By Carlos Pallordet.
As the government announces yet another set of stimulus measures to bolster the faltering economy, market expectations for GDP growth in 2012 continue to plummet. Stagnant economic activity and a series of weak economic indicators are rapidly diluting the already modest GDP growth prospects for 2012 (Chart 1). According to the latest central bank survey, market watchers now expect GDP to grow 2.2% in 2012, down from 3.2% just five weeks ago (Chart 2).
While we expect the stimulus measures, announced in the first half of 2012, to lead to a gradual recovery of economic growth in the second half of the year, the sudden change in mood may hinder their effectiveness. Moreover, if signs of a revival do not appear soon, the situation likely will prompt calls for the government to relax the primary fiscal surplus target. We believe any relaxation of the fiscal target under the current circumstances would make things worse rather than better.
The plan, announced by the government on 27 June, encompasses an increase of BRL6.6 bn (USD3.2 bn) in state purchases of military, education and health equipment and a reduction in the cost of borrowing from the state development bank (BNDES) from 6% to 5.5%. Guido Mantega, Brazil’s finance minister, said the government would continue to adopt anti-cyclical policies to stimulate the economy.
Chart 1: Economic growth wanes
Chart 2: Market growth expectations for 2012 have plummeted
Two weeks before, Mantega disqualified a report from investment bank Credit Suisse forecasting 2012 GDP growth at 1.5%, saying, “It’s a joke. It will be much more than that.” But the bleak outlook is justified. With stagnant economic activity in the last three quarters, Brazil’s GDP growth remains the lowest among the BRICs. Industrial production continues to languish despite lower interest rates, a series of stimulus measures and a weaker local currency since March. Even consumer spending, the main pillar of growth, is showing some difficulties with loan default rates on the rise.
The sharp decline in market expectations for GDP growth, after remaining roughly unchanged for over six months, indicates that analysts have come around to the idea that Brazil will grow less this year than in 2011. The problem is that this gloomier outlook may in turn render the new stimulus measures less effective to bolster growth, as confidence is undermined. With growth momentum waning, the government may decide to give up its primary fiscal target of BRL139.8 bn (USD81 bn), equivalent to roughly 3% of GDP.
However, we believe this would be a bad idea for two reasons. First, altering the fiscal surplus target not only affects the government’s credibility but it also reduces the scope of the central bank to permanently lower the interest rate closer to levels in other emerging markets. Second, loosening the fiscal target would mean persisting on a path that has already proved ineffective. So far, much of the government stimulus package has involved tax breaks, import restrictions, capital controls, subsidised loans and other measures that provide temporary support to the economy. But if the government does not address the structural shortfalls that are concerning market watchers, stimulus measures will increasingly become ineffective in putting the economy back on its feet.