Brazil: Short-term pain…

Since the aftermath of the 2008 crisis, growth has steadily eroded and Brazil is now in recession (chart 1). This has come about as a consequence not only of huge losses in terms of trade (chart 2) but also of low business and consumer confidence. Heightened political turmoil – the government faces accusations of illegal campaign funding – has also exacerbated the downturn, while monetary policy tightening (chart 3) has further dampened activity.

After a continuous deceleration since 2011, domestic demand suddenly came to halt in 2013. Investment in particular fell sharply (chart 4). With the deceleration in activity, the labour market deteriorated and weighed on consumption while the recent increase in regulated prices pushed consumption further down (chart 5). Unfortunately, Brazil is badly positioned to benefit from currency depreciation because of its export mix: despite slow growth in domestic demand, Brazil’s current account has continuously deteriorated (chart 6).

Economic activity is now contracting in Brazil and a vicious circle of low growth/low revenue is in progress. Fiscal consolidation, although necessary, will continue to add to the slowdown (chart 7). Moreover, there may be further monetary policy tightening. Indeed, despite the slowdown, inflation as well as inflation expectations remain elevated (chart 8).

With a Central Bank determined to restore confidence in its ability to manage long-term inflation expectations at the expense of short-term economic growth, GDP should contract by 1.5% in 2015 and grow only moderately in 2016 (+1.0%).