Economic Analysis - Recovery Looks More Cyclical Than Structural - SEPT 2017


BMI View : The Brazilian economy will stage a modest recovery over the coming quarters, driven largely by a cyclical rebound in consumption. Investment will remain subdued in response to uncertainty over structural reforms and the 2018 general election.

We retain our view that Brazil will exit recession in 2017. However, our assessment of the economy's growth trajectory is shifting. Amid rising uncertainty over structural reforms, investment is likely to remain more subdued than we previously expected ( see 'Investment Key To Modest Recovery', March 30). We now believe that a largely cyclical rebound in consumption will underpin the economy's recovery, which suggests a more modest and fragile recovery than previously anticipated. As a result, we have downgraded our real GDP growth forecast for 2017 to 0.4%, from 0.5% previously. In 2018, we forecast growth of 1.7%, from 1.9% previously.

Growth Outlook Poor Amid Subdued Investment
Brazil - Real GDP Growth, %
f = BMI forecast; Source: IGBE, BMI

We are downbeat on growth over the coming five years. Heavily indebted consumers and neutral fiscal policy will constrain consumption, while the modest scope of reforms and continued political volatility will limit investment. We believe that for Brazil to achieve more robust growth either commodity prices would need to rise materially above our current forecasts, or more substantive reforms to the pension system and labour market, among others, would need to be enacted.

Over the coming quarters, a cyclical rebound in consumption will underpin the recovery. Although Brazilian households are a long way from strength, the labour market has bottomed and historically low inflation is supporting household incomes. Net formal job creation through May was positive, retail sales grew in April for the first time in two years and consumer confidence has improved. Additionally, a stronger exchange rate has supported consumer goods imports over the first five months of the year. As a result, we have upwardly revised our forecast for real private consumption growth in 2017 to flat growth, from a mild contraction previously.

Labour Market Has Bottomed Out
Brazil - Sector Employment Indices, % y-o-y & Unemployment Rate, %
Source: BCB, BMI

Improving sentiment will offer only limited support to investment. Over recent months, PMIs and confidence indicators have crossed into positive territory as interest rates have fallen ( see ' Cyclical Disinflation Set To Fade In Q417 ' , June 7), reforms made some progress and aggregate demand appeared to be firming. In particular, record agricultural production and strong exports have generated visible green shoots ( see ' External Accounts Strong Though Risks Rising ' , June 26).

Sentiment Likely To Stay Choppy
Brazil - Purchasing Managers' Index & Business Confidence
Source: Markit, CNI, BMI

However, amid rising policy uncertainty we expect firms will look to satisfy demand with existing capacity rather than investing in new fixed assets. Industrial production is choppy and capacity utilisation remains near historic lows, at 76.5% in April, implying a wide output gap to be filled. In the year through May, capital goods imports fell 18.6% y-o-y, suggesting little movement toward expansion.

President Michel Temer's diminished political capital reinforces our view that reforms over the coming year will deliver only modest improvements to the business environment ( see 'Reforms Likely To Disappoint', June 27). While we expect labour reform and some form of pension reform to be enacted, pension reform will most likely need to be revisited by the next administration ( see ' Pension Reform Set To Challenge Next Administration ', June 15).

As a result, investment will likely remain subdued well into 2018 due to the lingering need for reform and uncertainty over the country's policy direction from 2019 onward. Amid a volatile political climate, there is as yet little visibility into the personalities or policies of the frontrunners for next year's general election, scheduled for October 2018, and significant room for self-styled anti-establishment candidates ( see '2017-2018 Elections: Policy Direction Hangs In The Balance', April 27).