In the last months, the sub-prime crisis was aggravated, culminating with severe financial difficulties of some important North-American and European banks and companies. While there is still some discussion on how deep will the US and European economies be affected, questions on how emerging market economies (EM) will be affected remain. There seems to be no simple or general answer to that, since exposure and economic structure vary significantly across EM countries.
With respect to Brazil, in particular, how deeply will its economy be affected? Is the Brazilian economy prepared to face the turbulent scenario ahead?
Undoubtedly, Brazil is more resistant to external shocks than in previous times. That can be credited to the external vulnerability reduction policy that resulted in a complete reversion of the net external debt position: Brazil moved from a 55.5% share of foreign currency linked debt to a creditor position in foreign currency of 28.0% of the total debt. In this sense, external shocks that previously depreciated the currency and increased public debt, worsening risk perception and feeding the Brazilian Real devaluation, nowadays result in Public Debt reduction as a percentage of GDP, thus becoming a stabilizing factor for the Brazilian economy.
In this article we use a set of macroeconomic indicators to show that Brazil is well prepared to face the new reality and, hence, is bound to absorb the shocks and adapt to the consequences of a global economic slowdown much better than in the past. External vulnerabilities were remarkably reduced, much has been done and the productive real sector is much stronger to bear the forthcoming cloudy days. It is also important to remember that, less than six months ago, market analysts were concerned about the fact that the economy could be overheated due the growing domestic demand.
The GDP growth1,2 achieved the 6.0% mark in the first semester of 2008, the best result since 2004. The higher than expected growth in the second quarter of the year was boosted by investments, which have beaten a 12 year record, and by the agricultural sector, which forecasts a track record for 2008 crops, reaching 143 million tons3. This result highlights some of the economical advantages of Brazil in face of the international scenario and shows that the country’s growth is currently driven by the domestic market. The Brazilian economy now benefits from years of stability and a suitable set of predictable macroeconomic policies.
The current economic growth cycle of the Brazilian economy is the longest since the beginning of the historical series, in 1996, lasting 20 quarters4 until now and with an accumulated expansion of 26.6% in the period. In this context, the objective of this article is to examine the extension and the intensity of the ongoing period of economic growth, emphasizing the dynamics of the domestic demand, especially regarding the investment path. In this sense, one should note that investment is far stronger in the current economic expansion cycle comparatively to previous ones, accumulating an expansion of 67.3% in the period (2003 III to 2008 II), thus consolidating the domestic demand as the main growth sustaining factor, in addition to the paths of credit, employment and real wage. It is evident that once the global recession unfolds, all countries will be affected, but because its particularities of exports diversification across countries and products, and its domestic market, Brazil it’s in a relative better position to go through this shaky period.
From the microeconomic point of view, Brazilian companies have improved a lot in the last years, regarding productivity, governance, generation of more qualified jobs and higher profitability. Well capitalized, the biggest Brazilian enterprises plan to maintain investment programs announced in 2008 despite the external conjuncture. Due either to the commitment with medium and long term contracts or to the great cash generation, the expectation of a relevant part of the industrial sector points to investment continuity even under a scenario of temporary, credit reduction.
In this sense, the optimistic perspectives of the domestic entrepreneurs impact positively on the continuity of the growing investment trend and consolidate the domestic demand as a crucial factor for the maintenance of the present economic expansion cycle. For the third consecutive year, the contribution of domestic demand is responsible, almost exclusively, for the economy growth. The analysis of the demand components keeps, hence, ratifying the importance of the domestic demand for the support of the economic activity growth process.
Brazilian GDP has been growing at increased rates in the last nine quarters, resulting in an average GDP growth of 4.5% in the last four years. Regarding the GDP growth in the last four quarters, one can highlight the Agriculture sector (7.0%), followed by Industry (5.5%) and Services (5.1%). Among the subsectors, it is worth mentioning the Insurance and Financial Intermediation (15.2%), Information Services (9.2%), Commerce (8.1%) and Construction (7.4%) sectors.
Despite the recent increase in the basic interest rate which now is at 13.75% p.y. in comparison to 11.25% in the beginning of the year, the 2008 growth prospects have not been influenced as market forecasts a 5.23%5 growth for this year.
When one compares the previous Brazilian economic performance with the current one, it is possible to observe that the international turbulence has had a much smaller impact on domestic growth as compared to previous experience. The market forecasts for 2009 and 2010 are of 3.00% and 4.00%, respectively, which is still higher than the 10 year average, even if smaller than 2007 and 2008 rates.
Even though the subprime crisis has shown to be more profound than imagined by analysts, market expectations for the 2008 GDP growth have been constantly increasing in the last two years. This indicates that market analysts tend to be conservative in their forecasts.
Economic Activity Indicators
Several indicators suggest that Brazilian growth is lead mostly by the domestic rather than the external market. The production capacity has been increasing over the years and investment is at its highest level in a decade. The investment rate has achieved 18.7% in the second quarter of the year, the best result since the first quarter of 2000, when it achieved 19.1%.
The Gross Fixed Capital Formation has achieved its peak since the beginning of the series in 1996, as well as the Apparent Machine Consumption Index, which measures the domestic consumption of machines. These data suggest that investments have followed the increase in the demand side, thus reducing the risks of future bottlenecks as the Plant Capacity Utilization indicates below.
When one looks at Capital Goods Production Growth Rate it is possible to clearly identify a level change in 2007. A growth rate of around 10% in previous years jumped to over 20%.
Credit achieved a 39.1% of GDP share in September compared to 28% in January 2006. This vigorous increase did not reflect in a higher default rate which, to the contrary, has been falling for over two years. This shows that there is still room for credit growth, especially when one compares Brazil to other countries. Government is especially concerned about this pace of growth – in this sense, the Central Bank monitors closely the sector and regularly conducts stress tests to check potential risks and balances.
It is undeniable that the increases in the credit rate together with higher GDP growth have stimulated consumption. The seasonal adjusted Retail Sales Volume Index shows that since 2004 general retail sales have been rising.
The conditions on the labor market are favorable, registering continuity of the reduction of the unemployment rate trend and the replacement of informal jobs by formal ones. In this scenario of higher formalization the course of increase of real earnings continues. The increase in the aggregate real wage, which is specially linked to the increase in occupation, shall continue in next months, as an important sustainability element for family consumption.
The higher GDP growth, in tandem with the acceleration of the investment rate and of the Gross Fixed Capital Formation, has had a large effect in employment. The unemployment rate has been falling consistently in the last three years, thus contributing to raise Central Government’s Revenues and boosting the domestic demand. The rate registered at October was the second lowest since the beginning of the series in 2002.
The fall in the unemployment rate was conjugated with an increase in formalization. In the first ten months of the year, 2.14 million jobs were created, which represented a new record for the series, 32.8% higher than the 2007 result. It is also important to highlight that, for the first time ever; over two million jobs were created in a single year.
Recently, a huge change in the social class structure was noted. The middle class (C) has become predominant. This was directly influenced by the higher economic growth as well as the formalization of the private sector, which helped to boost local demand.
The Foreign Direct Investment (FDI) can be regarded as an indicator of the level of international confidence in the Brazilian economy. In 2007, FDI amounted to R$34.6 billion, and the market forecasts point to R$35.0 billion and R$26.0 billion in 2008 and 2009 respectively, an extremely high amount when one considers the historical level and the crisis we are experiencing.
The confidence indexes (industrial and consumer) are at historically high levels. Probably, one of the main reasons for that is the good performance of the economy in recent years. This reflects future investment and consumption decisions and may indicate that the future growth will not be disrupted.
Both indexes decreased between April and October; nevertheless, the Consumer Confidence Index increased between July and September, remained stable in October and slightly decreased in November, showing that consumers are generally still confident.
Although the GDP future growth scenario is relatively comfortable, the Government has been conducting some actions to boost further the economic growth.
Until 2010, R$20 billion of tax exemptions6 are expected for the industrial sector. This will add to a series of other measures of financial, investment and export cost reductions, aiming at increasing external competitiveness and at setting the manufacture sector in a relevant position in the exports portfolio.
In addition to that, R$250 billion in investments, over the next three years, are projected to take place in 24 sectors, aiming at improving production capacity, technological innovation and modernization. Of this amount, R$210 billion will come from BNDES (Brazilian Development Bank) resources and from the budgets of the Development; Industry and Commerce, and Science and Technology Ministries. In addition to that, government will propose the accelerated depreciation of investments, reducing the taxes paid by companies.
One of the macroeconomic objectives of this policy is to increase the economy’s Investment Rate and the Gross Fixed Capital Formation from the current 15.5% to 21.0% of the GDP until 2010, an ambitious increase, which is considered crucial to make the sustained growth feasible over the years.
Compared to other countries, Brazil can be considered a relatively closed economy, with a trade to GDP ratio of around 22% in 2007. Considering that, one can say that the main impacts over Brazilian economy could derive possibly from the credit reduction due the international lack of liquidity instead of from a decrease in exports.
It is also important to highlight that the Government is carefully monitoring this turbulent scenario and will deliver its efforts to further the microeconomic agenda, which includes credit for the exports and a Tax Reform that is already being discussed at the Congress and is expected to be approved in the lower house soon.
Brazil has a solid financial system, less leveraged than developed countries and highly capitalized. Since 2004, the country has experienced a wave of Initial Public Offerings at BM&FBOVESPA stock exchange. Listed companies have raised over R$ 110 billion in public offerings in 2007 and 2008 and are ready to go on with their projects once the external outlook improves.
Additionally, Brazil presents a high level of political and social stability. After five well succeeded presidential elections, it’s clear that Brazil has a consolidated democracy. The country has a track record of policy continuity through political transitions having consistently achieved its primary surplus target, as well as the inflation target, representing one of the few countries that will meet the inflation target for 2008.
Recently, the Central Bank has taken a series of measures to increase liquidity both in dollars, by selling currency in the spot market, among other measures, and in domestic currency, by releasing part of the reserve requirements. Until the end of October R$54.60 billion on reserve requirement have been released and, potentially, there are almost R$100 billion to be released soon. These measures are important for the maintenance of the economic growth, as the credit has reduced worldwide.
In conclusion, one can say that the Brazilian economy is more prepared to face turbulent times and that the impact of the subprime crisis over Brazil will be limited, especially when compared to previous volatile periods. Economic activity indicators, such as Investment Rate, Gross Fixed Capital Formation and Plant Capacity Utilization indicate that the real economy has not been significantly affected by the subprime crisis. This can be confirmed by the increasing domestic demand, which is result of a higher employment rate, especially in the formal sector, in addition to a historically high credit level.