20 Sep 2018
Brazil is out of recession but the economy is still not firing on all cylinders. What is holding it back and do we expect this period of sluggishness to continue?
Following the 2016-2017 period when Brazil’s equity markets outperformed their peers in both the emerging and developed world, this year has been a complete contrast with the country being a laggard in the performance tables.
While a strengthening US dollar and rising US interest rates have brought fresh challenges for emerging markets in recent months, we need to take a step back to analyse Brazil’s latest shortcomings and assess whether the authorities can re-steer the economy back in the right direction again.
We believe that Brazil is suffering from economic hysteresis.
This refers to when a large recessionary shock seems to condition economic performance even after the recession ends.
The unemployment rate and international trade are other areas that are often used to explain the hysteresis effect.
The Brazilian economy contracted sharply in 2014-2016 when GDP fell 8% from peak to trough. This “Great Recession” was the deepest and longest in modern history.
Recoveries after “Great Recessions” tend to be shallow and fragile, and that has been the case in Brazil.
How the Brazilian economy has fared relative to its peers in the emerging world since 2010 is shown in Figure 1.
While Brazil enjoyed a period of steady GDP growth in the four years up to 2014, the country’s performance has widely diverged thereafter, leaving it firmly in the slow lane.
Although the Brazilian economy grew by 1% in 2017 and is expected to expand at a quicker pace this year -but not as much as initially hoped for given the recent truckers’ strike - the recovery remains weak.
This has left the country trailing below the lower quartile - evidence of post-recession hysteresis.
Figure 1: Real GDP comparisons
Source: UBS and Bloomberg, 30 August 2018. Peers = other emerging countries. Rebased to 100 = 2010
Even before the start of the recession in 2014 there were early signs of problems.
Figure 2 looks at industrial production, comparing Brazil once more to other emerging countries.
Brazil’s underperformance began around 2011 and got progressively worse for another five years.
Since emerging from recession last year, however, industrial production has picked up but again Brazil lags behind rivals and still remains in the lower reaches – testament of an economy that has gone through a deep contraction.
Figure 2: Industrial production versus emerging market peers
Source: UBS and Bloomberg, 30 August 2018. Six-month moving average, rebased to 100 = 2010
A positive consequence of hysteresis is lower than average inflation.
At the start of 2016, Brazil’s inflation rate stood in double digits.
Over the following months the headline rate fell sharply to an historic low of 2.5% before edging up lately to 4.5%, mainly due to higher energy prices and more expensive import prices as a result of a weaker local currency.
A benign inflation environment has given the central bank room to cut interest rates – the benchmark Selic-rate has fallen significantly over the past two years, down to the current 6.5% level from its 14.25% peak.
We believe that a low inflation and interest rate environment should provide a more beneficial and stable setting for companies to invest and operate in.
Consumer confidence levels are also on the up - rising to three-year highs – which should boost domestic demand.
The removal of protectionist measures under the Temer administration has started to lift investment and savings rates.
Firms are replacing machinery and other capital goods.
We believe there is a good chance that investment spending should return faster and stronger after the election uncertainty of 2018 passes.
As consumption growth gains momentum in H2 2018 and with investment expected to do even better in 2019, economic growth next year could impress at 3.5%.
Good GDP growth is likely to be supportive for company earnings as well as finally curing the patient from its bout of “hysteresis”.
Nicholas Mason is Emerging Market Equities Fund Manager for Invesco Perpetual.
This article is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.
Where Nicholas Mason has expressed opinions, they are based on current market conditions, may differ from those of other investment professionals and are subject to change without notice.