According to London-based research firm Capital Economics, Brazil’s consumption-led development model is coming under increasing strain. In a recent Latin America report, the firm’s EM economics team led by Neil Shearing said that the country’s “credit growth is unsustainable, the housing market is overvalued and macro imbalances are starting to build.”
More details of the report below:
“Brazil’s economic boom is starting to lose some of its gloss. Admittedly, the economy seems to have returned to growth, having effectively flat-lined over the second half of 2011. The business surveys suggest that GDP grew by 1% or so in Q1. (See Chart 1.) But the crucial point is that the economy remains stubbornly “two-speed”, with the consumerfacing service sector still the main engine of growth. Meanwhile, manufacturers continue to struggle. (See Chart 2.)
• We remain concerned about the durability of Brazil’s “two-speed” model. Indeed, we think the current consumer boom may be reaching its limits for three reasons. The first is that the current pace of credit growth is unsustainable. Household balance sheets look stretched and there are signs that the rapid expansion of credit is stoking bubbles. We think the housing market may be overvalued by 30-50%.
• The second is that our global team expects most commodity prices to fall by 15% over the next year, in part due to weaker demand from China. This would worsen Brazil’s terms of trade and expose the failure to accumulate savings in the boom times. And the final cause for concern is that capital flows to EMs, including Brazil, are likely to be disrupted if, as we expect, Europe’s debt crisis pushes the euro-zone towards break-up.
• Admittedly, given a more supportive global backdrop, Brazil’s two-speed growth model could be sustained for a little longer – albeit at the risk of overheating in the near-term. But our more bearish view of the world economy is consistent with a period of below trend growth in Brazil. The good news is that inflation should fall further, nearing its 4.5% central target by end-12. (See Chart 3.) This should allow further policy easing. We expect interest rates to fall to a record low of 8% by the end of this year, with the real breaching 2.0/$.
Capital Economics expects Brazil GDP to expand by just 2.5% this year.