Financial tightening and impacts of Rio Grande do Sul’s floods pose significant uncertainties for the year’s outlook

06/05/2024

---

Domestic absorption, which includes household consumption, investments, and government spending, rose by 1.6% in the first quarter — Foto: Maria Isabel Oliveira/Agência O Globo

Brazil’s GDP showcased robust growth in the first quarter of 2024, rebounding from a stagnant second half in 2023. The boost was propelled by a mix of one-time factors, including significant court-ordered debt payments and more enduring elements that bolstered household consumption and services. Investments saw a considerable recovery, and agricultural outputs exceeded expectations. However, the outlook for the upcoming quarter appears less promising.

While the resilience of the labor market and elevated household disposable income might persist through 2024, other elements introduce greater uncertainty. Worsening financial conditions amid a less favorable interest rate forecast and the ongoing repercussions from the catastrophic floods in Rio Grande do Sul contribute to a murky economic forecast. Economists are divided over the net impact of the state’s destruction and its subsequent reconstruction on the national GDP.

Brazil’s GDP experienced a 0.8% increase in the first quarter of 2024 compared to the fourth quarter of 2023, according to seasonally adjusted data. This growth slightly surpassed the median forecast of 0.7% projected by Valor from consultations with 73 financial institutions.

Economic activity in Brazil has rebounded from the stagnant second half of 2023. The Brazilian Institute of Geography and Statistics (IBGE) revised the GDP variation for the fourth quarter of last year from zero to a decline of 0.1%, following a modest rise of 0.1% in the preceding quarter.

According to Goldman Sachs, compared to the first quarter of 2023, GDP in 2024 expanded by 2.5%, surpassing the median forecast of 2.2%. In real terms, the economy is now 7.8% larger than its pre-pandemic level.

Economists suggest that the “carryover” left by the first quarter’s GDP implies a baseline growth of 1% for the year.

Following the recent IBGE release, some financial institutions have revised their 2024 GDP forecasts for Brazil upward, even considering the potential impact of the floods in the South. For instance, Goldman Sachs adjusted its growth projection from 1.9% to 2.1%, and Barclays increased theirs from 1.9% to 2.2%. “This adjustment reflects a stronger start to the year, offset by the ongoing uncertainty surrounding events in the South,” commented Roberto Secemski, Barclays’ chief economist for Brazil, in his report.

“We had impacts from the floods, which could affect not only agriculture but also industry and services, particularly from the supply side. However, the positive surprises in the first quarter’s GDP support our previous projection of 2.2% growth,” said Laiz Carvalho, economist for Brazil at BNP Paribas, in a commentary.

Domestic absorption, which includes household consumption, investments, and government spending, rose by 1.6% in the first quarter of 2024, compared to the fourth quarter of 2023, fueled by robust household consumption and investments. In contrast, Goldman Sachs noted that in the fourth quarter of 2023, this increase was just 0.1%.

Conversely, the net contribution of the external sector to GDP in the first quarter of this year was negative by one percentage point (pp), as imports surged significantly more than exports—6.5% compared to just 0.2% in the last quarter of 2023. Additionally, changes in inventories contributed 0.2 pp to GDP growth, according to XP.

As household consumption rose “well above GDP,” the savings rate dropped from 17.5% in the first quarter of 2023 to 16.2% in 2024, notes Rebeca Palis, IBGE’s national accounts coordinator. This marked the lowest rate for the first quarter since 2020, when it stood at 14.3%. According to a report by Genial Investimentos, the behavior of the savings rate at the start of 2024 suggests “that part of the solid year-over-year performance of household consumption was due to domestic dissaving.

The investment rate remained nearly constant in the first quarters of 2024 and 2023, at 16.9%, down slightly from 17.1%. Ms. Palis clarifies that this consistency was due to parallel growth in investment and GDP. The rate of 16.9% in 2024 was also the lowest for the first quarter since 2020, when it was 16.2%. However, some economists highlight progress compared to the fourth quarter of 2023, when the rate dipped to 16.1%.

According to Banco ABC Brasil, these investment and savings rates align with a potential GDP growth of between 1.5% and 2%. Despite this, the country appears to be expanding above these figures, which could pose challenges in terms of inflation.

Gross Fixed Capital Formation (GFCF), which quantifies investment in machinery, equipment, construction, and innovation, remains 15.1% below its peak in the second quarter of 2013—over ten years ago and prior to the 2015-2016 recession. This metric is part of the national accounts’ historical data, initiated in 1996.

Ms. Palis highlighted that GDP, services, household consumption, and government consumption have reached their highest levels since records began. Agriculture nearly matches its record high from the first quarter of 2023, yet the industrial sector still lags, currently 7.2% below its peak in the third quarter of 2013.

On the supply side, the industrial sector was the only one to register a decline when comparing the first quarter of 2024 with the final quarter of 2023, dropping by 0.1%. However, economists highlight a positive shift in the manufacturing segment, which, after two consecutive quarters of stagnation, rose by 0.7% at the beginning of the year.

“When you look at the first quarter of 2024 compared to the fourth quarter of 2023, the three industrial sectors that are declining are the same ones that experienced significant growth last year,” notes Ms. Palis, describing the general trend in the industrial sector at the start of 2024 as “slightly downward.”

The industrial sector encompasses manufacturing and extractive industries, along with construction and the production and distribution of energy and gas. The extractive industry saw a halt to seven consecutive quarters of growth, with a 0.4% decrease from January to March 2024. However, compared to the same period in 2023, this sector still shows a nearly 6% increase.

Some economists expressed disappointment with the construction sector, which declined by 0.5%. The energy and gas segment also experienced a decrease, falling by 1.6% compared to the fourth quarter of 2023. Ms. Palis attributes this to a high base of comparison since 2023 was a positive year following water-related challenges in 2022. Compared to the first quarter of the previous year, the industry involved in the production and distribution of electricity, gas, and water saw an increase of 4.6%. “A significant portion of this growth was driven by residential energy consumption. The beginning of the year was notably hot,” explains Ms. Palis.

The agricultural sector was expected to grow in the first quarter of 2024 relative to the final quarter of 2023 due in part to a weak basis for comparison—the sector contracted by 13.1% over the last three quarters of the previous year, notes Barclays. Yet, the sector exceeded expectations with an 11.3% increase, surpassing the median projection of 8.8%.

Despite concerns about adverse weather conditions for 2024 due to El Niño, even before considering the impact of the floods in Rio Grande do Sul, the first quarter’s GDP was predominantly influenced by soybean and corn harvests. These crops are more significant than those typical of the fourth quarter, such as oranges and wheat, explains Ms. Palis.

Despite the record harvest backdrop from the first quarter of 2023, agriculture experienced a 3% decrease this year, which still outperformed the anticipated 4.5% decline. “Production was slightly lower than last year, but still robust,” notes Ms. Rafaela Vitória, chief economist at Banco Inter.

However, the most notable performance among the supply components came from the services sector. It expanded by 1.4% in the first quarter of 2024 compared to the last quarter of 2023, surpassing the median estimate of 0.5%. This growth marked the best quarter-on-quarter performance for services since the fourth quarter of 2020, when the sector rebounded by 3.1% from the initial pandemic impacts.

Within the services sector, significant increases were seen in trade (3%), information and communication services (2.1%), and other activities (1.6%), many of which catered to family-related services.

Ms. Palis from IBGE points out that trade was spurred by the retail segment, which is closely tied to household consumption and was a standout in demand aspects. Information services benefited from growth in the internet and systems development segment, which is linked to investments, another prominent demand component within GDP.

“We haven’t seen the reliance on agriculture that characterized 2023, indicating a shift towards greater dependence on the external sector. When trade and services are driving growth, it signifies robust economic activity, suggesting an uptick in activity,” explains Mr. Gabriel Mota, head of variable income at Manchester Investimentos.

Lower interest rate pressures also played a role in boosting the services sector in the first quarter of the year, according to Mr. Claudio Considera, national accounts coordinator at Fundação Getulio Vargas’s Brazilian Institute of Economics (FGV Ibre) and head of the institute’s GDP Monitor. He particularly emphasizes the surge in the tourism sector, noting increases in sub-sectors like accommodation and food services, as well as transportation.

On the demand side, household consumption increased by 1.5% in the first quarter of 2024 compared to the previous quarter, surpassing the median expectation of 1.1% and reversing a 0.3% decline in the fourth quarter of 2023. This marked the most substantial growth since the 2% rise in the second quarter of 2022.

Economists attribute this robust performance to several factors: a strong labor market, rising wages, a real increase in the minimum wage, income transfer and anticipation policies, the payment of court-ordered debts, and more robust credit provisions. These elements collectively boosted families’ disposable income, thereby stimulating consumption during this period.

Mr. Secemski from Barclays highlights that the boost from the real increase in the minimum wage, effective from February, had a “ripple effect,” particularly significant given that almost two-thirds of public pensions are tied to the minimum wage.

“We believe that [household consumption] will underpin [GDP] growth throughout the year,” notes Ms. Carvalho from BNP Paribas.

Government consumption remained stable, following increases in every quarter of 2023 compared to the preceding three months. “This figure doesn’t include income transfer programs but rather reflects government spending on health, education, and security. It represents the final consumption of society,” explains Ms. Palis.

For many economists, the standout from the first quarter GDP announcement was the performance of GFCF, which surged by 4.1% compared to the fourth quarter of 2023, following a modest increase of 0.5% in that quarter. This 4.1% growth in GFCF marked the strongest quarter-on-quarter gain since the 6.4% rise in the first quarter of 2021.

Bradesco views the first quarter GDP figures as “positive news” and suggests “the economy’s trend growth might be slightly above consensus expectations,” according to a report led by Fernando Honorato at Bradesco.

Ms. Palis from IBGE notes that investments were bolstered by an increase in capital goods imports and strong performance in sectors like software development. “Software has seen significant growth again. It surged during the pandemic and then stabilized, but now this segment is even increasing in significance,” she explains.

“The decreasing trend in interest rates is beneficial; the appreciation of Brazil’s real aids the import of capital goods, as much of this equipment is sourced from abroad, and production declines are also lessening,” adds Ms. Palis. However, she cautions that the production of capital goods is still in negative territory when compared year-on-year.

Julia Gottlieb, an economist at Itaú Unibanco, acknowledges the growth in GFCF during the first quarter but notes that it remains insufficient to boost the country’s growth potential. “We expect it to increase over the next few quarters, yet it’s still at a low level,” she comments.

Genial Investimentos attributes the early 2024 rebound in GFCF to a more optimistic view at the beginning of the year regarding the extension of the monetary easing cycle, alongside a lower comparison base due to last year’s cumulative declines. “However, this recovery should be viewed with caution due to worsening conditions, particularly the rise in political and economic uncertainties in recent months,” the brokerage advises in a report.

In a briefing to clients, William Jackson, the chief economist for emerging markets at Capital Economics, indicates that Brazil’s strong economic performance in the first quarter may be fleeting, cautioning that it “does not herald the start of a robust recovery. We are skeptical that the growth observed in the first quarter can be maintained. Leading indicators suggest a weaker second quarter ahead,” he notes, pointing to a decline in the industrial PMI and the FGV consumer confidence indicator.

In the near term, economists anticipate a softer GDP performance for the second quarter, largely due to the pronounced effects of the floods in Rio Grande do Sul. According to estimates from ABC Brasil, the disaster is expected to reduce the anticipated growth for the quarter by between 0.4 and 0.5 percentage points—the bank forecasts a GDP increase of 0.4% for the period compared to the previous three months. Meanwhile, Santander and Genial Investimentos are projecting a mere 0.1% growth, and Rafaela Vitória from Banco Inter does not discount the possibility of a contraction in the second quarter.

The impressive GDP growth in the first quarter might have led G5 Partners to elevate its annual economic growth forecast from 2.1% to 2.5%. However, due to potential impacts from the Rio Grande do Sul disaster, Chief Economist Luis Otávio Leal opted to retain the existing projection.

“Our estimate would likely have been even higher if not for the uncertainties in Rio Grande do Sul,” notes Roberto Secemski of Barclays in a report.

Rebeca Palis from IBGE cautions that current market projections about the tragedy’s impact are still speculative at this stage. She emphasizes the importance of awaiting the IBGE’s monthly economic activity surveys, covering industries, agriculture, and commerce for May and June, to determine if the effects are widespread across sectors or more isolated.

*Por Alessandra Saraiva, Anaïs Fernandes, Ívina Garcia, Lucianne Carneiro, Marsílea Gombata, Marta Watanabe, Rafael Rosas, Rafael Vazquez — Rio de Janeiro, São Paulo

Source: Valor International

https://valorinternational.globo.com/