RGE’s Wednesday Note – Brazil’s Economy Exhales

Brazil’s GDP data release last Friday gave just about everyone, including us, a pleasant surprise. The better-than-expected outcome for Q2 GDP growth—8.8% y/y and a seasonally adjusted annual rate (SAAR) of 5.1%—caused us to revise up our growth forecast for 2010 to 7.5% (7.25-7.75%), though we maintain our conviction that Brazil’s monetary policy committee is done with hikes until Q1 2011. Less accommodative monetary policy already has contributed to cooling the growth rate from Q1’s unsustainable 9% y/y and 11.3% SAAR. With the external environment deteriorating and the boost from pre-election government spending about to disappear, Brazil will see its economic expansion ease further in H2. In our latest LatAm Focus Week Ahead report, available exclusively to clients, we lay out our vision for growth and inflation dynamics in the coming months.

From Q2 2009 to Q1 2010, Brazil registered an impressive average rate of 2.2% q/q for economic activity growth (including the latest revisions from statistics agency IBGE). In Q2 2010, every component but government spending decelerated compared with the previous quarter. Household spending continued to ease to 0.8% q/q (3.1% SAAR) from 1.4% q/q (5.6% SAAR) in Q1 2010, and investment lost momentum, increasing 2.4% q/q (9.8% SAAR) compared with 7.3% q/q (32.4% SAAR) in Q1. Net exports persisted in weighing on GDP: Exports slid to 1% q/q (4.1% SAAR) from 2.1% q/q (8.7% SAAR) in Q1, while imports decelerated to 4.4% q/q (18.9% SAAR) after increasing 12.9% q/q (62.6% SAAR) in early 2010. On the supply side, all sectors cooled. In contrast, government consumption rose sharply, by 2.1% q/q (8.5% SAAR) from 0.8% q/q (3.2% SAAR) in Q1, as spending swelled ahead of elections in October.

In our view, the cooling of economic activity growth resulted from the withdrawal of excess accommodation, a less benign global backdrop and a high base. Looking into H2 2010, we see the potential for growth to temper further, if July’s industrial output figures and the PMI for August are any indication. Although demand drivers such as labor conditions, credit and consumer confidence remain resilient, they are easing, which suggests economic activity will keep settling into more sustainable levels. Perhaps the biggest question mark for Brazil’s economic performance in H2 is external demand for exports, which continues to wane. Nonetheless, the output gap remains in positive territory—up 1.66% from 1.35% in Q1—and we think Brazil’s internal engine can keep it above neutral in H2 2010.


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