Analysis: Economy a headache for whoever leads Brazil

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BR BRAZIL2 Bloomberg A wall carries offers of dozens of services to residents of Complexo do Alemao shantytown in Rio de Janeiro. The Brazilian economy grew just 2.5 percent last year. Photo: Bloomberg

Rio de Janeiro - Traders in Brazil’s swaps market are paring bets that the central bank will raise interest rates after the presidential election in early October as economic growth hits more than a two-decade low.

Rates on swap contracts due in January 2017 have declined 13 basis points to 11.51 percent since June 5, when policymakers said in minutes published that day that “expansion of domestic activity tends to be less intense in comparison with 2013”.

The economy grew 2.5 percent last year. Rates trading implied the central bank would raise its Selic benchmark by 25 basis points at its January monetary policy meeting to 11.25 percent. Traders as recently as May 27 were pricing in that increase for October.

The change in view among traders reflects falling economic growth forecasts as well as pledges by leading candidates, including President Dilma Rousseff, to reduce spending in a bid to fight inflation.

The central bank signalled earlier this month that the board would keep the Selic rate unchanged as it weighs the impact of a year-long tightening cycle and slowing growth.

“The economy is going to be so bad at the start of 2015 that, regardless of a change in government, the trajectory of Selic is not upward,” Gustav Gorski, the chief economist at Quantitas Gestao de Recursos, said.

“The adjustment the Brazilian economy needs is much more on the fiscal side than the monetary side.”

Brazil’s economic growth in 2014 would be at least 3 percentage points less than the average for the other Brics nations – Russia, India, China and South Africa – said analysts surveyed by Bloomberg.

Inflation rates have remained above the official 4.5 percent target for 45 months.

The central bank’s press office declined to comment on market expectations when contacted by phone.

Policymakers raised the Selic by 3.75 percentage points over nine consecutive meetings before keeping it unchanged on May 28 at 11 percent, which was the fifth-highest among 60 key interest rates around the world tracked by Bloomberg.

Rates on swap contracts due in January 2022 dropped to 11.79 percent on June 13, the lowest in seven months. Swaps due in January 2015 fell to 10.8 percent. The gap was the narrowest in 27 months as traders expected the second-highest borrowing costs in the Group of 20 nations, coupled with slowing growth, to tame consumer prices.

One-year swap rates on June 5 fell below the Selic for the first time since January 2013, signalling that policymakers may cut rather than boost borrowing costs next year, said Tony Volpon, the head of Americas research for Nomura Holdings.

“Cutting will only be possible if there is a confidence shock, which includes tighter fiscal policy,” he said.

Rousseff’s finance minister, Guido Mantega, in February pledged austerity. Less than three weeks later he committed himself to reducing 44 billion reais (R211bn), or the equivalent of 4.2 percent, in expenditure from the 2014 budget.

Standard & Poor’s in March downgraded Brazil’s credit rating to one step above junk, citing sluggish growth and a still expansionary fiscal policy.

Inflation twice last year breached the 6.5 percent ceiling of the target range. Consumer prices in May rose 6.37 percent from a year ago while consumer confidence – as measured by the Getúlio Vargas Foundation, an education and research institution – fell to its lowest level since 2009.

Policymakers might still continue to boost the Selic to combat cost-of-living increases, raising it to as high as 12.5 percent by the end of next year, Alberto Ramos, the chief Latin America economist at Goldman Sachs Group, said.

“It would be beautiful if you could disinflate the economy without pain, but inflation itself is a manifestation of the pain. If you don’t fix inflation, you’re condemned not to grow, or to grow at very low rates for the medium term.”

Rousseff’s approval among voters has fallen as the economy shows signs of moderating. Gross domestic product in the first quarter expanded 0.2 percent, about half the pace of the previous three months, while the president in her first three years delivered the weakest growth of a Brazilian leader since Fernando Collor stepped down amid allegations of corruption in 1992.

Rousseff’s support slipped to 38 percent this month from 40 percent in May while candidate Aécio Neves edged up 2 percentage points to 22 percent, according to a June 4 to 7 poll of 2 002 people conducted by public opinion research company Ibope. The results have a margin of error of 2 percentage points.

“The prospects of her losing have definitely increased,” said Edwin Gutierrez, a portfolio manager at Aberdeen Asset Management. “Fiscal consolidation is long overdue, and you stand a much better chance of having a meaningful one with the opposition.”

Five-year break-even rates, based on the difference in yields of inflation-linked bonds and interest rate swaps, dropped 20 basis points to 6.06 percent on Monday from March 27, when a poll published by Ibope started showing a decline in Rousseff’s support.

Growth would remain weak next year, with at least one quarter of contraction, according to Standard Chartered International economist Italo Lombardi.

Economists surveyed weekly by the central bank on Friday reduced their gross domestic product forecasts for this year and next to 1.24 percent and 1.73 percent, respectively.

In both cases the figures were the lowest since the bank began publishing the data.

“Activity has really disappointed,” Gorski said. – Bloomberg


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