Soft landing or sharp drop?

Country Briefing Brasil
The Economist Intelligence Unit / Infoestrategica

Amid criticism from virtually all sides, Brazil’s Central Bank has unrepentantly maintained a tight monetary policy to quell inflationary pressures for the last eight months. Foreign direct investment and exports have so far remained strong. But the combination of high interest rates and solid foreign-exchange inflows has brought the dollar’s value against the Real to its lowest level in three years. As a result, long-term investors, notably exporters, worry that the coming economic deceleration from the 5.2% GDP growth of 2004 may be too precipitous.

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Officials have raised the benchmark Selic overnight rate from 16% in September to 19.5% at present, and have hinted at more to come. Meanwhile, even though the exchange rate has hovered around R2.5:US$1 in recent days, the Real has appreciated by 15.6% since January 2004.

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Brazil’s president, Luiz Inácio Lula da Silva, has ruled out any intervention, blaming the dollar’s weakness on US economic policy and its budget and trade deficits. However, the euro, whose value against the Real had remained stable for some time, has also lost some ground against the Brazilian currency in recent weeks.

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The growing exchange-rate differential has so far not affected Brazil’s foreign-trade dynamics. Brazil registered a record US$12.2bn trade surplus during the first four months of 2005 thanks to a 29.2% increase in exports (accompanied by a 19.6% rise in imports). Nevertheless, exporters are sounding the alarm.

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Brazil’s leading automotive manufacturers have said publicly that they are at the end of their tethers and stand to lose important export contracts. Fiat (Italy) has already cut its foreign sales targets, while General Motors (US) and Volkswagen (Germany) have warned that they might have to do so within three months if the Real does not depreciate.

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Hans-Christian Maergner, president of Volkswagen do Brasil, which was the country’s fifth-largest exporter last year (with foreign sales of US$1.5bn, including car parts), has described the current export scenario as “a disaster” from a financial point of view. Ford Motor (US) also warns that it will not keep exporting at all costs. Car-parts supplier Robert Bosch’s (Germany) local unit still expects a 14% increase in exports volume this year compared with 2004, but says a continued strong Real may hamper future investment.

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Dangerous curve
Corporate reactions are varied elsewhere in Brazil’s economy. Small and medium-size exporters of footwear have cried foul as they lose competitiveness in the international market. The textile and toy industries have also been hit. Aircraft and electronic-goods manufacturers have proved less sensitive to the Real’s  appreciation, as they import a significant degree of components.

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Some investment banks, such as Itaú BBA, have already reported that some of their clients are experiencing a drop in demand. Promon, a local engineering and telecommunications firm, has also complained that some infrastructure projects have been delayed due to exchange-rate volatility as well as higher interest rates.

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Investment decline
As a result, Brazil’s investment rate, which increased to 19.6% of GDP in 2004 (up 10.9% compared with the previous year), is likely to decline. Even though the investment data for the first quarter of 2005 has not yet been disclosed, Crédit Suisse First Boston (Switzerland/US) estimates that the investment rate might have suffered a 2% reduction compared with the previous quarter.

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The first palpable signs of economic slowdown have begun to emerge. In April imports fell by almost 10% compared with March’s total, as companies started to order less supply. According to estimates from economists at the Instituto de Pesquisa Econômica Aplicada (IPEA), a research centre linked to the Planning Ministry, GDP growth during the first quarter of 2005 compared with the last quarter of 2004 was less than 0.5%. (The Economist Intelligence Unit currently forecasts that GDP growth for the full year will decelerate to 3.6% from 5.2% last year.)

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Furthermore, consumer confidence, which was previously buoyed by abundant credit and recovering wages, has begun to erode, according to a monthly survey of the Getúlio Vargas Foundation (FGV), a Rio de Janeiro-based research institute. The share of respondents that felt that the economic situation was “bad” rose by almost four percentage points, to 28.6%, between March and April, while those who felt it was “good” dropped by more than two percentage points, to 13.1%.

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Declining consumer confidence is likely to compromise credit demand and retail sales in coming weeks. Lenders are expected to offer less credit in any case, as payment arrears increased in March after three consecutive monthly declines. Meanwhile, multinational companies may begin to reconsider Brazil’s role as an export platform in their global strategies.

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SOURCE: EIU/ INFO-e

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