Are Financial Markets Still too Bullish about Brazil’s 2015 GDP?

Written by Armando Castelar.

A friend once remarked that financial markets tend to be optimistic, because most investors are generally long on the economy: they hope for higher profits, more IPOs, more bond issuances … and higher bonuses. Brazilian financial market analysts, however, have not been as optimistic, at least judging by their GDP growth forecasts. Figure 1 shows how much they predicted Brazil would grow from 2000 to 2014, considering their median forecast on the last day of the previous year.[i] This is compared to how much GDP actually expanded. Taken together, they predicted an average growth of 3.4%, only slightly more optimistic than the 3.1% average annual GDP growth that Brazil delivered.

Figure 1: Predicted vs Actual GDP Growth Rates

   Sources: Central Bank of Brazil and IBGE.

Forecast errors were not random, though: they showed a pattern that is also telling by itself. Between 2000 and the global financial crisis, analysts generally short-changed Brazil, often to the tune of 2 percentage points (p.p.) of GDP growth, as seen in 2004, 2007, and 2010. In 2004-08, in particular, analysts clearly underestimated the effect of the commodity and credit booms on growth, as they did in 2010.

Just the opposite has happened since the financial crisis and, more to the point, after Dilma Rousseff became president of Brazil. Since then, market analysts have indeed been quite optimistic, failing to factor in how much Rousseff’s “new economic matrix” policies have become a drag on the economy. The average growth in 2011-14 (1.6%) was only half what financial market analysts had predicted (3.3%).

For some time now I have believed that analysts are also behind the curve regarding 2015 GDP growth. Figure 2 shows that, as late as October 2014, they still foresaw an expansion this year of 1%. Indeed, they currently still predict GDP to grow more in 2015 (0.4%) than in 2014 (0.1%).

Figure 2: Median forecast by financial market analysts for 2015 GDP growth (%)

Source: Central Bank of Brazil.

I find this forecast too sanguine, considering all the headwinds facing the Brazilian economy in 2015. Overall, I see eight main factors pressuring GDP down in 2015:

  • The federal government is tightening economic policy quite substantially. Interest rates have been on the rise since right after the elections. The policy Selic rate is expected to average 12.5% in 2015, compared to 10.9% in 2014. The Ministry of Finance set a target for the public sector primary surplus of 1.2% of GDP in 2015, against a recurrent primary deficit of 0.5% of GDP last year. Interest rates charged on subsidized credit by state-owned banks are also on the rise and the amount of new loans will also be curtailed.
  • Local state governments have also embarked on significant fiscal tightening, reversing the excesses of last year. Oil rich states will also have to accommodate the drop in revenues resulting from the decline in oil prices.
  • Private consumption is bound to drop, as unemployment rises, real incomes decline and consumer credit becomes more expensive and scarce. Consumer price inflation will go up, on account of significant rises in electricity prices and bus fares, a weaker currency, and the end of tax exemptions on a number of durable consumer goods. And cheaper oil will not help: gasoline prices will remain flat so that Petrobras can recover its previous losses and as taxes on fuels are raised.
  • The oil and gas sector will have a terrible year as a result of the Petrobras corruption scandal. The company is cash starved and will have a hard time rolling over its mammoth debt without an audited balance sheet. It has already suspended a number of contracts with suppliers implicated into the scandal.
  • Investment will contract substantially. Public sector investment will fall, as part of the adjustment in the public sector accounts. Investment in infrastructure projects will not pick up the slack: for one, because many projects belong to Petrobras’s suppliers, the finances of which are in shambles, as previously mentioned; for another, because they need to adjust for the rise in financing cost resulting from the higher rates charged by state-owned banks. Housing construction will also suffer from declining incomes and higher interest rates on housing loans. Investment in mining and agriculture will be negatively affected by the fall in commodity prices. Last but not least, investment in manufacturing and commerce is unlikely to go up with real incomes declining and credit more expensive.
  • Brazil will almost certainly experience a severe shortage of water for power generation and household and business use. This will harm production and be another drag on private investment. Obviously, if the situation gets as bad as to force a rationing of electricity the economy will be severely hit.
  • Many hope that the weaker currency will boost exports. I see very limited scope for that to happen. With declining prices and slow Chinese and European growth, commodity exports are unlikely to expand. The outlook for manufactured exports is not bright either. With important markets, such as Argentina and Venezuela, in recession and the loss of competitiveness in the US market, it is not clear which markets would absorb a rise in Brazilian manufactured exports. Moreover, manufactures currently account for a smaller share of total exports than ten years ago: 36% in 2014, as opposed to 55% in 2004. Thus, they would need to grow more to produce the same rise in total exports.
  • On a more technical note, the statistical carryover effect going into 2015 will be around 0.3 percentage point, half that of 2014, and will likely disappear when GDP falls in the first quarter of this year.

All in all, I see only two arguments favoring a less bad performance of the Brazilian economy in 2015. Firstly, it is possible that part of the drop in consumption and investment will fall on imports, rather than on domestically produced goods and services. Secondly, it could be that a substantial part of the adjustment in investment and private consumption was anticipated in 2014.

Although I am sympathetic to these arguments, I believe they are insufficient to preclude a drop in Brazil’s GDP in 2015. In the four quarters leading up to the third quarter of 2014, GDP expanded 0.7%. During this period, consumption added 1.5 p.p. to growth. On the other hand, investment--including changes in inventories--subtracted 0.7 p.p. from GDP growth, and net exports took away another 0.1 p.p. In 2015, I expect for consumption to stagnate or even contract slightly, the contribution of investment to be nearly as negative as it was in 2014, and for net exports to have a neutral impact on growth. Those of us who are not professionally disposed towards optimism would be wise to head the warning signs of a GDP contraction.

I use the surveys carried out by the Central Bank, which started in the second semester of 1999. The most recent forecast for 2014 is used as the actual figure.

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