Brazil: a macroeconomic analysis · macroeconomic analysis Enestor Dos Santos Economic Research...

1Economic Research DepartmentEconomic Research Department 1April 2010

Brazil: a

macroeconomic

analysis

Enestor Dos Santos

Economic Research Department

April 2010

Economic Research Department


Main messages

Current macroeconomic environment: The crisis is over and the country is already growing at pre-crisis pace. The robustness of the domestic demand is starting to drive both inflation and current account deficit high. While the fiscal policy will remain expansive, the Central Bank will soon have to adjust interest rates upwards.

Positive structural factors: Some factors support a positive view towards Brazil.

� institutional stability

� the size of the domestic market

� the demographic bonus

� the strategic position as a commodity producer

� the diversification of external markets

� soundness of the banking system

Risks and challenges: But the current optimism seems to be drawing the attention away from the existent risks and challenges.

� excessive public intervention

� management of oil resources

� low saving rates

� slow progress of economic reforms

� private sector imbalances


Index

Current macroeconomic environment

Positive structural factors

Risks and challenges

Conclusion


The international crisis had a strong but temporary impact on the Brazilian economy.


The GDP dropped two quarters in a row, in Q4 08 and Q1 09, due to a strong contraction of

external demand (global trade), a reduction in commodity prices, the deterioration of the

perspectives and liquidity problems. However, the economy has been recovering solidly in

the last quarters.

Stock Exchange: IBOVESPA

0

10.000

20.000

30.000

40.000

50.000

60.000

70.000

80.000

ene-07

abr-07

jul-07

oct-07

ene-08

abr-08

jul-08

oct-08

ene-09

abr-09

jul-09

oct-09

ene-10

Source: Bloomberg

GDP

(% q/q)

-4

-3

-2

-1

0

1

2

3

1Q 06

3Q 06

1Q 07

3Q 07

1Q 08

3Q 08

1Q 09

3Q 09

1Q 10

3Q 10

Source: Bloomberg, BBVA


Due to structural advances observed in the last years (improved public and external

accounts), during this crisis the country was able to implement countercyclical measures

for the first time.

The government cut taxes and kept expenditures growing at a high pace. Loans from public

banks accelerated to compensate for a drop in the loans from private banks. In the

monetary front, the Central Bank cut rates to historical lows (8.75%).

0

2

4

6

8

10

12

14

16

ene-07

abr-07

jul-07

oct-07

ene-08

abr-08

jul-08

oct-08

ene-09

abr-09

jul-09

oct-09

ene-10

Reference Interest Rates - SELIC

(yearly rate)

Source: Bloomberg


15

20

25

30

35

40

45

ene-07

mar-07

may-07

jul-07

sep-07

nov-07

ene-08

mar-08

may-08

jul-08

sep-08

nov-08

ene-09

mar-09

may-09

jul-09

Public Credit Growth

(y-o-y %)

Source: Central Bank of Brazil


Another important support to face the crisis came from the strength of private

consumption. Retail sales, for example, continued to grow strongly despite some initial

deterioration. Car sales, for another example, reached the highest levels ever in 2009.

Many factors contributed to the resilience and the strength of private consumption:

availability of credit (currently at 46% of the GDP vs. 24% in 2002), countercyclical

measures, improvements on the labor market front and structural advances such as

poverty and inequality reductions.


Car Sales

(units)

0

500.000

1.000.000

1.500.000

2.000.000

2.500.000

3.000.000

3.500.000

2002

2003

2004

2005

2006

2007

2008

2009

Source: Bloomberg

Retail Sales Index

(seasonolly adjusted)

130

135

140

145

150

155

160

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Source: IBGE


The labor market provided significant support to private consumption. Both the

unemployment rate and employment creation deteriorated less than expected and are

already recovering very positively.

The unemployment rate is close to historical lows. This is in part due to the reduction in

informality rates and in the structural reduction of the equilibrium unemployment rate

(NAIRU).

-800.000

-600.000

-400.000

-200.000

0

200.000

400.000

ene-08

mar-08

may-08

jul-08

sep-08

nov-08

ene-09

mar-09

may-09

jul-09

sep-09

Source: Bloomberg

Brazil: Net Job CreationUnemployment Rate

(%)

6

7

8

9

10

11

12

13

14

oct-01

abr-02

oct-02

abr-03

oct-03

abr-04

oct-04

abr-05

oct-05

abr-06

oct-06

abr-07

oct-07

abr-08

oct-08

abr-09

oct-09

Source: BBVA



All in all, the country was able to face the crisis better than in the past and also better than

most countries.

GDP Evolution

(Index Q2 08 = 100)

86

88

90

92

94

96

98

100

102

Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

Source:BBVA

BRA

RUS

USA

EUR

100

101

102

103

104

105

106

t-2 t-1 t t+1 t+2

GDP Performance During Different Recessions

(Index)

current

( t = Q2 2009 )

1998

2001

2003

Source: IBGE, BBVA



The crisis in Brazil is already over. Pre-crisis growth levels were already reached. The main

drivers of this good performance are expansion of private consumption and investments.

Despite the recent recovery, the GDP dropped 0.2% in 2009. For the next year a strong

domestic demand should continue providing support and the GDP should grow slightly

less than 6%.


GDP Forecasts: demand components

(%)

0

5

10

15

20

25

30

GFFC Private Cons Public Cons Exports Imports

2010 2011 2012

GDP

(%)

-1

0

1

2

3

4

5

6

7

2005 2006 2007 2008 2009 2010(f) 2011(f) 2012(f)

Source: IBGE, BBVA


The current dynamism of the economy, stimulated by expansive fiscal and monetary policies,

has caused some inflationary pressures. The downward inflation trend observed

throughout 2009 is already over. Market’s expectations for the end of 2010 are already at

5.1%, above the 4.5% inflation target.


Inflation

(y/y %)

2,00

2,50

3,00

3,50

4,00

4,50

5,00

5,50

6,00

6,50

7,00

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Source: IBGE; BBVA

Exchange Rate

(Real / USD)

1,50

2,00

2,50

3,00

3,50

4,00

Mar-02

Dec-02

Sep-03

Jun-04

Mar-05

Dec-05

Sep-06

Jun-07

Mar-08

Dec-08

Sep-09

Jun-10

Mar-11

Dec-11

Sep-12

Source: Central Bank of Brazil; BBVA

Strong growth and higher interest rates should put pressure over the exchange rate, but the

perspectives of intervention in FX markets by the government, electoral noise and

increasing current account deficit should avoid a strong appreciation of the Real, at least

this year.


We expect the CB to hike rates in response to higher inflation by 50bps in the April

meeting. The adjustment would continue in the next two meetings and rates would reach

10.50% in Q3 10. The inflation is by far the main driver of interest rate decisions although

political issues could have a (limited) impact on the decision.


Interest rates - Selic

(yearly rate)

0,00

5,00

10,00

15,00

20,00

25,00

30,00

Mar-02

Dec-02

Sep-03

Jun-04

Mar-05

Dec-05

Sep-06

Jun-07

Mar-08

Dec-08

Sep-09

Jun-10

Mar-11

Dec-11

Sep-12


Neutral Interest Rates

(in real terms)

0

1

2

3

4

5

6

7

Chile

Mexico

Peru

Colombia

Brazil

Fuente: BBVA

Although the Selic is currently at historical lows, interest rates continue at very high levels in

comparison to other countries.


The dynamism of both public and private domestic demand in Brazil has been leading to a

deterioration of external accounts. The current account deficit has started to rise and in

2010 it could easily reach 3% of the GDP after many years of surpluses or limited deficits.

External solvency is not a risk, as the country is currently a net creditor due to its large

international reserves (15% of the GDP). Up to now foreign capitals have been very

pleased to finance Brazil’s external deficit, but if the mood changes, foreign inflows could

slowdown and then the exchange rate would depreciate. External deficits should increase

exchange rate volatility in the coming years.


Current Account

(% GDP)

-5

-4

-3

-2

-1

0

1

2

3

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012


External Accounts

(% GDP)

-10

0

10

20

30

40

50

60

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

External Assets External Debt Net Debt



The countercyclical fiscal policy implemented by the government last year worked as a buffer

against the crisis but it caused a deterioration of the net public debt. In 2010, the

government should be able, with some effort, to reach a primary surplus close to 3% this

year. In addition, public debt should return to the pre-crisis downward trend.

Solvency is not an issue again, but the mix of fast rising expenditures (especially non-

investment expenditures) and high taxes creates an inefficient fiscal environment.

Increase in current expenditures fuel current account and inflationary pressures and high

taxes (40% of GDP) represent a heavy burden for the private sector.


Fiscal Accounts - Nominal Result

(% GDP)

-6

-4

-2

0

2

4

6

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Public Debt - Net

(% GDP)

-20

-10

0

10

20

30

40

50

60

70

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Domestic Debt External Debt Total



We use a financial programming model to estimate the impact of three exogenous shocks – drop in

commodity prices, rise in risk premium, and a currency depreciation – on three external and fiscal

indicators.

The results show that the deterioration of the fiscal result is more important in the case of an increase in

risk premium than in the case of lower commodity prices and than in the case of an exogenous

currency depreciation. And even in the case a 100 bps rise in risk hits the economy in the 2010-12

period, fiscal results would continue displaying a downward trend in the forthcoming years. The

exercise reinforces our view about the strength of the fiscal accounts in Brazil. On the other hand,

external indicators are much more sensitive to a currency depreciation. More precisely, in the event

of 10% depreciation in the 2010-12 period, the current account deficit would shrink by 0.7 bps and

the indicator “international reserves/current account” would increase 1.77 (i.e. reserves would rise

from 4.3 times the size of the current account deficit to 6.0 times). A strong appreciation should, on

the other hand, imply a big deterioration of current account but international reserves would still be

large enough in comparison to financial needs.


Fiscal Balance Current Account International Reserves

(% GDP) (% GDP) / Current Account

10% fall in key commodity prices -0,15 -0,18 -0,24

100 bp increase in risk premium -0,40 0,01 -0,70

10% devaluation -0,04 0,70 1,77

Brazil - Summary Table Sensitivity Analysis

(percent points difference with respect to baseline)

Exogenous Shock


We perform a second exercise to check the sensitivity of fiscal and external accounts to stress periods.

This time we construct a risk macroeconomic scenario (growth around 3%, lower inflation and a

more depreciated exchange rate which could be the result of a strong deterioration of the external

environment) and then check how fiscal and external indicators would change in comparison to our

base macroeconomic scenario.

Under this more negative scenario public accounts deteriorate in comparison to the base scenario but

both nominal result and total net debt continue to trend downwards. External indicators, on the

other hand, improve following the moderation of activity and the depreciation of the currency. All in

all, these exercises corroborates the view that neither external solvency nor fiscal solvency ar an

issue in the short and medium term.


2008 2009 2010 2011 2012 2010 2011 2012

Fiscal Indicators

Primary Result 3,68 2,14 3,13 3,18 3,37 2,85 2,47 2,21 Nominal Result -1,98 -3,46 -2,22 -1,34 -0,73 -2,24 -1,69 -1,63 Total Net Debt 39,92 44,54 42,34 40,09 37,07 43,19 42,14 40,63External Indicators

Trade Balance 1,58 1,64 0,43 0,11 -0,07 0,62 0,48 0,29 Current Account -1,79 -1,58 -2,75 -3,31 -3,89 -2,54 -2,75 -3,14 Capital and Financial Account 1,87 4,58 3,56 3,68 4,26 1,79 2,04 2,38 Net External Debt -1,76 -3,97 -3,13 -2,15 -1,15 -1,80 -0,13 1,60

Source: BBVA

Forecasts: Main Scenario Forecasts: Risk Scenario

Fiscal and External Indicators under Main and Risk Scenarios (% GDP)


Index




Conclusion


1) Institutional stability: The election of Lula in 2002 was a very important test for the country.

Since then political and economic stability have been important drivers of Brazil’s

development.

On the economic front, the positive performance of the Brazilian economy in the last years is a

direct consequence of the option for implementing orthodox economic polices (basically

inflation target, a flexible exchange rate and a fiscal discipline).

0

500

1000

1500

2000

2500

3000

Jan-95

Oct-95

Jul-96

Apr-97

Jan-98

Oct-98

Jul-99

Apr-00

Jan-01

Oct-01

Jul-02

Apr-03

Jan-04

Oct-04

Jul-05

Apr-06

Jan-07

Oct-07

Jul-08

Apr-09

Country Risk: EMBI +

Source: Datastream

2002 Elections: Lula I

2006 Elections: Lula II


Potential GDP and Components

(yearly %)

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

2020

Capital TFP Labor

Source: BBVA


2) The size of the domestic market: domestic demand is, and will continue being, the

main driver of the growth in Brazil.


GDP and Domestic Demand

(y-o-y %)

-1,00

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

8,00

2009 2010 2011 2012

Source: BBVA

In the last 5 years, almost 20 million people left the poverty condition. There are still around

40 million people to be incorporated by consumption markets.

Poverty(millions of people)

0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

2002

2003

2004

2005

2006

2007

2008

Source: IPEADATA


3) The demographic bonus: Brazil is in the beginning of a cycle in which the weigh of both

children and elderly in total population is small. The bonus period is estimated to last

around 25 years more.


Demographic Bonus

0

5

10

15

20

25

30

35

40

45

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016

2019

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

Source: IBGE

Children

(% Total Population)

Elderly

(% Total Population)

Beginning Demographic Bonus

End Demographic Bonus


4) Strategic position as a commodity producer: as a commodity exporter, Brazil will

continue benefiting from high commodity prices.


0

5.000

10.000

15.000

20.000

25.000

30.000

35.000

40.000

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Future

Brazilian Oil Reserves

(millions of barrels)

Source: Petrobras, Brazilian Government

Recent Discoveries

(only Iara, Tupi and Baleias Fields)

Commodity abundance:

• recent oil findings

• comparative advantage in

biofuels

•comparative advantage as well

as in many agriculture and metal

commodities

• abundance of arable land and

water


5) Diversified external markets: an alternative explication for the Brazilian resilience against

the international crisis is that the country benefited from the dynamism of Chinese

economy. Although partial, this explication illustrates the increasing dependence to

China. More generally, Brazil’s at some extent is being able to balance the dependence

of USA, Europe and Asia.


Weight of Asia in Brasil Exports

(%)

0%

3%

6%

9%

12%

15%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: COMTRADE. Asia: India, China, Korea and Japan.

Exports by Regions - 2009

(USD millions)

0

5.000

10.000

15.000

20.000

25.000

30.000

35.000

40.000

45.000

Europe

Asia

North

America

Latin America

Africa

Middle East

Oceania

Source: ALICEWEB

Europe Union

China

USA

Argentina


6) Sound financial system: Capitalization rates are higher than in the past and higher than in

most countries. Leverage is very limited despite some recent expansion. Currency mismatch

improved recently but during the crisis banks were threatened by client’s exposition to FX

derivatives. Current liquidity levels are adequate, but during crisis periods smaller banks are

much more exposed than the big ones due to their relatively large dependence on non-

deposit funding. In the next years, banks will face an increasing competition in the coming

years as banking spreads should continue moving downwards.


Basel Index

0

5

10

15

20

25

Francia

Italia

España

China

Chile

EE.UU.

Reino Unido

Alemania

India

Mexico

Brasil

Rusia

Turquia

Source:IMF

Banking Spread

(yearly rate %)

20

22

24

26

28

30

32

34

36

jun-00

sep-01

dic-02

mar-04

jun-05

sep-06

dic-07

mar-09

Source; Central Bank of Brazil


Index




Conclusion


Signs of larger interventionism:

•Public banks have now a higher share of

total credit

•Tax on foreign flows

• Intervention on FX markets

• Public sector’s higher role in oil sector

production and regulation

• Emergence of an explicit industrial policy

•Main presidential candidates, especially

Dilma Rousseuf, seem to favor a larger

interventionism


Public Loans (% Total Loans)

30

31

32

33

34

35

36

37

38

39

40

Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09


1) Increasing public intervention: As in many other countries, the intervention of the

public sector in Brazil has been increasing since the beginning of the crisis.


2) Low saving rates: public and private consumption rates are very high and therefore

domestic saving rates are small and make more difficult a significant expansion of

investment levels. External savings arises as an alternative, but it increases the

dependence of external capital inflows…


0

5

10

15

20

25

30

35

40

45

50

Brazil Russia India China LATAM

Source:World Bankl

Gross Fixed Capital Formation

(%PIB,2004-2006)

t

Saving Rate

(% GDP)

0

5

10

15

20

25

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Source: IPEADATA


3) Elections: Presidential elections will

be held in October of 2010 and they can

potentially add some volatility to

financial markets. The main candidates

(Dilma Rousseff and Jose Serra) have

recently criticized the current economic

model and they could favor a more

active intervention in foreign exchange

markets, or restrictions on Central

Bank’s independency. The risks

associated to presidential elections are

not null, but they have diminished

compared to the past thanks to a

growing consensus about main

economic policies. On the other hand it

is not clear whether any candidates will

be able to implement the economic

reforms that are still needed.


Presidential Poll

(February 2010)N.A

20%

Ciro

11%

Dilma

25%

Serra

36%

Source: IBOPE / Diario de Comercio

Marina

8%


4) Slow progress of economic reforms: the optimism regarding the country seems to have

take the attention away from the needed reforms (tax system, political system, pension

system, judiciary system…) Some progress has been made, but at a slow rate…

"Doing Business" Indicators 0

20

40

60

80

100

120

140

160

180

200

0 1 2 3 4 5 6 7 8 9 10 11 12

Indicators

Ranking

Singapur Mexico Spain China Argentina Brazil

Indicator1 Ease of Doing Business Rank

2 Starting a Business

3 Dealing w/ Construction Permits

4 Employing Workers

5 Registering Property

6 Getting Credit

7 Protecting Investors

8 Paying Taxes

9 Trading Across Borders

10 Enforcing Contracts

11 Closing a Business



5) Commodities dependence and management of oil

resources: Although less than other Latin American

countries, Brazilian exports are very concentrated in

basic products. In the last years the share of basic

products in total exports is increasing and this trend

is likely to continue as the country will continue to

feed the Chinese appetite. The perspectives of

becoming an important oil exporter also contribute

to the “commodity specialization” risk which make

the country more sensitive to commodity price

fluctuations. Management issues will be especially

important as the country will benefit from

increasing oil resources which will require an active

attitude to prevent rent-seeker activities and to

accommodate the interests of different players. It’s

not clear at this point whether the government will

have the required maturity to manage these issues.

Another risk associated to oil findings: Dutch-

disease.


Exports by Products - 2009 (% total)

Semi-manufactured

14%

Basic41%

Manufactured45%

Source: IPEADATA


6) Private sector vulnerability to financial shocks: the private sector holds an increasing

share of the Brazilian external debt. This and the still precarious management of FX risks

(as shown by the recent problems related to exposition to FX derivatives) could be a

future source of problems. On another front, despite increasing disposable income,

families’ debt burden is higher than in the recent past as lending rates continue at very

high levels (more than 40% in yearly terms) and as credit continues expanding

significantly.


Families' Debt Burden

(% GDP)

10

11

12

13

14

15

16

17

18

19

feb-01

nov-01

ago-02

may-03

feb-04

nov-04

ago-05

may-06

feb-07

nov-07

ago-08

may-09

Source: BBVA; Central Bank of Brazil

Gross External Debt

(% GDP)

0

5

10

15

20

25

2005

2006

2007

2008

2009

Private Debt Public Debt



Index




Conclusion


Conclusion

Positive structural factors: Some factors support a positive view towards Brazil:

� institutional stability

� the size of the domestic market

� the demographic bonus

� the strategic position as a commodity producer

� the diversification of external markets

� soundness of the banking system

Risks : current optimism seems to be drawing the attention away from the risks and challenges.

� excessive public intervention

� management of oil resources

� low saving rates

� slow progress of economic reforms

� private sector imbalances

Overall the balance of risks is positive, but the optimism towards the country seems to

have taken the attention away from existent risks.

Brazil: a macroeconomic analysis · macroeconomic analysis Enestor Dos Santos Economic Research...

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