Investment Slowdown To Temper Growth

BMI View: Brazil's weak Q114 GDP print reaffirms our view that the economy will continue to see tepid growth in the coming years, as the consumption story is dimming and investment has yet to pick up meaningfully. We have downgraded our headline real GDP growth forecasts for 2014 and 2015 to 1.8% and 2.2%, respectively, primarily due to a weakening outlook for fixed investment.

Weakening investment and private consumption growth in Brazil's Q114 GDP release highlight the continued challenges facing the economy, and inform our view that low growth is here to stay for the next several years. As such, we have downgraded our 2014 and 2015 headline real GDP growth forecasts to 1.8% and 2.2%, respectively, from 2.0% and 2.4%. This implies that growth will remain broadly in line with the headline print for Q114, which came in at 1.9% year-on-year (y-o-y), in the next few quarters.

We have long argued that a shift in Brazil's growth model away from consumption and towards investment was necessary in order to boost real GDP growth over the next five to 10 years ( see 'Lower-Trend Growth Ahead', October 11 2012). The Q114 GDP print illustrates that while private consumption growth continues to moderate, fixed investment is stagnating following an uptick in 2013. This is weighing on headline growth and leaving Brazil stuck in the middle of a rebalancing process. Without substantial government reforms to simplify the tax regime and reduce the overall tax burden for businesses, as well as greater efforts to keep inflation expectations anchored and ensure a more stable regulatory environment, we see little that could provide a sustained boost to growth in the next few years.

Economic Recovery Continues To Falter
Brazil - Real GDP Growth By Contribution, pp

Investment Slowdown To Temper Growth

BMI View: Brazil's weak Q114 GDP print reaffirms our view that the economy will continue to see tepid growth in the coming years, as the consumption story is dimming and investment has yet to pick up meaningfully. We have downgraded our headline real GDP growth forecasts for 2014 and 2015 to 1.8% and 2.2%, respectively, primarily due to a weakening outlook for fixed investment.

Weakening investment and private consumption growth in Brazil's Q114 GDP release highlight the continued challenges facing the economy, and inform our view that low growth is here to stay for the next several years. As such, we have downgraded our 2014 and 2015 headline real GDP growth forecasts to 1.8% and 2.2%, respectively, from 2.0% and 2.4%. This implies that growth will remain broadly in line with the headline print for Q114, which came in at 1.9% year-on-year (y-o-y), in the next few quarters.

Economic Recovery Continues To Falter
Brazil - Real GDP Growth By Contribution, pp

We have long argued that a shift in Brazil's growth model away from consumption and towards investment was necessary in order to boost real GDP growth over the next five to 10 years ( see 'Lower-Trend Growth Ahead', October 11 2012). The Q114 GDP print illustrates that while private consumption growth continues to moderate, fixed investment is stagnating following an uptick in 2013. This is weighing on headline growth and leaving Brazil stuck in the middle of a rebalancing process. Without substantial government reforms to simplify the tax regime and reduce the overall tax burden for businesses, as well as greater efforts to keep inflation expectations anchored and ensure a more stable regulatory environment, we see little that could provide a sustained boost to growth in the next few years.

Consumer To Remain Under Pressure

We expect that real private consumption growth in Brazil will remain moderate in the coming quarters, in line with our full-year forecast of 2.2%, down from 2.6% in 2013. This is underpinned by or view that currency depreciation will continue to erode households' purchasing power and high interest rates will temper demand for credit ( see 'Weaker Consumer To See Economic Recovery Falter', February 21). Indeed, we forecast the real to average BRL2.400/USD this year, significantly weaker than BRL2.160/USD in 2013, as a widening current account deficit and slow growth outlook weigh on the unit. Although we forecast only one 25 basis points (bps) rate hike to 11.25% before the Banco Central do Brasil (BCB) concludes its monetary tightening cycle, we believe that the bank's 375 bps of rate increases since April 2013 will weigh on consumers' demand for new loans this year.

Weakness Set To Persist
Brazil - Real Private Consumption Growth, % chg y-o-y

We expect that weak consumer confidence will also cap private consumption this year, with households less likely to spend in light of deteriorating economic prospects. Indeed, the 'future expectations' and 'current situation' readings for Brazil's ICC consumer confidence index are at multi-quarter lows, indicating that consumers view the economic situation as worse than in 2012, when headline real GDP growth was just 1.0%. While falling unemployment has been a silver lining in recent quarters, the IBGE's recent publication of a quarterly unemployment series shows the jobless rate as significantly higher than the monthly series does, calls into question the strength of the labour market. Given these dynamics, we expect retail sales growth to remain in a broad downtrend in the coming months, with periodic upticks likely to be driven by bouts of currency strength or temporary tax incentives.

Weak Confidence To Remain A Drag
Brazil - ICC Consumer Confidence Index (LHS) & ICEI Business Confidence Index (RHS)

Investment Dip Highlights Delayed Rebalancing

The 2.1% y-o-y contraction in fixed investment in Q114, which followed a 5.2% expansion in 2013, has caused us to temper our view on gross fixed capital formation this year. Indeed, we have revised down our real fixed investment growth forecast to 3.0%, from 4.9%, underpinning the downgrade to our headline growth figure. Low business confidence, as well as companies' concerns over rising electricity prices and potential electricity rationing, are likely to weigh on headline fixed investment growth this year, despite our Infrastructure team's forecast for a pick-up in real construction industry growth ( see 'Concession Programme Offers Short-Term Construction Boost', February 10).

Poor Business Environment Weighs On Fixed Investment
Brazil - Real Gross Fixed Capital Formation Growth, % chg y-o-y

Over the next several years, we believe that measures to simplify the tax code and reduce the overall tax burden for firms are necessary in order to see a substantial uptick in investment. In the next few quarters though, we expect that the Brazilian government will continue to rely on piecemeal tax breaks for the industrial sector in order to prevent further weakness in gross fixed capital formation. We previously highlighted that President Dilma Rousseff was likely to begin phasing out some tax breaks for the industrial sector in order to bolster revenue growth following the October election, but we now believe that she may leave several of these in place in the coming quarters. Indeed, the government indicated in late May that it would extend payroll tax breaks for several sectors. From a fiscal perspective, this means that the government is likely rely more heavily on extraordinary revenue from tax amnesty programmes and potential tax increases in other areas, such as cold drinks, to boost government inflows ( see 'Nominal Fiscal Deficit To Remain Substantial', April 2). While we do not believe that these measures are an adequate substitute for comprehensive tax reforms, they will prolong support for a number of ailing sectors in the coming months.

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