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February 28, 2014

Brazil and the Rio Effect

By Benjamin Shepherd  for Investing Daily

After posting Chinese-like gross domestic product (GDP) growth of 7.5 percent in 2010, Brazil’s economy has been a global laggard over the past few years. The following year it expanded by just 2.2 percent and, in 2013, managed to grow by just 1 percent. So the markets will likely breathe a sigh of relief that, after a 0.5 percent contraction in the third quarter, Brazil’s economy grew by 0.7 percent in the fourth quarter and 2.3 percent for 2013.

Data from Brazil’s Institute for Geography and Statistics, the rough equivalent of the US Census Bureau, showed that the country’s agricultural sector was the fastest grower at 7 percent expansion for the full year. The service sector was up by 2 percent and industrial output grew by 1.3 percent.

Brazil’s economy has long been driven by a duopoly of commodity exports and consumption growth. Consequently, it’s significant that consumer consumption was up by 2.3 percent for the year, despite the fact that the government has been steadily increasing interest rates. In December, the country’s official inflation rate for the trailing year was 5.91 percent, well above the central bank’s target of 4.5 percent. To combat those price pressures, the bank has been boosting the country’s benchmark interest rate, taking it up to 10.75 percent at is most recent meeting.

High inflation coupled with slow growth had left the government concerned about the risk of a “stagflationary” situation, where growth is low and inflation is high, ahead of general elections scheduled for October. The better-than-expected economic growth in both the fourth quarter and the full year shows that, so far at least, the government’s prescription of gradually increasing interest rates coupled with tax breaks on automobiles and durable goods such as home appliances appears to be stabilizing the economy.

Another extremely positive sign is that gross fixed capital formation, the value associated with the acquisition of new or existing fixed assets by business, households and government, posted a large 6.3 percent increase compared to 2012. That comes despite somewhat sluggish sequential growth of 0.3 percent in the fourth quarter but 5.5 percent year-over-year growth for the period. These trends show that both businesses and households are feeling more optimistic about Brazil’s economic future and are investing in everything from construction to manufacturing machinery.

However, not everything came up roses.

Despite the unexpectedly strong 2013 growth numbers, the government has decided to cut BRL44 billion (about USD18.5 billion) from this year’s budget in a bid to make its primary surplus target of 1.9 percent. It has also lowered its GDP growth estimate for 2014 from 3.8 percent to 2.5 percent.

That’s a flashing caution signal that the government plans to focus on bringing inflation down even further while staying on budgetary track. That’s by no means a bad thing; the Brazilian real has already responded positively to the news and it will likely avert the danger of a credit rating downgrade. It does indicate that more interest rate increases are likely to come down the pike though, potentially dinging growth. We’ve already gotten a hint of that from fourth quarter earnings results from a number of Brazilian banks which, while reporting fairly strong loan growth in the first quarter, warned that demand will likely slow this year.

Thankfully, though, the government intends to provide some additional economic support over the course of this year. The country will host the 2014 FIFA World Cup later this year and the 2016 Summer Olympics and substantial infrastructure construction still must be completed. That will be a government-sponsored boon for the country’s construction industry and companies such as Companhia da Saneamento Basico (NYSE: SBS), which provides water services in the region where most of the investment will be occurring.

Brazil still faces substantial uncertainty in 2014, but so far the government seems to be shoring up the economy in all the right places. Right now the biggest wildcard is the October elections. President Dilma Rousseff is still the favorite, but any upset could usher in an entirely different set of economic policies.

Courtesy Benjamin Shepherd for Investing Daily (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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