Since the start of 2022, the Brazilian economy has been confronted with several shocks. These have led to a slowdown in activity in January and the concurrent erosion of confidence indicators. Output in the extractive industry and harvests were affected by heavy rains in the South of the country, while the strong resurgence of Covid-19 cases, linked to the Omicron variant, slowed down activity in services (bars, restaurants, etc.) and caused a fall in automotive production (rise in absenteism).
The effects of the war in Ukraine are also starting to be felt. In industry, the additional costs induced by the rise in the price of raw materials and transport are coming on top of persistent problems regarding the availability of inputs – a lasting consequence of the Covid-19 crisis.
This new supply shock, although mitigated this time by the appreciation of the real, is particularly detrimental to confidence and output in the manufacturing sector (the manufacturing PMI was below 50 on average in the first quarter of 2022).
The sharp slowdown in credit to businesses (linked to the end of emergency programmes), the continued process of monetary tightening, the limited need for companies to rebuild inventories (unlike the situation at the end of 2020), rising inflation, and the deterioration of the external scenario (economic deceleration in Europe, renewed lockdowns and slower growth in China, widespread increases in inflation across the world and rising geopolitical tensions) are all weighing on growth prospects.
However, some positive developments deserve to be underlined. The risk of electric power rationing has greatly diminished (heavy rains have replenished hydroelectric reservoirs). The rise in commodity prices, in addition to its positive effects on fiscal revenues (increased royalties and dividends), is also beneficial to the agricultural sector and extractive industries through its favourable impact on income.
This should drive an increase in capital expenditure on machinery and equipment once uncertainty dissipates. The upturn in services in March (the only sector where confidence rose) could also help offset losses in activity in certain segments of industry. The service sector experienced a strong rebound in March helped by the significant improvement in the Covid-19 situation[1] and the further easing of mobility restrictions including on travels. Survey data shows a sharp increase in hiring in the month and a desire to expand capacity in the short term. Also, even if higher interest rates are starting to weigh on purchases of durable consumer goods, credit growth to households has yet to slow down (11.1% in real terms in January versus 6.3% a year earlier).
Finally, the authorities announced in early March a support package to cushion the impact of the inflationary shock on households’ purchasing power (BRL 150 bn or 1.7% of GDP, consisting primarily of regulatory adjustments on accessing allowances with no direct impact on the budget). Combined with the increase in real wages since the start of the year[2], declining unemployment and higher spending by Brazil’s federal states (election year), these measures could offer an upward bias to growth forecasts.
Exposure of the agricultural sector to russia
Brazil’s trade exposure to Russia and Ukraine is limited but is not negligible due to the high concentration of certain products in trade ties. The combined share of Russia and Ukraine in Brazil’s total imports and exports is just under 3% and 1% respectively. The strongest dependencies (measured as imports from Russia/Ukraine as a percentage of total imports of that product) are found in coal (14.9%), precious metals (13.8%), aluminium (10.1%) and fertilizers (23%, exclusively from Russia). Fertilizers alone account for around 60% of total imports from the zone[1]. The agricultural sector – which also sources 7% of its imports of fertilizers from Belarus – has shown increased concern over prospective supply disruptions arising from the effects of the sanctions[2]. As a result, it has sought to secure greater supplies from countries such as Canada and Morocco over the next few quarters (import data already shows a strong increase in purchases in March). Disruption to Russian and Ukrainian cereal exports could create opportunities for Brazilian exporters of maize (3rd largest producer worldwide) and to a lesser extent wheat (1% of global sales in 2021/22).
A positive financial shock for now …
From a financial point of view, Brazil’s dependence on Ukrainian or Russian investments is almost nil. However, the conflict, by prompting a rebalancing of investment portfolios on a global scale and fuelling the rise of commodity prices has helped support Brazilian assets. The equity market is made up of nearly 70% of commodity-related stocks (energy and materials) and banking/financial stocks. These are benefitting from the improvement in the country’s terms of trade and the sharp rise in interest rates. Compared to other net commodity exporters, Brazil also stands out because it offers investors positive real interest rates[1]. The large interest rate differentials between Brazil and most developed economies are, in particular, incentivizing carry trade flows, (investors borrow where the cost of credit is cheap and invest where real yields are attractive). The strong momentum in portfolio investment flows[2] has allowed the Brazilian currency to appreciate rapidly against the dollar in the first quarter (+20% approximately).
