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Thursday, July 31, 2008

Brazil Country Outlook August 2008

Claus Vistesen: Copenhagen

Brazil is a resource rich country in transition towards a much more diiversified economy where industry and high value services will begin to play an increasing role. Brazil has ample supplies of energy and agricultural products, and is currently hitting that “sweet spot” where a demographically driven growth dividend becomes available. Thus we can increasingly expect to see above trend “catch up” growth as the Brazillian economy benefits from the new wealth which accrues from the rapid global rise in commodity prices while the strong supply of young labour underpins the labour market and significant productivity improvements become available as the economy generally moves towards ever higher-value-added sectors of activity.

Perhaps the most telling sign of Brazil's rising status as a new global force to be reckoned with was the recent announcement by the National Petroleum Agency (ANP) of the discovery of a new offshore oil field (Carioca) which potentially holds as much as 33 billion barrels of oil - enough to supply every refinery in the U.S. for six years - making it the third-largest oil field ever discovered (only Saudi Arabia's Ghawar and Kuwait's Burgan fields are bigger). This, coupled with the discovery last year of the Tupi field - which has an estimated reservoir of between 5 and 8 billion barrels of oil – is now fast forwarding Brazil rapidly up through the ranks of global oil producing nations. Such new found oil prowess has even prompted president Lula da Silva to suggest that Brazil enter OPEC.

But Brazil is not only rich in energy; agriculture – that new high-value sector – is also an important contributor to Brazil’s rapidly growing GDP. Agricultural income should total 155.27 billion reais (US$ 71.4 billion) in Brazil in 2008, according to the Ministry of Agriculture. The estimate is based on crop surveys by the National Food Supply Company (Conab) and the Brazilian Institute for Geography and Statistics (IBGE).

And with global agricultural prices continually hitting record highs Brazil’s agricultural exports were up 15.22% in June over June 2007, and by 5.6% over May. The government estimate for this year’s total output includes 20 crops, some of them temporary ones such as soybean, maize, rice, wheat, sugarcane, and others permanent like coffee, cocoa, and oranges. Compared with 2007, the figure represents growth of 17.11% after inflation. The largest increases were expected to be in beans (87.78%), coffee (48.69%), wheat (40.79%), soybean (31.83%) and maize (30.65%). Brazil is now even producing grapes, and output is growing rapidly in the northeastern states of Pernambuco and Bahia.

Also Brazil's economy created a record 309,442 government-registered jobs in June as higher domestic demand coupled with revenue flows from rising commodity prices lead companies to add staff and increase output. Of these new jobs Brazil's agricultural sector accounted for the lions share, with 92,580 new jobs being created in June, the highest monthly figure recorded since the start of the current time series in 2003.

Recent Economic Indicators

The Brazilian economy continued to expand strongly in the first quarter of 2008, and turned in a respectable 5.84% increase in GDP when compared with the same period a year earlier. Looking at quarter on quarter growth on a seasonally adjusted basis (quarterly growth gives a much clearer “as things are now” snapshot of the current state of an economy at any point in time), the 0.71% reading reflected a moderate slowdown in the economy over the previous quarter. Consumption and investment both contributed to the quarterly growth rate, but it was government consumption which did the heavy lifting in Q1. The negative trade balance also acted as a drag on growth as exports declined while imports rose. Since Brazil is strong on commodity exports, and commodity prices have been very high in recent months, the underlying momentum is positive, although were inflation not to be kept in check some variant of the “dutch disease” could undoubtedly become a problem. At the present time however this danger should not be exaggerated, since underlying investment in capital goods is reasonably healthy, rising at rate of about 19% (12 month average) as compared to a rise of around 6.5% for industrial output generally.
The main driver of economic activity continues to be domestic demand. Private consumption rose in Q1 by 6.% (y-o-y) while investment held up well - rising by 15.2%. Nevertheless, the externally oriented sector has continued to weaken, largely because of the pressure on exports caused by the high Real, and exports were down 2.1% year-on-year. Imports, however, rose steeply - by 18.9%. The other aspect of growth was public consumption, which was up by 5.8%, which was the fastest rate since the middle of 2002.

One notable recent development has been the decision by ratings agency Standard & Poor’s to award Brazil investment grade, with the foreign currency debt rating being raised to BBB- from BB+. This decision has produced considerable debate as many long term Brazil watchers believe that the upgrade comes at a time when Brazil has all the cyclical winds blowing in her favour, and ask the not unreasonable question what happens when the weather shifts? It is clear however that Brazil has made tremendous improvements over the past decade in terms of central bank independence, reigning in inflation and setting public debt on a sound footing, so whatever the fine print details, Standard and Poor’s decision can surely not be considered an imprudent one.

As regards its external balance Brazil is rather different from many other large emerging economies since while the central bank (which has a high level of independence from government) does intervene in the spot market to try to keep a lid on the Real’s rise and to built up a “war chest” of international reserves the bank has allowed the currency to rise substantially against the US dollar (as of July the Real had appreciated by some 13% against the dollar in 2008) and Brazil has also recently opened a small but quite manageable deficit on its current account, which means that Brazil as it develops is becoming a net consumer of excess capacity in the global economy. A break-down of the current account position reveals that Brazil continues to retain a surplus on the goods balance due to the importance of commodities and food but that services and in particular a negative income account are now gradually pulling the overall balance into negative territory. This is really what one could reasonably expect in the context of an emerging economy at Brazil's stage of development.

On the monetary policy front the central bank is rapidly earning a reputation for itself as Latin America’s new Bundesbank, and governor Henrique Meirelles delivered a decisively hawkish message during the last monetary council meeting to accompany the decision to hoist rates by 75 basis points to the current 13% level. Brazil's interest rate is now the the second-highest inflation-adjusted one in the world after Turkey's. Brazil's real interest rate, or the benchmark 13 percent rate minus annual inflation of 6.06 percent, is 6.94 percent. Turkey currently has the world's highest so-called real interest rate at 7.55 percent.

This decision is the continuation of a hiking campaign set in motion in order to establish strong credentials for the central bank as an inflation fighter, and to prevent generalised inflation expectations from taking a hold among the population. The central bank is attempting to keep inflation within the the official target of 4.5% and with inflation forecast to be somewhat above that figure in 2009 the central bank is simply acting accordingly.

Such aggressive tightening is, however, not without its problems, and policy makers now face a serious dilemma. Predictably, given the state of the current global environment, the central bank's larger than expected interest hike was rapidly translated into an appreciation of the Real – pushing it to its strongest level since 1999. So far, the 13% rise against the USD this year puts the real in the pole position amongst emerging market currencies versus the USD. This position is reasonably comprehensible taking into account the recent decision to award Brazil investment grade status; this coupled with a nominal yield on 10 year government notes at about 15% and a benchmark stock index – the Bovespa – which is up approximately 10% from its January level, implying a 20% gain in US dollar term, basically mean that international investors are finding it hard not to put money into Brazil at this point in time.

Consequently, with a global credit crisis far from over, a hawkish central bank, and a hard currency making exports more difficult one could only reasonably expect the economy to slow in line with weaking global momentum. The key point with respect to the Real would be that a continuing rise will push the external balance further into negative territory. Moreover, in a likely scenario where global commodity prices somewhat pare-back their recent impressive upward movement Brazil’s external bookkeeping will further come under pressure.

Outlook on Key indicators

  • Following the most recent rate hike market expectations have now solidified towards further interest rate increases in the pipeline. The driving orce here will, as ever, be inflation running above the central bank's nominal target. Here at Emerginvest we see the Central Bank of Brazil aiming for a nominal rate of 15% which should be reached over the course of the next three meetings.

  • The Real is likely to continue to be supported by a hawkish central bank but as the external balance moves steadily into negative territory macro-fundamentals may take over, and as the economy slows and inflation comes into the target zone the central bank will once more move into loosening mode pushing the Real down in the process. A violent correction however is not expected.

  • GDP growth is expected to moderate in 2008 compared to the levels seen in 2007 but at this point growth projections remain solid, and we certainly see Brazil’s mid term sustainable growth rate as being above the consensus 3%-5% rate once inflation is firmly under control.

2007 Data

GDP (2007) - 5.4%
Inflation (2007) - 3.6%
Current Account Deficit -0.27% of GDP
Fiscal Deficit - 2.27% GDP
Debt to GDP ratio - 42.8%

Debt Ratings (local currency, long term)

Fitch - BBB-
S&P - BBB+
Moody- Ba1

2008 Central Bank Inflation Target - 4.5% (+ or – 2pp)

Population Median Age -29 years
Total Fertility Rate (2007) -1.88 child per women
Male Life Expectancy - 68.57 years

Development Indicators Rank (131 economies in total)

Global Competitiveness (World Economic Forum)
72/131 (2007-08)
Business Competitiveness (World Economic Forum)
59/131 (2007-08)

Selected Sub-components

Institutions - 104/131
Infrastructure - 78/131
Macroeconomic Stability - 126/131
Health and Primary Education -84/131

Short Term Data

Retail Sales Growth (May, y-o-y, volume index) - 10.5%
Industrial Output (May, y-o-y) - 2.4%
Inflation (July 2008) - 6.3%
Central Bank Interest Rate (SELIC Rate) - 13.0%

Thursday, July 24, 2008

Brazil Central Bank Raises Interest Rates Again In July

Brazil's central bank, raising interest rates more than expected for the second time in three meetings yesterday, wrong footing a lot of analysts (myself included) and justifying the nickname the "Bundesbank of Latin America" as it showed it is ready to push up lending costs as fast as it feels necessary to fight inflation. The real rose to a nine-year high on the back of the news.

Policy makers led by President Henrique Meirelles raised the overnight rate by three quarters of a percentage point to 13 percent in a bid - as they put it - to bring inflation back to target in a "timely fashion".

The increase aims to slow domestic spending as food and energy costs continue to rise. Consumer prices rose 0.63 percent in the month through mid-July, pushing annual inflation to a 32-month high, according to the latest data from the national statistics agency. Inflation as measured by the benchmark IPCA-15 index quickened to annual rate of 6.30 percent, close to the upper end of the central bank's 2.5 percent to 6.5 percent target range.

On the present showing Mereilles and his team look set to miss their inflation goal for the first time since 2003 this year. For 2009, inflation forecasts are on the rise and consumer prices and many economists expect inflation to increase in the 5 percent range. Yesterday's increase from the central bank, which was the biggest in more than five years, puts the key rate at the same level it was in January 2007, canceling the effect of five of the six rate cuts last year.

Brazil's interest rate is now the the second-highest inflation-adjusted one in the world after Turkey's. Brazil's real interest rate, or the benchmark 13 percent rate minus annual inflation of 6.06 percent, is 6.94 percent. Turkey has the world's highest so-called real interest rate at 7.55 percent.

Also we learn that Brazil's economy created a record 309,442 government-registered jobs in June as higher domestic demand coupled with rising commodity prices lead companies to add staff and increase output according to a July 17 Labor Ministry report showed. Of these new jobs Brazil's agricultural sector accounted for the lions share. The agricultural sector was responsible for the creation of 92,580 of the new jobs created in June, the highest monthly figure recorded ever since the current time series began in 2003.

Agricultural exports are up 15.22% on June 2007, and 5.6% over May. One highlight of Brazil's new agricultural prosperity is grape production, which registered the highest job generation rates in the northeastern states of Pernambuco and Bahia.

Agricultural income should total 155.27 billion reais (US$ 71.4 billion) in Brazil in 2008, according to the Strategic Management Advisory (AGE) at the Ministry of Agriculture, Livestock and Supply. The income is calculated based on crop surveys by the National Food Supply Company (Conab) and the Brazilian Institute for Geography and Statistics (IBGE).

The estimated value for this year includes 20 crops, including temporary ones such as soybean, maize, rice, wheat, sugarcane, and permanent ones such as coffee, cocoa, orange and grape. Compared with last year, the figure represents growth of 17.11% after inflation.

Another 14 products saw an increase in income in 2008. The greatest increments were those of bean (87.78%), coffee (48.69%), wheat (40.79%), soybean (31,83%) and maize (30.65%). Income results per region show that the Midwest and the South have the highest income expansion rates in comparison with last year.

The overall economy grew 5.8 percent in the first quarter after expanding 6.2 percent in the fourth, the fastest in 3 1/2 years. Unemployment rate fell to 7.8 percent in June, its second-lowest level in more than six years, the statistics agency said today.

In Q2 business confidence - as calculated by CNI - dropped from 62 to 59, in line with seasonal patterns. The index did however remain well above the 50 break-even level. The fall was clearest among the larger corporation (down from 64.4 to 60.3), followed by medium companies (down from 60.5 to 57.8). Confidence among the small businesses also diminished, albeit at a lower pace, dropping from 60.2 to 58.4.

Consumer confidence (FGV) also fell sharply in June. The index tumbled from 107.2 to 101.9, - mostly as the result of a deterioration in the current assessment, which fell from 112.9 to 101.2. However, future expectations were also down - from 104.2 to 102.3. Th sharp slowdown in the current assessment suggest that inflation is having a corrosive impact on the disposable income of the population.

Brazil's real rose to a nine-year high after the central bank increased its benchmark interest rate advancing 0.4 percent to 1.5767 per dollar at 3:34 p.m. New York time, after most trading in Brazil had ended, from 1.5836 the day before.

The real has now gained 12.9 percent this year, the biggest rise against the dollar among the 16 most-actively traded currencies, while the Bovespa is up approximately 10% from its January level, implying a 20% gain in US dollar terms.

Wednesday, July 16, 2008

Brazil Retail Sales May 2008

Retail sales volume was up 0.6% month-on-month in May, on higher sales of food, beverages, personal items and office equipment. Data from government statistics agency IBGE said six of the eight sectors surveyed showed higher growth during the month. Sales were up a strong 10.5% when compared with May 2007. The sales growth was led by a 1.1% rise in sales of supermarket sales, which rebounded from a 0.2% drop in April. Sales of personal items rose 2% in May, after a 1% fall in April. And sales of office equipment rose 5.1%, rising from a 3.7% growth in April.

Saturday, July 12, 2008

Brazil Monthly Inflation Falls Back (Slightly) In June

Brazil's monthly inflation rate slowed slightly in June from May, though prices still registered their second-biggest rise of 2008. On an annual basis inflation rose at the fastest pace since November 2005, underscoring central bank concern about price pressures.

The benchmark IPCA consumer price index was up 0.74 percent in June, down slightly from the 0.79 percent increase registered in May, according to the statistics agency IBGE. Annual inflation in June rose to a 31-month high of 6.06 percent.

Slowing inflation may give the the central bank - which the Economist wryly refers to as the new Bundesbank - room to pause on the current pace of rate increases which have seen policy makers push up the so-called Selic rate from a record low 11.25 percent to 12.25 percent this year.

Food and beverage prices jumped 2.11 percent in June after a 1.95 percent increase the May and there was a generalised gain in most items surveyed. Prices of staple foods, such as rice and black beans, surged last month, rising 9.9 percent and 7.54 percent, respectively. Clothing prices rose 0.42 percent in June, slowing from a 0.98percent monthly rate in May, while personal spending costs climbed 0.54 percent after a 1.11 percent rise in May, helping the slowdown in the month-on-month IPCA data.

Brazil's annual inflation rate has been running above the 4.5 percent midpoint of the central bank's annual target range throughout 2008.

Despite the strong commitment from the central bank to fighting inflation, my feeling is that the bank will now be more cautious about raising rates too fast. Interest rate hikes need time to have an impact - The central bank estimates that the impact of interest rates starts to be felt on real GDP with a lag of about one quarter - and there are now accumulating signs that Brazil's economy is slowing.

Retail sales growth eased up in April, rising by 8.7 percent from April 2007, was down from the 11 percent increase registered in March.

Also Brazil's industrial output expanded less than most economists expected in May, and this again may well reduce the appetite at the central bank to press ahead rapidly with interest-rate increases. Industrial production rose a mere 2.4 percent on a year on year basis, down considerably on the revised 10 percent increase in April.

The trade surplus was also down in May, and again I think there will be nervousness about any move which can push the real further upward and make exporting for nascent industries more difficult. In addition the finance ministry is now busy tightening fiscal policy, raising its target for the primary surplus (ie, before debt payments) from 3.8% of GDP to 4.3%. The increase represents 14.2 billion reais ($8.83 billion) in savings, and these could be used to further plans to build a sovereign wealth fund, according to Brazil's Planning and Budget Minister Paulo Bernardo Again this fiscal claw-back will tend to slow the economy yet further, and this may well be a more effective way of doing so - ie weakening demand-pull pressure for inflation pass-through - than raising interest rates excessively and in the process further raising the real making exports more difficult, especially since the yield differential only attracts additional funds which simply add to demand side pressures and make the upward move in interest rates counterproductive.

Brazil received $37.2 billion of foreign direct investment in the 12 months through April, a record annual inflow, and foreign exchange reserves were up to $195 billion in March 2008.

Despite the fact that Brazil's Planning and Budget Minister Paulo Bernardo is constantly stressing that the government will take ``all necessary measures'' to curb inflation I would be cautious about any overly rapid judgement that central bank President Henrique Meirelles and his team are about to raise rates for a third time in 2008 when the Monetary Policy Committe meets on July 22-23 next.

Interestingly Morgan Stanley's Marcello Carvalho in a recent piece for the GEF comes down on the side of upside (and not downside) risks on the rate hike front. While he accepts growth is slowing, he still feels:

Risks for rates seem biased to the upside. In all, recent inflation data, trends in expectations and policy signs consolidate the notion that the Copom could have to hike for longer than it originally envisaged. Our forecast continues to assume a full hiking cycle of 300bp, to 14.25%, by end-2008. But risks around our call remain biased to the upside. Depending on how inflation expectations evolve, our econometric work suggests that the hiking cycle could prove to be in the range of 400-500bp (see “Brazil: Taylor-Made Monetary Policy”, This Week in Latin America, June 2, 2008).

Basically Cavalho is skeptical that the potential non-inflationary growth rate is as high as many imagine, and I suspect this is the difference between my view and his.

To keep things in perspective, 3% real GDP growth in 2009 should be interpreted as a sign of success for Brazil, given a darkening global outlook and Brazil’s own lackluster average growth performance in recent decades − not to mention outright recessions during previous downturns....Estimates for potential growth in Brazil may well be revised down, as a consequence. Most estimates would appear to put Brazil’s real GDP growth potential currently in the 4-4.5% range. We would not be surprised to see a downgrade in such estimates to the 3-4% range by the end of next year.
Marcello Carvalho

I think capacity growth in Brazil is now higher than many imagine, and I also think that the slowdown in growth in the developed economies (and possibly China at some point) will take a lot of the sharp sting out of upward pressure on global commodity prices a lot sooner than pergaps many imagine. Remember energy and food prices remaining comparatively HIGH is not the same thing as inflation (which is the rate of increase) remaining high. Absent second round effects inflation in those economies which are not pushing capacity limits (and Brazil would be the locus classicus here) can susbside as rapidly as it surged up. Indeed only yesterday Societe Generale SA's Albert Edwards - the analyst who predicted the Asian currency crisis a decade ago - was out there warning central bankers that deflation may soon overtake surging prices as the biggest risk to the world economy.

Tuesday, July 01, 2008

Brazil Trade Surplus, June 2008, Industrial Output and Retail Sales

Brazil's trade surplus narrowed to $2.7 billion in June from May as a rising currency and expanding domestic demand boosted imports. Imports rose to a record $15.9 billion from $15.2 billion in May, according to the trade ministry today. Exports fell to $18.6 billion from $19.3 billion. The May surplus was $4.1 billion.

Brazil's 12-month trade surplus narrowed to $30.8 billion in June, the smallest in four years, from $31.9 billion in May. The 12-month indicator has been shrinking since May 2007, when it peaked at $47.8 billion.

The Brazilian real has risen 20 percent against the dollar in the last 12 months, the best performance among the 16 most- traded currencies.

Brazil's industrial output expanded less than economists expected in May, possibly reducing the pressure on the central bank to accelerate interest-rate increases. Industrial production rose 2.4 percent in May on a year on year basis, down considerably on the revised 10 percent increase in April, according to the latest national statistics agency report.

One indicator that economic growth may now be slowing is that car production fell 5.5 percent in May from April. Another 15 of the 27 industrial activities tracked by the government also experienced monthly declines.

Further indication of the slowdown comes to us from Brazil's retail sales, which rose at the slowest pace in seven months in April, as rising consumer prices and tighter credit deterred household spending. The country's retail sales rose 8.7 percent in April year on year, down from a revised 11 percent gain in March.

Brazils central bank increased rates in June,to 12.25 percent from 11.75 percent, and it is clear more increases are in the pipeline. This batch of data may simply mean that rates neither rise so far, nor rise so fast as was previously being anticipated.