Brazil: muddling through for a few quarters more…

Nearly 50% of Brazilian exports are made of primary products. The plunge in commodity prices has therefore provoked a huge terms-of-trade¹ shock. Combined with the global industrial slowdown, this has contributed to a sharp contraction of activity: GDP fell by 6% between Q4 2014 and Q4 2015 (chart 1). The unemployment rate rose from 4.5% mid-2014 to 8% and the annual nominal wage increase has slowed to less than 3%. With inflation rising above 10% – the government decided to raise regulated prices last year (chart 3) – consumption has been hit and is doomed to remain depressed.

The only bright spot is the rebalancing of the current account. But this is far from explained by the significant weakening of the real (-30% in effective terms since mid-2014 (chart 2)). While this depreciation has helped restore some of the competitiveness losses of the Brazilian economy, non-price competitiveness problems have not allowed manufacturing exports to fully benefit from it. Instead, the improvement in the current account was due mainly to the fall in imports driven by the contraction in domestic demand. Actually, there are reasons to believe that this depreciation has fuelled further inflationary pressures, making the BCB’s task harder! In this context, the Central Bank of Brazil (BCB) raised its target rate (Selic) from 7.25% in 2013 to 14.25% in June 2015, when it decided to pause for breath, given the harsh recession the country was experiencing.

With a modest acceleration of world growth in 2016, we don't expect a significant rise in commodity prices. At the same time, the slippage of the 2015 fiscal deficit has to be corrected. A contraction of activity in 2016 is still likely, all the more so as Brazilian politics has taken a turn for the worse with, among other issues, an impeachment procedure against President D. Rousseff that will weigh on households and business confidence and hence also on activity.

With well-anchored medium-term inflation expectations (chart 4), the BCB could eventually be slightly more accommodative since the base effects from regulated prices will turn favourable over the next few months and inflation should decelerate. Still, activity should remain depressed a few quarters longer before improving.

(1): “Terms of trade” is the ratio of export prices to import prices.