Data for Q1 confirm Brazil remains immersed in a deep recession, outlook still grim

The Brazilian economy had another disappointing quarter in January–March as GDP fell 5.4% when compared with the first quarter of 2015 (year on year). The sharp decline was driven by plunging investment and private consumption; meanwhile, government consumption also declined down but not so severely. Net trade partially offset the fall as volume exported grew 13.0% and imports fell 21.7%.

From the supply perspective, all sectors posted declines, except for utilities, as the improvement in weather conditions allowed for increased production of hydropower/electricity. A year earlier a severe drought almost depleted water reserves in reservoirs and forced production cuts. The sectors that performed well below the average were commerce, manufacturing, construction, and mining. The Brazilian consumer is constrained by lower income as high inflation is hurting real salaries. Higher unemployment not only implies that the workers who lost their jobs will limit their purchases but also that many workers who have not lost their jobs, but fear they might because of the recession, will also limit their purchases. Also, tighter credit standards from banks along with higher interest rates translate into declining credit for consumption.

Manufacturing is hurting all across the board but, in particular, the automotive sector is in a depression as it is in the trough of a boom bust cycle; the boom was artificially pushed by government support that included subsidies, tax breaks, and easy access to credit. Demand for cars surged previously and now that the incentives have been withdrawn sales are plunging. Another set of manufactures that are suffering significant declines because of the recession is appliances and electronics; the Brazilian consumer is now more cautious about making purchases of durable goods. Construction also had a bubble during the boom years, albeit small; the correction of this mini-bubble as well as the corruption scandal in Petrobras which involved major construction companies are precluding this sector from growing. Lower oil prices are hurting oil production and reducing output in the mining sector, which includes hydrocarbons.

Seasonally adjusted data and the quarter-on-quarter comparisons

Seasonally adjusted data show that GDP fell 0.3% in the first quarter as compared to October–December 2015; this marks the third consecutive month of deceleration in the pace of contraction of the Brazilian economy. If GDP were to stabilise at its current levels and remained flat during April–December 2016, then in the full year GDP would drop 2.6%. IHS expects the GDP numbers for first quarter will be revised slightly downwards, because this is not very consistent with the drop of individual sectors. Agriculture was down 0.3%, industry declined 1.2%, and services fell 0.2%; services have a sizeable weight in overall GDP and the seasonal adjustment is applied to individual series, so by definition it does not have to add up; however, based on previous data, it is likely that a slight downward tendency will follow.

Still, it is a fact that the severity of the declines (quarter on quarter) has been declining since July–September 2015, and it is becoming more likely that the economy will level off by year-end; although at depressed levels.

Inventories continued to decline during the first quarter of 2016 and IHS estimates that there will still be some more downward adjustments in the next two quarters before they level off. The decline in fixed investment has been brutal; currently, investment represents 73% of its peak level in mid-2013, and IHS estimates that the replacement of worn-out capital cannot be postponed much longer in certain corporations and overall investment will stop falling towards year-end.

Outlook and implications

Brazil's GDP fell significantly during the first quarter of 2016, although seasonally adjusted data suggest that the harshness of the declines is tapering. The change in government that occurred in May has brought a positive confidence shock that should alleviate the severe confidence crisis that is making businesses cancel and/or postpone investments and consumers to be very cautious on their purchases. However, Interim President Michel Temer and his cabinet still have to prove that they can fix the economy, mainly to reduce the sizeable fiscal deficit and to reduce inflation. In order to narrow the fiscal gap, the government must implement unpopular measures (spending cuts and perhaps higher taxes) that need congressional approval, and this is the major challenge. Now, the Workers' Party (Partido dos Trabalhadores: PT) of incumbent president Dilma Rousseff is part of the opposition and may not co-operate on measures that Rousseff was proposing not too long ago. On a positive note, the deep recession will help reduce inflation as it implies lower consumption and lower upward pressure on prices; this in turn will allow cutting interest rates. A very large fraction of the public debt is linked to the SELIC policy rate and also to inflation, so once these two variables have declined the burden of interest payments on public debt will also weaken. The results for the first quarter were better than what IHS anticipated and this will imply a revision of our forecast during our June round; we expect to revise the current 4.0% drop for 2016 to a 3.6–3.8% drop, and our prediction for 2017 may also improve slightly.