Weaker Growth Prospects In H213

While Q213 real GDP growth for Brazil surprised to the upside at 3.3% year-on-year (y-o-y), as compared to survey estimates of 2.6% y-o-y, we maintain our view that slower growth is ahead in H213 ( see 'Significant Headwinds To Weigh On Growth In 2013 And 2014', August 14 ) . This is underpinned by weakening high frequency data for the manufacturing sector, as well as our view that the consumer will remain unde r pressure on the back of rising interest rates, a weak real , and still-elevated consumer price inflation . That said, we acknowledge upside risks to our 2013 real GDP growth forecast of 2.0% stemming from the robust Q213 growth print .

Strong Q2 real GDP growth was driven by a pick-up in fixed investment and stronger exports, which expanded by 6.3% y-o-y after contracting by 5.7% y-o-y in Q113 on the back of falling metals prices and delays in getting agricultural exports to market. While robust fixed investment growth, in particular, is a positive sign, our Infrastructure team remains sceptical that we will see a substantial uptick in construction industry growth this year, as the impacts from the government's PAC II growth acceleration programme have been minimal thus far, and regulatory changes affecting the country's infrastructure concessions programme are likely to keep foreign investors wary of investing in Brazil ( see 'Growth Revised Down As Government Gets In The Way Of Potential', July 26).

We believe a number of factors will weigh on economic activity in the latter half of this year, including high inflation, weak consumer sentiment, and growing signs that the manufacturing sector's recovery is faltering ( see 'High Frequency Data Indicates Faltering Economic Recovery', August 7). Recent data reinforces this view, as the services, manufacturing and composite purchasing managers' index (PMI) readings for August came in below 50 for the first time since July 2012, indicating that Brazil's economic recovery is slowing. Moreover, with PMI data having remained in a downtrend since January, we believe a significant positive shock to the economy would be necessary to break the trend. Similarly, although industrial production growth remained in positive territory in July at 2.0% y-o-y, growth has been erratic in recent months, and gains in industrial capacity utilisation appear to have stalled.

Pace Of Recovery Will Not Be Sustained
Brazil - Real GDP Growth & Expenditure Breakdown, % chg y-o-y

While Q213 real GDP growth for Brazil surprised to the upside at 3.3% year-on-year (y-o-y), as compared to survey estimates of 2.6% y-o-y, we maintain our view that slower growth is ahead in H213 ( see 'Significant Headwinds To Weigh On Growth In 2013 And 2014', August 14 ) . This is underpinned by weakening high frequency data for the manufacturing sector, as well as our view that the consumer will remain unde r pressure on the back of rising interest rates, a weak real , and still-elevated consumer price inflation . That said, we acknowledge upside risks to our 2013 real GDP growth forecast of 2.0% stemming from the robust Q213 growth print .

Pace Of Recovery Will Not Be Sustained
Brazil - Real GDP Growth & Expenditure Breakdown, % chg y-o-y

Strong Q2 real GDP growth was driven by a pick-up in fixed investment and stronger exports, which expanded by 6.3% y-o-y after contracting by 5.7% y-o-y in Q113 on the back of falling metals prices and delays in getting agricultural exports to market. While robust fixed investment growth, in particular, is a positive sign, our Infrastructure team remains sceptical that we will see a substantial uptick in construction industry growth this year, as the impacts from the government's PAC II growth acceleration programme have been minimal thus far, and regulatory changes affecting the country's infrastructure concessions programme are likely to keep foreign investors wary of investing in Brazil ( see 'Growth Revised Down As Government Gets In The Way Of Potential', July 26).

PMI Weakness Here To Stay
Brazil - Purchasing Managers' Indices

We believe a number of factors will weigh on economic activity in the latter half of this year, including high inflation, weak consumer sentiment, and growing signs that the manufacturing sector's recovery is faltering ( see 'High Frequency Data Indicates Faltering Economic Recovery', August 7). Recent data reinforces this view, as the services, manufacturing and composite purchasing managers' index (PMI) readings for August came in below 50 for the first time since July 2012, indicating that Brazil's economic recovery is slowing. Moreover, with PMI data having remained in a downtrend since January, we believe a significant positive shock to the economy would be necessary to break the trend. Similarly, although industrial production growth remained in positive territory in July at 2.0% y-o-y, growth has been erratic in recent months, and gains in industrial capacity utilisation appear to have stalled.

Industrial Sector Unlikely To Provide Significant Support To Growth
Brazil - Industrial Production & Economic Activity, % chg y-o-y

In addition, although headline consumer price inflation dipped back within the BCB's 4.5% ± 2.0% tolerance band at 6.3% y-o-y in July, we believe that the risks to our average inflation forecast of 6.2% y-o-y for 2013 lie to the upside. This is underpinned by the sharp sell-off in the real in recent weeks, which took the unit back to its lowest level since December 2008, and could see price pressures tick up once again. Although the Banco Central do Brasil (BCB) has been moderately successful in stemming the real's recent rout following the announcement of an FX intervention programme in late August, we do not rule out another sharp depreciation. As such, we see little significant upside for consumers' purchasing power in the next few months.

Furthermore, we believe it is telling that consensus growth forecasts have moved little since the robust Q2 GDP print, with Bloomberg consensus estimates for 2013 real GDP growth actually dropping to 2.2% in August, from 2.3% in July. In addition, we have seen little convincing positive movement in Brazilian FX and fixed income assets in recent days, indicating that the reading has done little to change investor sentiment towards the economy. Given these factors, we maintain our below-consensus 2.0% real GDP growth forecast for this year, and continue to believe that Brazil's economy faces a number of significant challenges over the medium-to-long term ( see 'Growth Revisions Reinforce Mexico Over Brazil Outlook', September 5).

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This article is tagged to:
Sector: Country Risk
Geography: Brazil, Brazil, Brazil, Brazil
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