Brazil's GDP Beats Expectations

By Craig Botham, Emerging Markets Economist at Schroders

Brazil’s fourth quarter GDP growth came in at 1.9%, beating City expectations. The economy expanded 0.7% in the final three months of 2013, against a 0.5% contraction in the previous quarter. This brings growth for 2013 to 2.3%, year on year, a positive surprise. Yet a look at the growth breakdown reveals a less rosy picture; every sector of the economy shrank except for government spending. Growth appears to have been fuelled by higher government spending.

Though government spending helped the country finish stronger than expected in 2013, it seems unlikely it can continue. The government recently announced a new fiscal package, including spending cuts, to pursue a 1.9% fiscal surplus this year as it seeks to fend off a ratings downgrade. At present, the country’s debt is only two notches above a junk rating. As a result, there would appear to be less scope for fiscal populism ahead of the elections in October next year, removing some support for growth. Without it, it is difficult to see where growth will come from in 2014.

Activity data so far this year has not been encouraging. Though we have seen improvement in the manufacturing surveys, weakness is evident in services surveys, industrial production growth, and the central bank’s economic activity index. Meanwhile, consumption, the other driver of growth for much of 2013, is likely to struggle in the face of rising debt costs.
Particularly worrying is the continued decline in investment.

Though inflation has begun to respond to tighter monetary policy, with 350 bps of hikes now since April last year, interest rate hikes can only do so much to contain inflation in an economy with supply side problems, and Brazil will need investment to resolve its inflation problem in the long run.

Yet there seems little prospect of an investment recovery until after October’s elections. The recent drought is also likely to cause higher food and electricity prices in the coming months. We expect monetary policy to remain tight this year, as the central bank continues attempts to anchor expectations and re-establish credibility.

To sum up, although this GDP number has provided a pleasant surprise, nastier ones could lurk ahead.