Brazil's economy expanded just 0.2 percent in the first quarter compared with the final quarter of last year, setting the stage for another disappointing year and casting new doubt on the health of emerging markets.

The low growth, which was less than half what markets expected, marked a third straight quarter of weak activity in the world's sixth-largest economy. It will also increase pressure on President Dilma Rousseff to enact much bolder reforms that could reclaim Brazil's mantle as a favourite of global investors.

That reputation has faded since mid-2011 as Brazil failed to cope adequately with the challenges posed by its boom over the past decade. An overloaded transport system, an expensive and underqualified labor force and chronically low levels of investment have combined to hold back the economy.

The data released by the government on Friday showed that, despite numerous stimulus packages enacted by Rousseff since late last year, investment shrank in the first quarter. Some business leaders say that much more dramatic steps - such as an across-the-board simplification of Brazil's byzantine tax code - are necessary to get the economy back on track.

“The government needs a growth plan. It's not enough to carry out isolated measures because they don't take us anywhere,” said Miguel Daoud, director for Global Financial Advisor, a consulting firm.

The worst-performing sector in the first quarter was agriculture, which has been damaged by a severe drought in southern Brazil. While industry did better than some expected, separate and more up-to-date data released on Friday suggested a meaningful recovery in that sector also remains far off.

Taken together, the data seem likely to spark more interest rate cuts by Brazil's central bank and cause another wave of downward revisions to the economic outlook. Economists had already expected growth of just under 3 percent this year - in line with growth of 2.7 percent in 2011, and a far cry from the booming 7.5 percent expansion in 2010.

“These are signs that, really, GDP (this year) may end up below what people are expecting, what the government's expecting,” said Rodrigo Melo, chief economist at Maua Sekular, an asset management firm in Sao Paulo.

Several other big emerging markets are also sputtering, threatening to deprive the global economy of one of its only sources of fast growth. India reported its slowest quarterly pace of growth in nine years on Thursday, while South Africa may also struggle to reach 3 percent growth this year.

Payroll data released in the United States on Friday also added to pessimism about the global economy.

The darker economic outlook at home and abroad caused Brazil's real to weaken about 0.6 percent against the dollar by midday. Brazil's stock market fell more than 2.5 percent before recovering to trade down about 1 percent.

Interest rate futures also fell sharply as investors bet the central bank would continue an easing cycle that has already caused the benchmark Selic rate to fall 4 percentage points since last August, including a 50 basis-point cut announced on Wednesday.


Brazil's problems are to some extent a reflection of problems abroad, including a slowdown in China, its biggest trading partner, and a loss of confidence in the euro zone. Rousseff has blamed a monetary “tsunami” of cheap money in Europe and the United States for making Brazil's currency over-valued and causing its exports to become uncompetitive.

Yet other Latin American countries have generally held up better, with the International Monetary Fund forecasting the region as a whole will grow 3.7 percent this year. That suggests that more local factors - such as a lack of investor confidence - are playing a big role in Brazil's woes.

Finance Minister Guido Mantega told Reuters on Monday that the economy should accelerate in the second half of this year as interest rate cuts and measures to stimulate credit and relieve high industry inventories take effect.

Private economists also expect some improvement. But a deeper look at Friday's data shows several problems, particularly the chill in investment, that could limit Brazil's prospects going forward.

Spending on capital goods declined 1.8 percent compared with the previous quarter, the IBGE statistics agency said. Investment overall fell to 18.7 percent of GDP compared with 19.5 percent in the first quarter in 2011.

“The plunge in investment is the issue that appears of most concern to us, underscoring that, not only the destocking cycle is hurting the economy, but also that confidence is deteriorating,” Mauricio Rosal, an analyst for Raymond James, wrote in a research note.

The farm sector contracted 7.3 percent compared with the previous quarter after dry weather over the past season dragged down output from Brazil's two most important crops - soybeans and sugar cane.

Industrial output expanded 1.7 percent from the last quarter of 2011, IBGE said. Yet the HSBC Purchasing Managers' Index for Brazil, a survey released separately on Friday, showed that manufacturing activity contracted for a second straight month in May as output and new orders fell.

Household consumption, the driving force of Brazil's economic boom over the last decade, expanded 1 percent in the first quarter from the previous quarter.

Gross domestic product had been expected to expand 0.5 percent on a quarter-on-quarter basis, according to the median forecast of 29 analysts polled by Reuters.

Latin America's largest economy grew 0.8 percent in the first quarter compared with the year-earlier period, IBGE said. That was below expectations of growth of 1.3 percent, according to the median forecast of 25 analysts in the poll. - Reuters