External demand is decelerating and high levels of debt and default threaten to slow the consumer boom. However, a favorable monetary policy may set the stage for a rebound in 2013.
A number of things have changed in Brazil recently. In our last quarterly report, we noted that Brazil’s leaders were concerned about upward pressure on the currency stemming from an abundance of portfolio capital flowing into the country. Now they are concerned about downward pressure on the currency and a flight of capital. In early 2012, Brazil seemed headed for a modest deceleration in growth. Now Brazil’s economy appears headed for a considerable slowdown, the result of strong headwinds from Europe.
Let us begin by considering the capital market situation. Two things have changed in the past few months. First, global markets have been spooked by tremendous uncertainty, mainly about the future of the Eurozone. As such, there has been a general flight to safety. Brazil is not alone among emerging countries in experiencing a flight of capital heading to perceived safe havens. The United States, Japan, Switzerland, and the United Kingdom have all been the recipients of capital looking for safety. Second, Brazil’s central bank, like those of several other emerging countries, has significantly cut its benchmark interest rate in order to stimulate sagging economic activity. Indeed, in the past year, the benchmark rate has been reduced by 400 basis points. The effect, of course, is to make the country less attractive to foreign portfolio investors who are in search of higher returns. Consequently, Brazil is no longer attracting vast amounts of portfolio capital. The end result has been downward pressure on the currency. While that is a good thing from the perspective of exporters, it has the potential to boost inflation beyond the already uncomfortably high level.
Next, what about growth? On the negative side, the industrial sector has begun to witness declining activity. The latest purchasing manager’s index fell below the critical 50.0 level, below which activity is believed to be falling. This is due largely to the impact on exports from the slowdown in Europe and China. Moreover, the crisis in Europe has probably had a negative impact on business confidence and willingness to take risks. The result has been a sizable slowdown in the growth of overall economic activity.
On the positive side, Brazil has experienced strong consumer spending growth, which has helped to offset the negative impact on industrial output stemming from the Eurozone crisis. In part, this spending has been fueled by consumer borrowing, itself due to the attractiveness of historically low interest rates. Unfortunately, consumers have borrowed a bit more than they can handle. The result has been a sizable increase in the default rate on consumer loans, especially automotive loans. This is likely to dampen consumer borrowing and spending going forward. Moreover, banks have tightened lending standards after witnessing an increase in their rate of nonperforming loans. Thus, the boom in consumer spending may be coming to an end.
The tightening of bank lending standards also means that the impact of lower interest rates is being negated. If banks are reluctant to lend, lower official rates will not matter. Indeed, the rate of private-sector credit expansion has decreased recently. To deal with this and offset the private-sector credit crunch, the government is stepping in with more subsidized loans for private-sector companies.
There are a number of reasons to be cautiously optimistic about Brazil’s likely performance in the coming year. First, the central bank has managed to aggressively ease monetary policy while retaining its credibility regarding inflation. Second, the government’s finances are in reasonably good shape. The recent announcements of modest fiscal stimulus are not likely to seriously impair Brazil’s fiscal probity or shake financial markets. Third, the banking system is believed to be reasonably robust; consequently, the rise in the rate of nonperforming loans is not expected to endanger the health of major banks. Finally, Brazil’s upcoming hosting of the World Cup (2014) and Summer Olympics (2016) is expected to boost the level of investment and, therefore, contribute to faster growth.
Barring a disintegration of the Eurozone, Brazil is expected to experience acceleration in economic growth by 2013.