With rising commodity prices, Brazil’s terms of trade1 have improved considerably (chart 1), resulting in a recovery in confidence indices for both households and businesses. Real activity indicators remained mixed, however. In the fourth quarter, economic activity shrank by another 3.4% on an annualised basis.
Further declines in capacity utilisation rates, still-high interest rates and the deleveraging begun in early 2016 suggest that business investment will remain weak in 2017. As for households, the steep run-up in unemployment (chart 2) is squeezing their purchasing power. And exports are unlikely to support growth either, due mainly to the real’s 30% year-on-year appreciation vs. all currencies.
Meanwhile, faced with a massive worsening in public finances, the new government has set off clearly down a path of fiscal rebalancing. A law capping spending at the previous year’s inflation rate has already passed, and a social welfare reform bill (pensions in particular) is currently being discussed in parliament. So fiscal policy will lend no support to economic activity in the coming years.
In light of the above, the monetary lever is the only one left. The sharp drop in inflation (chart 3) – from 10.7% in early 2016 to less than 5% in February 2017 – has given the central bank some manoeuvring room. It has thus begun to lower its key rates – from 14.25% last autumn to 12.25% in February. If inflation continues to recede to the 4.5% target and if government promises to shore up public finances are believed, that should be enough for the central bank to continue (or even accelerate) its easing cycle. As a result, after falling by 3.6% on average in 2016, economic activity is likely to turn up slowly (chart 4): growth could then stay close to 0% in 2017, followed by 2.0% in 2018.
1Terms of trade: the ratio between export prices and import prices