Brazil may have escaped recession, but not the minefield

November 26, 2014

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Brazil’s newly-re-elected government is set to announce on Friday that the recession that began at the start of 2014 is now over. But a minefield of risks surrounding Latin America’s largest economy recommends caution before celebration.

How to quantify the damage from an unprecedented police investigation that could incriminate dozens of politicians within Rousseff’s coalition? How to measure the harm caused by the ongoing U.S. Department of Justice investigation into Petrobras, the giant oil company that represents alone one tenth of all investments in Brazil, according to some estimates?

How to judge whether Brazil will lose its investment-grade rating if nobody knows yet to what extent the government of re-elected President Dilma Rousseff will cut spending and hike taxes? And what if Sao Paulo, one of the world’s largest cities, runs out of water? Reservoirs have never been so low, and it is unclear if there is a credible Plan B.

Economic modelling can’t do all of that.

Add to that the fact that Brazil’s statistics agency IBGE will change the methodology for GDP calculations in 2015, and you will end up totally lost if using current market consensus as an accurate guide.

“GDP numbers will become more precise with the new method, but it is more complicated to estimate it with the data we have available now,” wrote José Francisco de Lima Gonçalves, chief economist at Banco Fator, in a note.

Market analysts in a Reuters poll earlier this week said their best guess was that Brazil’s economy probably grew 0.3 percent in the third quarter after a 0.6 percent contraction in the second. Forecasts ranged from -0.1 percent (so no exit from recession) to 0.6 percent growth.

Nobody sees Latin America’s largest economy returning to its glory days over the next couple of years, but most analysts still see Brazil improving slowly through 2015 despite expectations of higher interest rates in the United States and soft economic growth in China. The median forecast for Brazil’s 2015 growth is at 0.8 percent. That is weak for an emerging economy, but still better than the 0.3 percent rate expected for 2014.

But things will not necessarily change only for the worse. Policy measures taken by Rousseff after winning re-election could improve business sentiment significantly and boost pent-up demand.

“Expectations in the market have fallen so low that engineering positive surprises, ironically, should not be that difficult,” Tony Volpon, the head of Americas emerging markets research at Nomura, wrote in a recent research note.

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