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Depec-Bradesco Economic Highlights

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Year XIII Number 143 - June, 3 2016

Source: IBGEProduction and forecast: BRADESCO

Growth review for 2016 and 2017 prospects

Activity indicators have surprisingly shown positive results since early on in the year, suggesting a faster stabilization of the economy than originally anticipated.

Such uptrend was initially led by the confidence indicators, lower inventories (essentially in the industry, but also in commerce), and the improved prices of f inancial assets (such as the interest rate slope, exchange rate appreciation, and lower sovereign risk). The uptrend was later strengthened by multiple hard data indicators, such as the import and export of capital goods, toll circulation on highways, vehicle number plate licensing (light vehicles and trucks), supermarket sales, etc. Some of these indicators were highlighted in a specific

publication issued in April1.

Two more comprehensive indicators were disclosed last week: the first-quarter GDP – which showed a better variation than estimated (margin down 0.3%, compared to the -0.7% estimate) –, and industrial production in April (first relevant information for the second-quarter GDP), which also showed much more favorable results than expected.

Both indicators show a potential stabilization of the GDP in the second quarter. In fact, we are now estimating no variation in the GDP for the second and third quarters, followed by an increase of 0.2% in the fourth quarter. We estimate a drop of 3.0% for the year (compared to the previous estimate of 3.5%).

Igor Velecico

GDP – deseasonalized margin evolution

0,0

0,8

1,6

0,2 0,3

1,7

0,6

-0,2

0,4

-1,2

0,0

0,2

-1,2

-2,0

-1,6-1,3

-0,3

0,0 0,00,2

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

2,0

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Dec

-14

Mar

-15

Jun-

15

Sep-

15

Dec

-15

Mar

-16

Jun-

16

Sep-

16

Dec

-16

PIB

An in-depth analysis of the first-quarter GDP reveals the lingering downturn in household consumption rates and, as a result, in household absorption: household consumption was down 1.7% in the margin, compared to -0.9% in 4Q15. Despite the slightly underwhelming results, we believe there is

sufficient evidence suggesting a certain stabilization of consumption rates in the third quarter (vehicle number plate licensing and retail sales have already stabilized, while the consumption of services – which are inherently less cyclical – are still stabilizing.)

1 Depec-Bradesco highlight dated April 29, 2016.

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GDP and domestic absorption (ex inventories) – margin variation in %

Source: IBGEProduction and forecast: BRADESCO

1,8

-4,1

-1,9

2,31,6

1,2 0,9

0,0 0,2

0,0

1,6

0,3

1,7

-0,2

0,4

-1,2

0,0

0,2

-1,2-1,6

-1,3

-0,3

2,41,7

2,8

-3,5

-0,8

3,2 3,5

2,21,6

-0,1

1,00,8

1,41,9

0,60,1

-1,0

0,8

-2,5-2,7-2,1

-1,4

-5,0

-4,0

-3,0

-2,0

-1,0

0,0

1,0

2,0

3,0

4,020

08q0

120

08q0

220

08q0

320

08q0

420

09q0

120

09q0

220

09q0

320

09q0

420

10Q

0120

10Q

0220

10Q

0320

10Q

0420

11Q

0120

11Q

0220

11Q

0320

11Q

0420

12Q

0120

12Q

0220

12Q

0320

12Q

0420

13Q

0120

13Q

0220

13Q

0320

13Q

0420

14Q

0120

14Q

0220

14Q

0320

14Q

0420

15Q

0120

15Q

0220

15Q

0320

15Q

0420

16Q

01

GDPDomestic absorption

PIB E ABSORÇÃO DOMÉSTICA (EXCLUINDO VARIAÇÃO DE ESTOQUES) - TAXA DE CRESCIMENTO EM RELAÇÃO AO

Fonte: IBGEElaboração: Bradesco

A consumption contraction of 0.8% and increase of 2% in investments are expected for the second quarter, which should virtually stabilize household absorption in the margin. Both consumption and investment rates should start to improve in the second half.

We have maintained our growth estimate of 1.5% for 2017, above the market average (currently at 0.6%). The market’s uncertainty surrounding the strength of recovery is, in fact, related to the recovery of the final demand (government, investments and household consumption). There is no growth without final demand.

The main arguments for household consumption are that there is an ongoing deleveraging process in course to lower indebtedness or commit income, while unemployment rates will continue to rise and further compress the overall wage bill. When it comes to investments, the argument is that the actual use of installed capacity is still very low, and the monetary policy is still extremely contractionary. Therefore, the ongoing fiscal adjustment is clearly contractionary.

We will begin with the last argument. Most of the 2015 recession is attributed to the lower confidence, among economic agents, that the prospective trend of the public debt is sustainable. This generated enormous pressure over the exchange rate and sovereign risk, ultimately raising inflation and the market interest curve. Therefore, the uncertainty surrounding public finances negatively impacted the activity. In partial equilibrium (everything else constant), an expansion in spending boosts the activity. In general equilibrium, however, that is not always the case.

In addition, we disagree with the need for deleveraging households. We believe that consumption is currently at a very low level, partly due to precautionary reasons,

in light of the massive uncertainty surrounding the unemployment rate. As the economy starts to stabilize once again, such uncertainty fades and consumption can return to normal, even with higher unemployment rates for a few quarters.

However, let us assume, for a moment, that the market consensus expecting weak household demand is correct. In this case, we must shift our discussion towards inflation. Its most recent drivers are (i) the output gap, related to domestic demand; (ii) the behavior of the exchange rate; (iii) the credibility of the monetary policy; (iv) inertia and expectations; and (v) commodity prices.

In our view, a scenario of extremely low domestic demand renders the drivers (i) and (ii) clearly asymmetrical in the sense of mitigating inflation. Regarding drivers (iii) and (iv), the evolution of the Selic rate in 2015 was paramount to guide expectations towards the target. Therefore, we are left with an eventual commodity shock as a potential risk of inflation increase.

Hence, we believe that an environment of weak domestic demand generates an asymmetry in the prospective scenario for inflation and the Selic rate, as a result. In this case, uncertainties regarding growth should not lie on domestic demand, but rather on the ability of interest cuts to leverage the consolidated demand of the economy. There has not been any example of shortage of demand in Brazil so far. In 2012, when interest rates were lowered and the GDP did not grow, the economy featured good employment rates and a high current account deficit, which indicates that the problem lies in the supply, rather than demand. Therefore, we are confident that the GDP’s performance in 2017 will surpass market expectations.

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4,4

1,4

3,1

1,1

5,8

3,24,0

6,15,1

-0,1

7,5

3,9

1,9

3,0

0,1

-3,8-3,0

1,5

3,0

-4,5-3,5-2,5-1,5-0,50,51,52,53,54,55,56,57,58,5

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

GDP variation (%)

Source: IBGEProduction and forecast: BRADESCO

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Octavio de Barros - Macroeconomic Research DirectorFernando Honorato Barbosa Global economics: Fabiana D’Atri / Felipe Wajskop França / Thomas Henrique Schreurs Pires / Ellen Regina Steter Brazil: Igor Velecico / Estevão Augusto Oller Scripilliti/ Andréa Bastos Damico / Myriã Tatiany Neves Bast / Daniela Cunha de Lima / Ariana Stephanie ZerbinattiBrazilian sectors: Regina Helena Couto Silva / Priscila Pacheco TrigoProprietary survey: Leandro Câmara Negrão / Ana Maria Bonomi BarufiInternships: Gabriel Marcondes dos Santos / Wesley Paixão Bachiega / Carlos Henrique Gomes de Brito

Team

DEPEC - BRADESCO does not accept responsibility for any actions/decisions that may be taken based on the information provided in its publications and projections. All the data and opinions contained in these information bulletins is carefully checked and drawn up by fully qualified professionals, but it should not be used, under any hypothesis, as the basis, support, guidance or norm for any document, valuations, judgments or decision taking, whether of a formal or informal nature. Therefore, we emphasize that all the consequences and responsibility for using any data or analysis contained in this publication is assumed exclusively by the user, exempting BRADESCO from all responsibility for any actions resulting from the usage of this material. We all point out that access to this information implies acceptance in full of this term of responsibility and usage. The reproduction of the content in this report (partially or in full) is strictly forbidden except if authorized by BRADESCO or if the sources (the name of the authors, publication and BRADESCO) are strictly mentioned.