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Second Quarter’s GDP: A Surprise on the Upside

Written by Armando Castelar.

Today IBGE, Brazil’s statistics bureau, released the national accounts for the 2nd quarter of 2013. At 1.5% quarter on quarter (qoq), seasonally adjusted (sa), GDP growth came at the top of the range of forecasts published by market analysts, which were on average around 1%. As in the 1st quarter, when the economy expanded a more meager 0.6%, agriculture and investment led the expansion. In the output side, both industry and services performed surprisingly well. In the demand side, the main surprise was the significant positive contribution of net exports, reversing the terrible result in the 1st quarter. Consumption growth, on the other hand, remained subdued, at 0.3%.

The results for the 2nd quarter show a much overdue rebalancing of the economy, towards more investment and less consumption, as well as a lower reliance on the expansion of net imports. Likewise, it is positive that agriculture and industry are the leading sectors, while growth in the more labor intensive services sector falls behind. Should one read these results as signaling that the Brazilian economy is entering a healthier growth track? Yes and no.

Agriculture, manufacturing and investment performed poorly in 2012, contracting respectively 2.3%, 2.5% and 4.0%. It is only reasonable that they bounce back this year. Performance in agriculture should remain strong, given Brazil’s competitiveness, the weather permitting. The weakening of the real will help manufacturing in the medium term. In the short term, though, it will affect the sector negatively, given its reliance on imported inputs and the difficulty to pass along cost increases, due to the weakness in consumption.

As we move into 2014 investment growth will likely come down, with rising interest rates and economic and political uncertainty. It is difficult to predict by how much, for this will depend on the strength and effectiveness of economic policy. It is noteworthy, in this sense, that while in the 1st quarter the rise in investment was due almost entirely to a greater absorption of capital goods, with construction performing weakly,  in the 2nd quarter construction took the lead. In the 1st quarter, in addition to the need to transport the agricultural crop to the ports, the acquisition of capital goods was boosted by the highly subsidized credit provided by BNDES to the acquisition of capital goods. In the second quarter, in turn, it was the expansion in housing credit by government banks that boosted construction.

I expect the rest of 2013 to show much weaker GDP figures than those of the 2nd quarter. Declining consumer and business confidence, rising interest rates, contracting credit concessions and the piling up of inventories all bode ill for growth. Still, with the surprising figure for the 2nd quarter, GDP growth for the year is now more likely to fall in the 2.0% to 2.5% range, than below 2%, as previously expected.

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June’s Retail Sales: Leveling Off?

Written by Armando Castelar.

Yesterday IBGE published the results for June´s retail sales. Two different indices were published, one incorporating sales of vehicles and construction materials, the other without those items. Month on month, in real terms, and adjusting for seasonality, results for the extended index showed a rise of 1.0%. The less encompassing index, in turn, went up 0.5%. The latter, in particular, came somewhat short of market expectations, which hovered around 0.7%.

Overall, I expected an even worse result, due to the protests that took the streets in June, as malls and stores tended to close during the rallies. Analysts seem to be focusing instead on the decline in sales of supermarket and other food and beverage stores. This, in turn, is being ascribed to higher food prices. Yet, food price inflation actually fell to a modest 0.04% in June, down from an average 1.1% per month in the previous 12 months. Moreover, it is hard to square that explanation with the 1.8% rise in retail sales of food and beverages in May, when their prices went up 0.31%.

Indeed, high volatility makes it hard to interpret monthly statistics, so we should resist the temptation to draw too much from them. It is better, instead, to focus on longer-term trends. Looking at quarterly data, what strikes me is how retail sales have leveled off for the last three quarters. Thus, in the last quarter, seasonally adjusted, retail sales were up just 1.2% against the third quarter of 2012. For the extended index, results were better, but not by much: 1.8%. These compare to 6.7% and 8.2% a year earlier.

Using a simple regression between commerce GDP and retail sales, one may predict the former to mark around 1.4%, year on year, in the second quarter of 2013. This compares favorably to the 0.1% expansion a year earlier, but pales against the annual average of 5.7% in the previous eight years. I expect that commerce GDP will continue to expand at slightly above 1%, year on year, in the second half of the year. For some time at least, it will stop being a driving force pulling output growth up.

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July’s inflation: If only it were always so low

Written by Armando Castelar.

Today IBGE announced July’s consumer price inflation, as measured by the IPCA, the price index used for inflation targeting. No surprises: a low 0.03%, which compares to an average 0.52% per month in the first half of the year. Inflation was also less widespread, with the proportion of prices going up dropping to 58%, from a peak of 73% in February.

Unfortunately, this was insufficient to remove concerns about Brazil’s high inflation. Not only because 12-month inflation is running at 6.3%, but also because July’s low inflation was due to non-recurrent factors: the favorable seasonality, the fall in food prices, and the reversal of the annual rise of public transportation fares, motivated by street protests.

On average, over the last four years inflation in July was 0.25 percentage points below the average for the year. Thus, ceteris paribus, inflation will rise in the rest of the year. The fall in food prices subtracted 0.08 percentage points from inflation in July. Food prices may fall  further, since they are still up 11.4% year on year, but probably not by much. It is even less likely to see a repeat of the deflation in transportation prices, which subtracted 0.13 percentage points from July’s IPCA.

If these three factors were all that counted, it would be reasonable to expect inflation to rise to slightly above 0.40% per month in the rest of 2013. This would bring annual inflation to 5.5% this year, down from 5.8% in 2012. One might then reasonably expect that in 2014-15 the Central Bank could bring inflation closer to the official, albeit half forgotten, target of 4.5% per year. Unfortunately, reality is seldom so linear.

In the next two years, a weaker labor market will help to control inflation. The unemployment rate rose in June and is expected to go further up over the rest of the year and in 2014. Thus, wage rises, which have already been more subdued in the first semester, will probably not keep up with inflation. The minimum wage in 2014 will also increase by less than in recent years, going up between 6.5% and 7.0%.

Lower wage increases will moderate the inflation of non-tradable goods – medical assistance, rent, hairdresser etc. -- which over the last four years averaged 8.0% per year. But this moderation will be gradual, for inflation expectations are unanchored. To bring inflation to the target would require keeping a relatively high unemployment rate for a long time. Market analysts do not believe it. It suffices to say that they project inflation in 2017, four years ahead, at 5.5%, a full percentage point above the target.

A stronger dollar, on the other hand, will play against falling inflation. With the economy cooling down, as expected to happen in the rest of this year, the exchange rate devaluation will impact prices only moderately. But it will impact them, even if slowly. Furthermore, it is likely that the dollar will strengthen further, as the U.S. brings its monetary policy back to normal, reinforcing the pressure on the prices of tradable goods.

Moreover, and more importantly, inflation is being pulled down by unsustainable means. In the past 12 months, prices of transportation rose only 2.2%, less than a third of the mean increase in the remaining prices. In the last four years, the so-called monitored prices – power, gasoline, bus fares etc. -- increased on average just 3.6% per year. This was only possible because the government is spending tens of billions of reals a year in subsidies. These go from transfers to power distributors and bus companies to having Petrobras incur large losses in the sale of gasoline. Eventually, bus and subway fares, as well as gasoline prices, will have to be adjusted for inflation and a weaker real. And this will not entail just a small rise in these prices. It will not happen this year or in 2014, but neither can the government wait much longer than that.

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June’s industrial output: less encouraging than the headline suggests

Written by Armando Castelar.

Today IBGE unveiled June’s industrial output statistics. The headline figure – 1.9 percent month on month (MoM) rise, seasonally adjusted (sa) – surprised on the up side. But, coming after a 1.8 percent contraction in May, it only brought output back to April’s level. Overall, though, this year is proving to be a better year for industry than 2012, when its output fell 2.6 percent. In the first semester, industrial output went up 1.9 percent, year on year (YoY), led by a surge in capital goods (13.8 percent) and durable consumer goods (4.9 percent).

The uneven sector performance makes me a bit concerned about the sustainability of this recovery. The expansion in the output of capital goods is closely linked with the surge in the production of trucks: a 48 percent rise in the first semester (YoY). This comes after a 40% contraction in the first half of 2012 (YoY) and is associated with the excellent crop harvested this year, which needs trucks to be transported to Brazil’s ports. In contrast, the output of intermediate goods continues to perform poorly, expanding only 0.4 percent in the first semester YoY, while the output of nondurable consumer goods dropped 0.6 percent.

With most of export crops already harvested, the demand for trucks should cool down. The recent sharp drop in business confidence in industry, construction and services suggests that overall investment is unlikely to perform well in the second half of the year. The outlook is not bright either for consumer goods, given the slowdown in new consumer loans, the weakening labor market and the decline in consumer confidence.