Global Insight Perspective

Significance

Q1 GDP growth was at its slowest since the last trimester of 2003 and raises concerns about the short-term sustainability of the ongoing expansion cycle. Although most sectors showed growth deceleration in the first quarter, the behaviour of investment in particular raises serious concerns about the current state of the Brazilian economy.

Implications

Q1 GDP figures suggest that the ongoing monetary tightening by the central bank has decreased output levels. The negative effects of higher interest rates hurt investment in the first quarter, and the Brazilian economy faces challenges in 2005 with rising inflation and decelerating GDP growth.

Outlook

Global Insight does not expect a drastic turnaround over the remainder of 2005. Stubbornly high inflation levels and a softening global economy will prevent the Brazilian economy from making a strong rebound in the last three quarters of 2005, but there may be a minor rebound because of the resilience of the exporting sector and our forecast that inflation will begin a downward trend in the second half of 2005, allowing a small drop in interest rates.

Brazil's Q1 Economic Growth Worse than Expected

Brazil's Statistics Office (IBGE) laid out preliminary figures for GDP in the first quarter of 2005 and also issued revised data for full-year 2004. The institute now pegs growth last year at 4.9%, down from the 5.2% originally estimated. However, after a stellar performance in 2004, the Brazilian economy faces a much more challenging environment in 2005. The overall performance of the economy in the first three months of 2005 was worse than expected with rising inflation and decelerating GDP growth. Higher interest rates hurt investment in the first quarter and prompted a decline in key sectors such as construction, communications and manufacturing. The economy grew just 2.9% year-on-year (y/y) in the first quarter, down from 4.7% from the previous quarter. Investment grew just 2.3% y/y in the first quarter, down sharply from 9.3% in the previous quarter.

Strong Agricultural Sector Prevented a Bigger Slowdown in Q1

The Agricultural sector grew by a solid 4.2% y/y in the first quarter of 2005, which prevented a bigger overall slowdown over this period. According to IBGE, the agricultural sector benefited from the solid performance of key sectors such as soy and cotton. Meanwhile, the other two economic sectors of industry and services grew just 3.1% and 2.0%, respectively, over this period. Within the industrial sector, mining and manufacturing had the best performance over the first quarter, with growth rates of 3.7% and 3.6%, respectively. Although the mining results represent an improvement over the previous quarter, the performance of the manufacturing sector indicates a sharp slowdown compared with the last quarter of 2004, when it expanded 9.1%. Meanwhile, construction activity showed the worst result within the industry sector, with an expansion of just 0.6% over the first three months of 2005. This key sector has been hurt by rising interest rates and low levels of investment in public infrastructure. 

Within the services sector, commerce and transport showed the biggest growth rates over the first quarter at 4.2% and 4.1%, respectively. These positive performances had been anticipated by indicators such as retail sales and tax collections. Fortunately, the negative effect of higher interest rates on commerce has been low so far, but this could change in the next quarter. Similarly, the real estate sector had a moderately positive performance in this period, with an expansion rate of 3.7%. However, financial institutions, other services, government, and communications grew just 2.8%, 2.0%, 0.2% and -3.2%, respectively, over the first quarter. Some of these sectors have been hurt by increasing interest rates and rising uncertainty, while government services growth remains slow amid a relatively tight fiscal policy. 

Real Export Growth Continues to Surprise 

Brazil's export sector has shown great resilience over the last few months as it continues to grow at double-digit rates despite worsening domestic and external conditions. Exports of goods and services grew 13.6% y/y over the first quarter, down from 13.6% in the previous quarter, but still very solid. Moreover, this growth rate comes on top of a 20.5% expansion in the first quarter of 2004, which makes for a very high comparison base. Despite such resilience, we still expect some softening in the next three quarters as the global economy remains sluggish and Brazilian-made products become relatively more expensive because of the recent appreciation of the real. 

Meanwhile, imports of goods and services also remained strong in the first quarter. Real imports grew 12.2% y/y during this period, only down slightly from 12.8% in the previous quarter. This figure also comes on top of a very high comparison base, as imports grew 12.5% in the first quarter of 2004. Imports continue to benefit from a strong domestic currency and rising disposable income. We expect these conditions to remain in place for the most part over the remainder of 2005, although a slowdown in income growth due to the softer economy will prompt a similar reaction in import growth. 

Outlook and Implications

Lower-than-expected first quarter GDP figures make our initial 2005 economic growth forecast of 4% a difficult target. As a result, we have lowered this projection to 3.5% for the year as a whole. Our new forecast also takes into consideration the fact that interest rates are likely to remain high throughout the end of the year amid higher-than-expected inflation over the first five months of 2005. Nevertheless, we expect GDP growth to rebound somewhat in the last three quarters of the year, aided by fresh fiscal stimuli and the resilience of the export sector.