Hurt by the global slump in commodities and mismanagement by government officials, Brazil’s economy has been battered both internally and externally. Given the current domestic political crises in Brazil over the alleged Petrobras payments to politicians, and the country’s current budget crisis, I believe it is unreasonable to expect any near-term recovery.
Gross domestic product (GDP) and industrial production have dropped
Over the past year, Brazil’s real GDP and industrial production have declined sharply, continuing a trend that began with the collapse of output and production following the Global Financial Crisis of 2008 and 2009. Since peaking in the first quarter of 2014, Brazil’s real GDP has fallen by a cumulative 3.5%, while industrial production has declined by 6.8% (on a 12-month moving average basis).1
The Brazilian economy is laboring under “twin deficits.”
- The first is an external current account deficit that implies that the economy has lost some competiveness and/or that there’s a build-up of overseas debt.
- The second is a growing fiscal deficit that the government appears very unwilling to bring under control.
The worrying aspect of Brazil’s macroeconomics is that both deficits are currently widening, suggesting a marked lack of discipline with respect to spending. Normally a government faced with this kind of situation would attempt to rein in fiscal expenditures by reducing the fiscal deficit or private expenditures, leading to an improvement in the current account balance. However, the fact that Brazil is not doing either of these two things is a major reason to expect the currency to weaken further.
With the government’s unwillingness to bring the country’s fiscal deficit under control, most of the burden of adjustment rests on the central bank’s interest rates, which are very high at 14.25%,2 and the currency, which has depreciated sharply despite high domestic interest rates.
Recession extension likely
Brazil’s economy is in a protracted slump. Given the weakness of demand abroad for Brazil’s key commodities, and the inability to revive the economy at home, it seems likely that the recession will be extended.
Key indicators of domestic spending show a gloomy picture:
- New car sales were down 13.2% year-on-year in June
- Industrial production was down 6.6% year-on-year in July
- The latest comprehensive figures for retail sales show they were down by 3.0% in June.
Outlook
With high inflation eroding purchasing power and high interest rates curtailing credit growth, it is hard to envision any near-term upswing in the domestic economy for Brazil.
Going forward, I believe Brazil’s currency is likely to depreciate further, and interest rates will like stay high until the twin deficits are properly addressed.
Article by John Greenwood, Chief Economist of Invesco Ltd
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