Eco Perspectives

Delayed recovery

04/18/2019

A lethargic start to the year

In 2018, the economy grew at the same pace as in 2017, at an annual average rate of 1.1%. The year’s growth performance was largely tainted by the truckers’ strike and the general elections. Household consumption remained the main driver of growth thanks in particular to a rise in consumer credit, which spearheaded the recovery in credit growth (+5% in 2018) after two years of contraction in 2016 and 2017. Investment recovered some lost ground (+4.1% y/y) after declining for four years. Nonetheless, investment as a share of GDP remains well below its 2013 peak (17.4% versus 22.8% of GDP). Meanwhile, the contribution of net exports was negative (-0.5 pp) for the first time since 2013. The current account deficit (USD 14.5 bn) was contained (0.8% of GDP) and was largely covered by net FDI flows (USD 74.3 bn, or 4.1% of GDP). Due to the very slow pace of economic activity in Q4 (+0.1% q/q) the statistical carry-over for 2019 is weak.

Growth and inflation
Monthly proxy for GDP (IBC-BR) has contracted

Despite the upswing in confidence witnessed post-election, economic indicators have largely disappointed since the onset of the year. Industrial production remained flat over the first two months of the year (-0.8% m/m, in seasonally adjusted terms in January followed by + 0.7% m/m in February). Mining production fell sharply (-15% in February) following the break-up of the Brumadinho dam in late January. Idle capacities in industry remain high, which partly explains—alongside the drop in subsidized credit—why corporate credit growth is recovering only very slowly (+ 2% y/y in February). More surprisingly, retail sales have remained largely erratic despite the rise in real wages since November and the strong growth in consumer credit (+ 9% y/y in February). Against this backdrop, the labor market deteriorated (unemployment rose to +12.4% at the end of February against 11.6% in December). Finally, activity in the services sector has also slowed since January. More importantly, the central bank's leading indicator of economic activity (IBC-BR)—a monthly proxy for GDP—declined both in January and February
(-0.3% and -0.7% m/m, sa), raising concerns about a potential contraction in GDP in Q1.

For now, financial markets have not yet adversely reacted to the weak performance of the economy. The stock market—which broke 100,000 points in March for the first time in its history—continues to perform well despite the sluggish business cycle. The risk premiums on sovereign debt remain around 250 basis points (bps) after dropping by nearly 100 bps since early September 2018. Meanwhile, the BRL which gained some ground against the US during Bolsonaro’s first month in office (+ 6% in early February) has since returned to its level at the beginning of January. The currency however remains down 12% compared to a year ago.

At this point, hopes of seeing economic activity accelerate strongly are limited. Fiscal consolidation leaves no room for increased public spending, while the climate of watchfulness resulting from the fiscal reform will likely hold back investment decisions. External factors are not also particularly supportive: in addition to the slowdown in the global economy the shortfall resulting from the recession in Argentina is weighing on exports of capital goods, particularly in the automotive industry. On the flipside, loose financial conditions and the process of disinflation remain favorable to private consumption and credit growth. The benchmark rate has been at a historical low (6.5%) for a year now. Meanwhile, inflation should remain contained below the Central Bank’s target in 2019.

A peak at the state of public finances…

Overview of public finances

Brazil’s fiscal accounts have largely deteriorated since 2014 when the primary balance (excluding interest payments on government debt) turned negative after 10 years in surplus. Over period 2014-2018, the central government’ fiscal deficit averaged 6.8% while the primary deficit averaged 1.7%. The deteriorating trajectory of the fiscal balance owes to cyclical factors (meagre recovery, revenues collapsing during the recession in 2015, 2016) but is mostly symptomatic of large structural imbalances which have led spending to grow 3 times as fast as GDP in the past 10 years. Spending has remained rigid owing to the incompressibility of mandatory social spending in particular social security and pension benefits which entitlements are protected under the constitution. The wage bill has also grown rapidly. Central government payroll has increased by 8% on average over period 2010-2017 accounting for about 4% of GDP. Costly indirect or direct subsidies are also to blame and have yet to be phased out. While the offering of subsidized credit through BNDES is being gradually phased out, the concurrent reduction of energy subsidies has remained politically sensitive. Subsidies associated with the truckers’ strike (May 2018) is estimated to have cost the equivalent of 0.2% of GDP in 2018.Despite the adoption of the spending cap[1] in 2016, the inability to alter the course of mandatory spending (social spending and pensions in particular) has meant that limited progress in terms of fiscal consolidation has been made. Given Brazil’s structurally high interest burden (~ 5% of GDP), recurrent primary deficits have led to a sharp increase in public debt (+25 pp of GDP since 2013 to 77% in 2018). The public debt burden is high but its financing does not currently pose a problem. Moreover, the profile of the debt has improved over time (longer maturities, low foreign-currency debt, better amortization profile, gradual replacement of floating rate instruments with fixed ones). The government also enjoys good coverage of its large financing needs thanks to the presence of a liquid domestic capital market. 96% of the public debt is domestic debt and is mostly held locally with ~11% held by non-residents at end 2018. Non-residents have continuously reduced their sovereign exposure since May 2015 when holdings reached a high of ~21%. Meanwhile, the monthly average borrowing costs of the central government on its domestic debt have eased (17.5 % in 2015 vs 10.6% in 2018) enabled by disinflation and the drop in the benchmark SELIC rate.

….as the pension reform bill is examined

The pension reform bill - introduced by the government in February is currently under discussion in Congress. The reform[2] projects fiscal saving in the range of USD 300 bn over 10 years (around 1.5% of GDP per year). A recent Datafolha survey reveals that popular support for the reform has improved (51% rejection vs. 71% in April 2017).In all likelihood, the size of the fiscal savings will be revised downwards by at least one-third after negotiations in Congress. Recent tensions between the executive and Congress however have cast doubts about the government's ability to find the necessary support to approve the reform. To make things worse, President Bolsonaro’s popularity - the main lever for pushing a fragmented Congress to form a qualified majority (3/5) - has been significantly challenged. A poll conducted by Ibope in March reports a drop in the President’s approval ratings from 49% in January to 34% in March. At best, the reform should help reduce the primary deficit by 0.7 to 1 pp of GDP, which on its own will be insufficient to stabilize the public debt.

[1] According to the law, the non interest part of central government expenditure (ie primary spending) cannot grow faster than inflation for a period of 20 years. Penalties for not complying with the cap include the prohibition to grant adjustments to civil servants’ wages, hire new personnel or generate additional expenditure.

[2] The new pension system which seeks to narrow the gap between workers in the public and private sectors would be rolled out over a 12 year transition period. The current proposal would (i) set the minimum retirement age at 65 for men and 62 for women for both public and private sector workers (ii) increase the length of contribution to social security, (iii) make important changes to how retirement benefits are calculated, (iv) align the rules applied to federal government civil servants with those of states and municipalities (v) eliminate certain discrepancies across professions (ie. teachers, police, military for instance benefit from early retirement rules).

THE EXPERT ECONOMISTS WHO PARTICIPATED IN THIS ARTICLE

Other articles from the same publication

Global
Lingering concerns despite hopeful signs

Lingering concerns despite hopeful signs

Recent data in China and the eurozone point towards a stabilisation of growth and have been met with relief. Although the US economy is slowing, growth should remain at a satisfactory level in the near term [...]

Read the article
United States
Inversion, then recession?

Inversion, then recession?

Although losing steam, the economic activity in the US is seen keeping on a rather dynamic path in 2019. The International Monetary Fund still forecasts a 2 [...]

Read the article
Eurozone
External dampers, internal hopes

External dampers, internal hopes

The eurozone’s manufacturing sector has been hard hit by the decline in foreign trade and persistently high uncertainty. Very open internationally, the eurozone is sensitive to global cyclical slowdowns [...]

Read the article
Germany
Manufacturing woes

Manufacturing woes

Since the middle of 2018, economic activity has virtually stagnated largely because of a slowdown in world trade. The most recent surveys and hard data confirm that weakness in the manufacturing sector continued in Q1 2019 [...]

Read the article
France
A glimpse of stability in an ocean of uncertainty

A glimpse of stability in an ocean of uncertainty

Business confidence surveys are showing signs of levelling off. Hard data for January and February are rather positive. These factors are consistent with the economy keeping up growing at about 1.2%, which is our growth forecast for 2019 [...]

Read the article
Italy
Recession in the short term, demographic challenge in the long term

Recession in the short term, demographic challenge in the long term

The Italian economy entered the third recession in the last ten years. In 2018, value added in the manufacturing sector recorded four consecutive contractions. Domestic demand disappointed, as both households and firms remained extremely cautious [...]

Read the article
Spain
Resilient growth

Resilient growth

In a morose economic environment, Spanish growth stands out as one of the most resilient in the eurozone, and it seems to have entered the year at a very similar pace to the one in H2 2018 [...]

Read the article
China
What lies behind the rise in corporate defaults?

What lies behind the rise in corporate defaults?

Industrial enterprises were squeezed by tighter financing conditions in 2017 and early 2018, and then hit by a slowdown in production and revenue growth last year [...]

Read the article
India
Economic track record on the eve of elections

Economic track record on the eve of elections

After nearly five years in power, Narendra Modi’s track record is generally positive, even though the last year of his mandate was tough, with a slowdown in growth in Q3-2018/19 [...]

Read the article
Russia
Economic growth faces headwinds

Economic growth faces headwinds

Economic growth slowed in the first months of 2019, and is now close to its potential growth rate of 1.5% according to the central bank. A 2-point VAT increase on 1 January has strained real wage growth and sapped household consumption. Inflation (5 [...]

Read the article
Japan
Pale horizons

Pale horizons

Economic activity in Japan remains in a slump, and the slowdown observed in 2018 seems set to last. Manufacturing activity deteriorated in the first quarter [...]

Read the article
United Kingdom
False start

False start

By opting to leave the European Union (EU) without any exit plan, the United Kingdom has come face to face with an impossible choice [...]

Read the article