First the positive bankers and traders: financial flows and assets have jumped in the last 14 months or so. The Bovespa has more than doubled as international investors have moved into one of the largest emerging markets.
The rally has also been enjoyed by many local investors, who rode the stock performance generated by a rapid fall in the country’s risk premium and lower debt servicing costs from the fall in the base rate. Selic (the central bank’s overnight rate) is expected to hit 6.5% – a record low. Just 14 months ago the central bank had Selic at 14.25%.
The lower ‘risk-free’ rate has created a small but important shift in domestic risk appetite, with bankers reporting healthy demand when raising new alternative asset investment vehicles, such as private equity, distressed debt funds and commercial real estate investments. And bankers confirm that many more of these non-traditional fund raising plans are in the works.
But despite the fall in interest rates, the real economy is failing to pick up momentum. True, it did return to positive territory in 2017, but barely. A 1% increase was a sideways move after a near 8% contraction in the preceding two years.
Bigger things were certainly expected for 2018. Many economists were predicting that GDP would easily beat 3%. Now the consensus is falling every time the central bank’s monthly publication comes out. The most recent forecast is 2.83%, and even this seems optimistic. The latest figures show a slowdown after four months of steady, if unspectacular, GDP growth.
Local newspaper Valor reported that one local consultancy, established by former president of the central bank Affonso Celso Pastore (AC Pastore & Associados), has recently rounded down its growth projections to 0.5% for the first quarter. If he is accurate, the economy would need to hustle into an annualized rate of 5.9% for the remaining three quarters.
Itaú Unibanco also sees first-quarter GDP growth of 0.5%, but it hasn’t lowered its 2018 GDP forecast of 3% (yet). It has, however, updated its commentary that risks “appear more to the down side”. Yet the bank says 3% is still realistic given the reduced Selic rate – which is now “expansionist” – the continued favourable global environment for EMs and the improvement in the balance sheet of companies and individuals in Brazil.
Unsurprisingly, the government is maintaining its forecast of 3% – any lower would complicate the already difficult fiscal position after the failure to reform pensions. Also, analysts quickly point out that, as finance minister Henrique Meirelles tries to find a path to candidacy for the presidential elections, any cut to the 2018 prediction would be a needless self-inflicted setback to his already low chances.
So, what explains the long-lasting and increasing bifurcation of the financial markets and the real economy in Brazil? There are many plausible explanations.
The first is that the financial flows usually come first anyway. None of the economists currently revising their GDP forecasts lower is moving them anywhere near negative territory. Expansion is underway and will continue, just at a slower rate than we have seen in the financial markets. This could just be a time lag.
Some argue the financial flows are actually impeding the real economy. The country’s currency has been strengthening (although in March there was a slight correction in this longer-term trend).
Neal Shearing of Capital Economics said in recent client note that the lower-than-expected GDP figures are “the first sign that the strength of the real is becoming a problem for Brazilian producers.”
Another issue is the still elevated spread banks charge for credit in Brazil. Even with the base rate at 6.75%, consumers are being charged over 46% on average. Throw in an unemployment rate of more than 12% and it is easy to see why the country isn’t being tempted into a new credit binge, however many records the central bank breaks for its new low rate.
Such consumer behaviour also feeds into corporate activity. If consumers are not showing demand for credit, then that puts a speed limit on corporate growth. Add in the political uncertainty and, again, the lowest interest rates in decades (corporate rates are still double on average the Selic rate, thanks to the spread bancario) haven’t sparked a spike in credit demand.
At some point, one feels, there will need to be some convergence; either the economy speeding up or the financial markets correcting. It will probably be the former when Brazil sees increasing growth once the political uncertainty is resolved, the unemployment rate slowly comes down and as banks reduce their spreads.
But for now, the discrepancy between the real economy and the financial sector is an example of the relative impotence of the monetary policy rate in isolation.