures are expected to be much milder – consumption growth is expected to
decelerate to 4% y/y. The risk of actual rationing is small. Scattered official energy-saving
measures are more likely.
 Budget implications: The government needs to fund the Energy Distribution Companies
(EDC) to make up for the gap between prices paid and prices charged – essentially a
subsidy. In 2013 BRL 7.9bn was transferred. In 2014 the government announced BRL 13bn
in transfers – not enough. The EDC will issue BRL 8.0bn in debt – costs to be passed to
consumers starting in 2015.
 Currently consumers pay BRL 110/MWh, while wholesale prices are at BRL 800/MWh.
 Uncertainty on energy tariffs is likely to continue into 2015.
 Rio Madeira hydroelectric plants to significantly increase capacity in 2014-15.
Source: Standard Chartered Research
14
Presidential elections 2014 – More uncertainty
 Dilma Rousseff is currently well ahead in the polls. However, it is too early to draw
conclusions, five months before the start of the campaign: Fragile lead
 World Cup will attract a lot of attention. Social media makes it easy for large groups of
protesters to quickly organise and go to the streets – as in June 2013.
 Inflation remains high | Frustration with public services | Urban violence
 Participation of violent groups has frustrated those who favour peaceful protests
 Election risks for Rousseff are that she doubles up on interventionism, protectionism and less
orthodox measures.
 Other candidates are very well accepted by the business community. If anything, a victory by
Aécio Neves (PSDB) or Eduardo Campos (PSB) could result in a market rally.
 At this point 24% of voters have not yet decided.
 Lula does not want to come back now -> economy is doing badly and even he could lose.
Source: Standard Chartered Research
15
Growth – Private consumption to grow at a pace more consistent
with GDP and income growth
Real wage bill highly correlated with consumption
Private consumption to growth to stabilize in 2014
6%
Growth of private consumption and
fixed investment has been the base for
Brazil’s growth model over the past
decade:
4%
 Private consumption is the most important
10%
Wage bill
8%
component of demand (63% of GDP)
2%
Private
consumption
 Over the past three years, the growth of
private consumption has decelerated
gradually
0%
-2%
 We expect consumption to continue to be
an important source of growth
-4%
 However, household leverage has reached
-6%
a point where it is unlikely that consumption
will grow faster than GDP and income
growth
-8%
-10%
Mar-04
Mar-06
Mar-08
Mar-10
Mar-12
Mar-14
Source: Standard Chartered Research
16
Consumer confidence close to multi-year low
Consumer confidence index is the lowest since June 2009
From the peak in Apr-2012 the index has already fallen 20%
130
125
120
115
110
105
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Source: FGV, Standard Chartered Research
17
Growth – Investment likely to be flat in 2014
Fixed investment to be flat in 2014
Fixed investment vs. our model (level)
Elections and market volatility, among other
concerns, keep business confidence weak:
200
Fixed
investment
190
 Higher real interest rates and a weaker real
exchange rate may sideline investment in 2014.
 Despite the negative outlook for 2014, large
infrastructure projects are likely to boost
investment in 2015-18 – PPP and concessions
180
Model
estimates
170
2013
2014
Real interest rate (%)
2.2
4.5
Real exchange rate (level)
89.5
88.7
Business confidence (level)
54
54
Investment growth (%)
5.7
0.0
160
150
140
130
120
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Source: Standard Chartered Research
18
Growth – Government spending cuts to weigh on growth
Central government spending to grow much less
Government consumption vs. spending
6%
Central govt
spending
4%
20%
Fiscal tightening on course for 2014
 In the short term, fiscal tightening has a
negative impact on aggregate demand and
growth
10%
 The federal government announced a total
spending cut of BRL 44bn for 2014
2%
0%
Government
consumption,
LHS
0%
-10%
-2%
-20%
 Despite the uncertainties about fiscal figures
and market skepticism, the economy will
likely go through a fiscal adjustment
 Medium-term, fiscal adjustments have a
positive impact on growth, reducing inflation
risk and risk premium, and adjusting relative
prices distortions
 We think that the current fiscal adjustment is
gradual and will last through 2015
-4%
-30%
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14
Source: Standard Chartered Research
19
Growth – Net exports to help significantly in 2014
Net exports to improve significantly
Exports vs. imports, y/y
Weaker imports and stronger exports in 2014
 Net exports are expected to improve significantly in
40
2014:
 When production is weak and domestic demand
remains strong, imports fill in the gap
30
 In 2014 we expect both private and government
Imports
spending to moderate, as well as investment to
weaken; the result is less need for ‘external
savings’ or imports.
20
 Stronger global growth (3% from 2009-13; 4.0%
10
expected for 2014) and a weaker BRL to help
boost exports
Exports
 From 2004-08 exports of goods and services
0
grew by 7.3% y/y; from 2009-13 they grew by
only 2.0% y/y on average
 If exports had maintained the same pace of
-10
growth, GDP growth would be closer to 4.0% in
2009-13 as opposed to 2.7% on average
-20
4Q' 04
4Q' 06
4Q' 08
4Q' 10
4Q' 12
4Q' 14
Source: Standard Chartered Research
20
Growth outlook – Short term vs. Long term
 2014-15: Macroeconomic adjustment + beginning of a new administration
 2015 onwards: Recovery of economic stability will lead to better business
sentiment and investment
 Infrastructure investment boosted by PPPs and concessions to play an
important role
Source: Standard Chartered Research
21
Growth outlook – Different mix, same headline
2013
2014
2.3
1.8
Private consumption
2.3
1.8
Government consumption
1.9
1.8
Fixed investment
6.3
0.0
Exports
2.5
3.2
Imports
8.4
3.0
GDP
Source: Standard Chartered Research
22
Balance of payments to improve gradually
Trade balance to recover importantly through 2015 Constructive view for the trade balance medium12-month accumulated trade balance (USD mn)
term:
50,000
40,000
30,000
 Capacity expansion in the oil sector
 Increased refining capacity behind a shift from deficit to
surplus on the oil trade balance.
 Current oil production of 2mb/d to 4mb/d by 2020
 Oil deficit of USD 5bn in 2013 to a surplus of more than
USD 40bn by 2020
20,000
10,000
0
-10,000
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14
2013
2014
2015
2.6
6.0
25.0
Current account (USD bn)
-81.4
-63
-58
Current account (% GDP)
-3.6
-2.8
2.4
FDI (USD bn)
64
54
54
Reserves (USD bn)
376
373
385
Trade balance (USD bn)
Source: Standard Chartered Research
23
Balance of payments to improve gradually
Current account deficit to improve over 2014-15
Current account % of GDP
3
We expect the current account deficit to
improve gradually
 Real exchange rate depreciation of more than 30%
2
since 2011 is expected to have an impact on
services and income deficits.
1
 Weak economic growth to keep imports from
growing much faster
0
 But, international commodity prices remain soft;
-1
Argentina is expected to perform very poorly, profit
and interest remittances abroad are expected to
increase.
-2
We expect FDI inflows to slowly moderate
-3
High interest rate increases attractiveness
of carry-trade, improving the outlook for
portfolio inflows – hard to forecast
-4
-5
-6
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-11
Jan-14
Source: Standard Chartered Research
24
Balance of payments to improve gradually
FDI breakdown by sector (2013)
% of total FDI
Real estate
1%
Services 50%
Retail ex-auto 11%
Transportation 6%
Insurance 6%
Financial 4%
Agriculture 16%
Oil and gas 11%
Industry 33%
Metals 5%
Food 5%
Auto 5%
Source: Standard Chartered Research
25
Balance of payments to improve gradually
Argentina remains relevant
Brazil’s exports: Manufactured goods to Latin
America, % total
50
45
Developments in Argentina are clearly
negative for Brazil:
 Around 90% of Brazil’s total exports to
40
Argentina in 2013 were of manufactured
products
35
 The bulk were autos (passengers’ cars
30
account for 25% of exports to Argentina
Latam
ex-Argentina
25
 Argentina is also the third-largest supplier to
Brazil, accounting for 7% of Brazil’s total
imports (cars are also the highlight)
20
15

10
Exports to
Argentina
5
0
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Argentina accounted for 8% of Brazil’s total
exports in 2013 (USD 20bn); therefore, the
depreciation of the USD-ARS exchange rate
will likely affect Brazil’s currency as well
Jan-12
Source: MDIC, Standard Chartered Research
26
Inflation – Any relief?
Underlying measures of inflation to remain elevated
Headline, services, monitored and market price inflation (% y/y)
10
9
Services
8
Market
7
IPCA
6
5
4
3
Monitored
2
1
0
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Source: Standard Chartered Research
27
Inflation – Any relief?
Risks to the upside for inflation in 2014




Exchange rate – FX volatility and asymmetry of pass-through
Inflation expectations consolidating above the target
Large lag between administered prices and market prices – distortions
Foods prices – Unusually low level of rainfall
 Risks to the downside:
 Good grain harvest expected for the year
 Weak activity and a moderation in labour market to ease pressures on services
Source: Standard Chartered Research
28
Fiscal policy – A course adjustment?
% of GDP
2011
2012
2013
2014
3.1
2.4
1.9
1.6
2.3
1.7
1.6
1.4
Revenues
19.7
20.0
20.4
20.6
Spending
17.5
18.3
18.8
19.2
0.8
0.5
0.3
0.2
2.7
1.8
1.0
0.8
Public-sector primary surplus
Central government primary surplus
Regional government primary surplus
* Recurring primary surplus
Source: Standard Chartered Research
29
Fiscal policy – A course adjustment?
3.5
3.0
Primary surplus
2.5
2.0
1.5
Recurring
1.0
0.5
0.0
2009
2010
2011
2012
2013
2014
Source: Standard Chartered Research
30
Fiscal policy – A course adjustment?
Spending cuts or ‘contingenciamento’:
 Total of BRL 44bn planned for 2014 in spending cuts
 Government is targeting 1.9% or GDP or BRL 99bn
 Election year = slower increase in public payroll spending (limited hiring)
 Deceleration in public pension spending due to a smaller increase in the minimum
wage
 Electricity subsidies expected to increase from BRL 9bn in 2013 to BRL 15bn
Source: Standard Chartered Research
31
Brazil – Monetary policy: BCB on hold for now
SELIC rate rollercoaster
SELIC target rate (%)
Inflation expectations drifting higher
12-months ahead IPCA expectations (Focus survey)
13
6.5
12
6.0
11
5.5
10
9
5.0
8
4.5
7
6
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
4.0
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Source: Standard Chartered Research
32
Brazil – Monetary policy
Hiking cycle seems close to an end
 BCB has been preparing to end the hiking cycle since November 2013
 Loose fiscal policy makes life for the monetary authority more difficult
 Anchoring inflation expectations is more complicated
 Long end of the curve widens
 Recent moderation (January) in inflation is likely temporary – IPCA to end 2014 at
6.3%, but the peak may be 6.8% in Jul/Aug-2014
 BCB projects better numbers for 2015, but models still call for inflation above the
center of the target of 4.5%
 The exchange rate remains a significant risk
 The pass-through is larger and quicker the higher the level of the USD-BRL
 FX volatility is typically higher in the second half of an election year
 Weak growth will prevent the output gap from widening (more positive)
Source: Standard Chartered Research
33
Brazilian real (BRL) – 2014 Outlook
 Brazil has, in the last six months, been included in the so-called ‘Fragile Five’ group
of countries. However, we view this grouping as an over-simplification of the
macroeconomic issues in these economies.
 Granted, Brazil shares some fundamental weaknesses with Turkey and South Africa,
such as sluggish growth, high inflation and a weak current account position.
However, there are also critical differences.
 We think Brazil’s overall balance-of-payments position is better than the ‘Fragile Five’
and less vulnerable to turns in market sentiment.
 Brazil runs a healthy capital account surplus, offsetting the current account deficit.
The financial account surplus was USD 75.3bn in 2013, up from USD 70bn the
previous year.
34
Brazilian real (BRL) – 2014 Outlook (part 2)
 The removal of the IOF tax in June 2013 should be positive for capital inflows
medium-term. Brazil’s FX reserves, at USD 377bn, are substantially larger than those
of Turkey and South Africa, both on an absolute basis and as a percentage of GDP.
 Our BM&F positioning signals show that net BRL short positions have been reduced
since early 2014 (see page 36); much of the bad news for Brazil is already priced in
– even a credit downgrade from Standard & Poor’s was largely expected by the
market.
 We maintain our Overweight the BRL both short and medium-term versus current
forwards; long-term capital flows into Brazil have been less disrupted by recent
volatility.
 With portfolio and FDI inflows remaining strong in 2014, the expected narrowing of
the current account deficit to 2.4% of GDP should further improve Brazil’s balance-ofpayments dynamic throughout the year.
35
Positioning signals have produced useful reversal points for BRL
Excessive differentials in domestic and foreign positioning have produced useful FX signals
BM&F USD futures positioning by domestic and foreign investors, no. of contracts
400,000
300,000
200,000
100,000
0
-100,000
-200,000
-300,000
-400,000
Dec-07
Foreign investors
Domestic investors
Bullish USD-BRL signals
Bearish USD-BRL signals
Onshore/offshore differential
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: BM&F, Standard Chartered Research
USD-BRL reversal points
Domestic/foreign positioning extremes have produced directional signals for USD-BRL historically
2.6
2.4
2.2
2.0
1.8
1.6
1.4
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: Bloomberg, Standard Chartered Research
36
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