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Monthly Economic Analysis
COMMENTS ON THE BRAZILIAN ECONOMY
June 1, 2005 / N° 195
. In brief...
. Brazil's GDP grows only 1.3%...
. ...and the Central Bank raises interest rates once again...
. Government's congressional troubles deepen...
. ...but markets look elsewhere and keep improving...
. External accounts remain on track...
. ...and the fiscal accounts as well...
. Furthermore...
. Table
In brief...
Brazil grew only 1.3% on a yearly basis in the first quarter of 2005. Citing inflation resilience, the Central Bank (CB) raised interest rates once again. The government troubles in Congress deepened with the launching of an investigation into alleged corruption practices at the postal service. Markets reacted calmly, and Brazil's risk went down while the Real continued to appreciate. External accounts remained positive, with foreign direct investment and M&A activity surging forward. Fiscal accounts yielded excellent results.
Brazil's GDP grows only 1.3%...
On a yearly and seasonally adjusted basis, Brazil's GDP grew only 1.3% in the first quarter of 2005. All three major components of domestic demand, namely, private consumption, investment and government spending went down. It was only through an annualized 34.1% surge in net exports that GDP managed to expand from the last quarter of 2004. The weakening of economic activity is reflected in the composition of GDP growth, as agriculture advanced 10.8% in an annualized basis, whereas industry and services shrank.
...and the Central Bank raises interest rates once again...
In For the 9th month in a row, the CB raised the overnight rate to 19.75% from 19.50% the previous month. The CB defended this additional tightening citing the resilience of inflation. In fact, the mid-month consumer price inflation index reached 0.8% in May, only slightly lower than the 0.9% of April. However, upon reading the minutes of the CB meeting, markets decided (even before the release of the GDP figures) that the tightening cycle is all but over, as the inflationary pressures cited in the minutes have substantially eased, with a good help from an appreciating Real. Thus, encouraged by a deflation in the wholesale price index and a forecast of a rise of only 0.6% in the full-month May consumer price index, at month's end the 1y interest rate swap dropped to 18.7% from 19.2% in April.
Government's congressional troubles deepen...
The government was unable to avoid the launching of a joint House and Senate investigation into an alleged corruption scheme at the postal service, involving party leaders in President Lula's governing coalition. With the help of dissidents from the government camp (including 14 representatives and 1 senator from President Lula's Workers' Party) the opposition gained more supporters for the investigation than the legally required 1/3 of both the House and the Senate. The government fear is that, if confirmed by a plenary vote, the investigation might extend to other agencies, such as the reinsurance state monopoly, damaging President Lula's popularity even more than already indicated in the last monthly Sensus survey.
....but markets look elsewhere and keep improving...
Markets took on stride the government's troubles in Congress and also in the Supreme Court. (The Court is in the process of clearing the way for another congressional investigation on the government, and also decided to look into the federal prosecutors' accusations against central bank chairman Meirelles, for alleged tax evasion, and social security minister Jucá, for alleged provision of false guarantees on a 1996 loan from a state-run bank.) Enticed by lower long US interest rates and reduced concerns on hedge funds losses, markets brought Brazil's BR 40 bond spread over US Treasuries down to 424bp from 478bp the previous month. With the help of positive balance of payments flows, the Real appreciated to R$2.40 to the USD, its strongest end-of-month level since April 2002. The stock market partially reversed a two-month loss to end May up 6.8% in USD terms.
External accounts remain on track...
Ignoring for the time being the appreciation of the Real, the trade surplus was a hefty $3.5 billion in May, with exports gaining 23.6% on a daily average basis over the same month last year, while imports advanced 31.8%. In April the current account remained positive but the best news came from net foreign direct investment inflows reaching an impressive $3.1 billion in the month, reflecting a flurry of M&A activity, including the buyingout of Ambev's minority shareholders by Belgian beer giant Inbev, and French group Casino's acquisition of a large share of Pão de Açúcar, Brazil's foremost supermarket chain.
...and the fiscal accounts as well...
The public sector budget yielded a surplus in April, thanks to a large tax intake and a decline in the social security deficit. In the year, the primary (or non interest) surplus reached R$44 billion easily surpassing the government target of R$36 billion for the period. The net public sector debt dropped to 50.1% of GDP in April from 50.8% in March and, with the help of an appreciating real, is expected to go under 50% of GDP this May for the first time since April 2001.
Furthermore...
Political eyes will converge towards the joint congressional inquiry on corruption allegations at the post office, trying to evaluate how damaging to the government its proceedings might be. Markets otherwise will make their bets on whether or not the CB will call an end to its long tightening cycle. The government will attempt to focus public opinion attention on a positive administrative agenda, involving the first public-private partnerships for infrastructure projects, an investment-cost tax cutting law, and the resumption of legislative voting in Congress.
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