Cablegate: Economic Growth Remains Sluggish

This record is a partial extract of the original cable. The full text of the original cable is not available.




E.O. 12958: N/A
SUBJECT: Economic Growth Remains Sluggish

1. Summary. The Brazilian economy is showing the sluggish
effects of high real interest rates, which were raised in
October, 2002 to contain growing inflationary pressure. On a
quarterly basis, GDP fell slightly in the first quarter of the
year. Annual results are somewhat better, growing 2.2%.
Industrial production has been particularly weak, particularly in
sectors that rely on domestic demand. End summary.

2. The Brazilian economy, to use a local term, "walked sideways"
in the first quarter of the year. Depending on the measure the
economy either declined slightly or is growing modestly. One
thing is certain, though, and that is that economic growth is
weak. This is largely due to the high interest rates, which
where increased by 8.5 percentage points since October to fight
inflation, reaching 26.5% in February, thus weakening economic
production. On June 18, the Central Bank lowered the benchmark
interest rate (SELIC) to 26%.

3. Part of the debate on the impact these high nominal interest
rates have on the economy depends on just how high they are in
real terms. Deflating the basic interest rate levels (SELIC) by
past inflation (IPCA), real interest rates ranged between 8-10%
in 2002 and the first quarter of 2003, as higher nominal interest
rates were offset by increasing inflation. However, forward-
looking inflation expectations have tumbled in recent months. As
a result, forward-looking real interest rates climbed up to 15%.

4. The GDP results, released by the Brazilian Institute of
Statistics and Geography (IBGE), showed that the economy grew
2.2% for the 12-month period ending in March. This represents a
steady improvement for the 12-month growth rate, which was 1.5%
at the end of 2002, 0.5% as of September, 2002, and flat (0%) at
the end of the first half of 2002. (Note that production was
weak in the last half of 2001 and the first quarter of 2002
because of the 2001 energy crisis. Given this low point of
comparison, the 2.2% growth through March suggests that the
economy remains sluggish.)

5. The concerns about a sluggish economy are reaffirmed by the
quarterly data, which show that the economy declined by 0.1% in
the first quarter of 2003, compared to the last quarter of 2002.
Analysts suggest that this downturn is an indication that the
modest uptick in growth that took place in the last quarter of
2002 has been suppressed by a tight monetary policy.

6. The good story lies in agriculture, which has pulled the rest
of the economy along. On an annual basis, all sectors showed
some growth, led by a strong agricultural sector: agriculture,
6.6%; industry, 3.2%; and services, 1.3%. On a quarterly basis,
however, industry, which accounts for about 37% of the Brazilian
GDP, fell by 2.2%, while agriculture rose 3.7% and services

GDP by Sector
March 2003

- First quarter 2003 Annual
- (seasonally adjusted)
GDP -0.1 2.2
- Agriculture 3.7 6.6
- Industry -2.2 3.2
- Services -0.1 1.3

7. The poor performance by the industrial sector is troubling,
since it has historically been an effective proxy for growth
trends. (Industry accounts for a larger share of the economy
than does agriculture, while the services sector, which is even
larger, is relatively stable.) The industrial sector displayed
its vulnerability to the interest rate increase imposed since the
last quarter of 2002. Investment has dropped due to credit
restraints (credit to industry fell 5% from Oct02-Apr03) and
consumer demand has fallen as well since real income has been
depressed by rising inflation (13% in the same period). On the
plus side, the Brazilian Institute of Industrial Development
(IEDI) points out that the industrial sector has benefited from
the excellent results of exports and a temporary recovery of
durable goods consumption prior to February 2003 (when the
Central Bank again increased interest rates by a percentage

8. IBGE releases industrial production data on a monthly basis.
Looking at industrial subsectors, intermediate goods had the most
favorable results, mainly due to the growing petroleum output and
the outstanding export performance of the pulp and paper sector.
Intermediate goods production increased 2.7% in the first four
months of 2002, compared to the same period in 2002. Capital
goods performed reasonably well, in part because of investment by
exporting firms that are facing capacity constraints and because
companies are switching to locally produced goods as part of an
import substitution process which was triggered by exchange rate
depreciation. But even so, according to IBGE figures, capital
goods output fell 1.5% in the first four months of the year.
Subsectors which depend heavily on the internal market (and
therefore on favorable credit conditions), such as durable goods
(e.g. automobiles and home appliances) and non-durables
(clothing, food, pharmaceuticals), fell 4.6% and 5.3%,


9. The demand side of GDP confirms the poor domestic
performance. Family consumption and investment both fell on
annual basis, (-0.9% and 2.0%, respectively), as well as on a
quarterly basis (-0.6% and 4.6%, respectively). Roberto Olinto,
the Head of the National Accounts Department of IBGE, attributes
the low consumption performance to falling real wage, low credit
availability and high banking spreads. Family consumption bears
the highest weight in the growth calculation, equal to about 60%.

10. Growth was driven by trade, with exports of goods and
services rising 12.9% on an annual basis, and imports decreasing
9.5%. Government consumption increased modestly, 0.5%. Export
success stories include high value added manufactures such as jet
planes and also mineral and agriculture products such as iron ore
and soybeans, all benefiting from a favorable exchange rate.

GDP, Demand components
March 2003

- First Quarter 2003 Annual
- seasonally adjusted
GDP -0.1 2.2
Family Consumption -0.6 -0.9
Government 0.5 0.5
Investment -4.6 -2.0
Exports -1.3 12.9
Imports 4.5 -9.5


11. The current reduction of economic activity also reflects on
unemployment rates. At the same time that internal consumption
and investment fall, the number of lay-offs tend to increase.
According to the Brazilian Institute of Geography and Statistics
(IBGE), the unemployment rate for the six main metropolitan areas
increased to 12.1% in March, from 11.6% in February. The number
of informal employees increased by over 9% for the last 12 months
prior to March, while the number of formal employees increased
only by 3.3%. The National Confederation of Industry (CNI) also
shows a 7.7% decrease in real industrial payroll on a twelve-
month basis.


12. Given the recent signals that a sluggish economy is slowing
even more, some analysts have revised downwards their estimates
for the 2003 economic growth. In the Central Bank survey of
market analysts, the average growth forecast is 1.8% for 2003
(four weeks ago, the average forecast had been 1.9%). The
official Economic Research official agency (IPEA) dropped its
forecast to 1.6%, from 1.8%. The recent Central Bank decision to
lower the SELIC rate 50 basis points, to 26%, probably will not
provide much relief this year, since the market was already
anticipating lower rates, real rates remain high given falling
inflation expectations, and there is a six-month lag before
changes in monetary policy have an impact on production.


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