Brazil: Optimistic Estimates

The Central Bank of Brazil announced last Friday some official estimates for inflation and economic growth in 2009.

The real GDP official projection is 0.8%, while the inflation forecast (consumer price index, IPCA) is 4.1%.

Naturally, such estimates are already taking into account the GDP figures for the first quarter (negative growth) as well as some preliminary numbers for the second quarter. Also with respect to inflation, we have already five months with final numbers for the so-called IPCA.

The purpose of this note is to bring a certain degree of realism to such estimates, to the extent that we fear that there are serious risks in both cases that the Central Bank might be mistaken on the optimistic side.

In other words, it is perfectly possible that GDP in Brazil in 2009 might show a negative number or at least zero as opposed to 0.8%. By the same token, inflation calculated by consumer prices might stay above 4.5%, which by the way is the Central Bank target within the so-called inflation targeting model.

As far as real GDP is concerned, there are at least arithmetic reasons to suggest that it might be quite difficult to reach a positive number close to 1% for the year as a whole. The first quarter showed a negative figure and for the second quarter many available indicators suggest a number very close to zero. Consequently, the last two quarters of 2009 would have to show very high and positive growth rates in order to reach 0.8% for the year as a whole. And there are no strong reasons to expect a robust recovery; on the contrary, the W hypothesis should not be discarded.

Going beyond arithmetic, industrial production continues to indicate very negative numbers and has decoupled entirely from real GDP as a whole. Naturally, this means that services (more than 50% of GDP) are helping to explain this decoupling, that is, the relatively neutral numbers for real GDP around 0%. However, it must be emphasized that it is well known in Brazil that the measurement of the services sector is an authentic black box, as far as transparency is concerned.

With respect to inflation, it is clear that the Central Bank is expecting a certain stability (or even more appreciation) of the exchange rate, in addition to a recessive climate, which is reflected in the measurement of the output gap, which is a fundamental part of the Central Bank inflation model related to the inflation targeting system.

However, one should not discard a reversal in the exchange rate trends, having in mind the decline of interest rates, some commodity price increases, as well as a deterioration of the balance of payments. The decline in exports of manufactured products is certainly bringing a great deal of preoccupation for the Government.

The futures market for interest rates in Brazil is probably exacerbating a high degree of confidence in an inflation stabilized around 4%. But the Central Bank itself in recent reports keeps repeating that there are exchange rate risks and that Brazil continues to have a high level of inertia or persistent inflation, due to the fact that inflation memories continue to visit the minds of Brazilians.

For example, the public in general might very well interpret this new phenomenon of a one-digit nominal interest rate as a situation of zero real interest rates, due to high inflation expectations (outside of financial markets) related to the memories of the last century.

The last Central Bank report also indicated an increase in the ratio public debt/GDP. Such information (42%) might influence inflation expectations, suggesting a major decline in tax collections and an increase in Government spending, in spite of lower interest costs for the public debt.