Brazil Economy Shrinks More Than Forecast on Falling Investment

Brazil's economy shrank in the third quarter more than economists forecast as above-target inflation, deteriorating fiscal accounts and rising interest rates sapped confidence and crimped investment.

Brazil's gross domestic product fell 0.5 percent in the third quarter from the previous three months, its first contraction in two years, after expanding a revised 1.8 percent in the second quarter, the national statistics agency said today in Rio de Janeiro. That was a larger contraction than the median forecast from 38 economists surveyed by Bloomberg, who predicted a 0.3 percent drop. Investment declined by 2.2 percent.

Earlier this year, President Dilma Rousseff's administration attempted to revive growth by extending tax cuts to stoke demand for durable goods, boosted subsidized credit to businesses and auctioned concessions for her $240 billion infrastructure program to draw private capital. Her measures fueled inflation and widened the budget deficit. At the same time, she didn't push for more sweeping changes to the tax and labor laws that would reduce production costs for the economy as a whole, said Jankiel Santos, chief economist at Banco Espirito Santo de Investimento.

"If Brazil had done what it was supposed to have, people would say there's tremendous potential here," Santos, who estimates investment fell 2.7 percent in the third quarter, said by phone from Sao Paulo. "Since we haven't done that, the market's looking at Brazil and saying it's time to fly away."

Swap rates on the contract maturing in January 2015, the most traded in Sao Paulo today, fell eight basis points, or 0.08 percentage point, to 10.67 percent at 9:09 a.m. local time. The real weakened 0.1 percent to 2.3547 per U.S. dollar.

Protest Perception

Growth in the world's second-biggest emerging market will accelerate this year to 2.5 percent from 0.9 percent last year, according to analysts surveyed by Bloomberg. That would be less than one-third China's rate and about half of India's. The analysts forecast a 2.4 percent expansion in 2014.

Protests that rocked the nation in the middle of the year deepened concern about the economy and how the government would respond with a presidential election coming next year, according to David Beker, Brazil economist for Bank of America Merrill Lynch. Industrial and consumer confidence levels fell in July to more than four-year lows before rebounding partially in subsequent months, according to the National Industry Confederation and Getulio Vargas Foundation.

"We don't know how much adjustment we'll see in monetary policy or in fiscal policy, and that uncertainty makes it more difficult for companies to plan ahead," Beker said by phone from Sao Paulo. "You only make investments when you have long-term visibility, and that visibility declined over the last years."

Largest Hindrance

In the third quarter, 54 percent of Brazilian businesses said the largest hindrance to growth is economic uncertainty, according to a survey of 300 companies by Grant Thornton International. That's up from 36 percent in the second quarter.

Rousseff's government has repeatedly pledged to boost Brazil's investment rate, which was 19.1 percent of GDP in the third quarter, compared with 18.2 percent for all of 2012. Last year, China's investment rate was 48 percent of GDP, India's 36 percent, and Russia's 26 percent, according to the World Bank.

Even as growth contracted in the third quarter, the central bank continued the largest rate-raising cycle of economies tracked by Bloomberg in order to damp above-target inflation. The bank last week raised the benchmark Selic (BZSTSETA) for the sixth straight time, to 10 percent, marking 275 basis points of increases since April.

Consumer inflation in the year through mid-November accelerated to 5.78 percent after slowing for four straight months. Policy makers target inflation of 4.5 percent plus or minus two percentage points, and price increases have remained above the midpoint throughout Rousseff's nearly three years in office.

Consumer Demand

Economists in the latest weekly central bank survey forecast inflation of 5.92 percent in 2014, and a 10.5 percent Selic at the end of next year. Higher rates will hamper consumer demand, according to Andre Perfeito, chief economist at Gradual Investimentos.

"Household consumption is already at a very high level, and can't grow any faster," Perfeito said. "Credit is getting expensive for families. We can't control inflation and at same time have growth. We haven't created that magic yet in Brazil."

The central bank's campaign against inflation has been offset by deteriorating government accounts. The nominal budget deficit in October was wider than economists predicted and set a record for the month, adding to evidence that the administration will miss its fiscal policy target this year. The primary surplus, which doesn't include interest payments, was 1.4 percent of gross domestic product in the year through October, compared with the target of about 2.3 percent.

Better Outlook

As the government shifts its focus away from tax cuts meant to spur consumer demand, the outlook for growth is better than it was months ago, particularly as auctions for infrastructure concessions gather speed, according to Roberto Padovani, chief economist at Votorantim Ctvm Ltda.

The government in October auctioned the Libra offshore oil field concession and was paid a 15 billion reais ($6.4 billion) signing fee. Last month it sold rights to operate Rio de Janeiro's international airport, for which the winning bidder offered 19 billion reais, nearly four times the minimum asking price.

"We have a much better situation, but because of the confidence crisis in the recent past, people remain negative," Padovani said.