Year of 2004 starts with favorable economic signs
Few years have started out as 2004 has: a favorable foreign scenario, domestic economic activity in a recovery mode and growing corporate and consumer confidence. This year the PT government will collect the benefits from the responsible policies and attitudes it has demonstrated in its first year in office. Brazil started 2004 announcing a new government issuance. The foreign scenario is marked by strong international liquidity and hearty investor appetite for bonds coming from emerging economies. These factors open up an excellent opportunity to issue sovereign bonds.
In the domestic front, the industry is growing, retail sales were positive during the Christmas season and inventory is low, sustaining the demand for restocking. Long-term interest rates have dropped to 15% per year, credit is being expanded, confidence improves and there is a repressed demand for durable goods. Investments in machinery and equipment are also reacting well. The recovery of semi durable and non-durable goods is limited due to the retraction of income, but a slow recovery of the labor market will improve the segment’s performance. In agriculture we expect another record harvest. The maintenance of the primary target at 4.25% of the GDP already incorporates a fiscal expansion and during the last few months foreign demand has returned to favorably contributing to activity.
This panorama shows that restrictions to growth are not due to a structural problem in demand but in inflation. With interest rates and required reserves high, there is no lack of capacity to induce consumers to buy in Brazil, despite the depressed income, credit or a reduction in public spending. With the major worries about inflation behind us, the challenge now is not to induce demand, but to regulate the monetary policy to avoid excesses. The apparently favorable scenario hides the arduous task to be undertaken by the Central Bank: a scenario where demand is a primary source of inflationary pressure.
It is important to note that similarly to what was seen in December, inflation and core indexes will remain high in January and February. During this period there is usually a concentration of seasonal price increases. Inflation levels should return to more favorable levels in March. We forecast an IPCA (consumer price index) of 0.7% for January and 0.8% for February. This increase, however, cannot be interpreted as a deterioration of the inflation scenario. In terms of the fiscal sector, with the high government surplus and the recovery of the results from state-owned companies in November, the public sector registered a surplus of R$ 6.3 billion. This result increased the accumulated surplus for 2003 to R$ 70.3 billion. To comply with the R$ 65 billion surplus target established between the government and the IMF, December may register a deficit of up to R$ 5.2 billion. Usually both the federal government and state and municipal governments register deficits in December, but the deficit of December of 2003 should be lower than R$ 5 billion.
In the political scenario, the difficulties faced by President Lula in obtaining a consensus in relation to his cabinet reshuffling are not surprising. Such reform is complex, since each change must be compensated in another manner. It is important to note, however, that differently from other administrations, the Lula administration chose to organize a cabinet which is essentially composed of PT members. This cabinet reshuffling, therefore, should be more difficult than others done by prior administrations.
Cardoso X Lula: the image in the mirror
The dynamics of the Brazilian economy at the beginning of the Lula administration is the mirror image of what was seen during the first term of the Cardoso presidency. The government of Fernando Henrique Cardoso started out with an appreciated exchange rate, expanding income and domestic demand, easing of fiscal policies and a growth in the foreign deficit. The Lula government starts with a depreciated exchange, depressed income and domestic demand, tightening of fiscal policies and a spectacular foreign adjustment. Cardoso took over in the middle of a strong appreciation of the Brazilian real. The domestic demand took advantage of the credit growth and the wage indexation policy.
The fiscal policy, since 1993, has been easing so that the primary surplus which was approximately 5% of the GDP was reduced to zero from 1996 on. The combination of exchange and fiscal policies led to a rapid growth of the deficit in current transactions. In this context, the crises of 1997 and beyond led to an exchange crisis in 1999.
President Lula, on the other hand, took over under different conditions. With the fluctuating exchange rate, the threat of an irresponsible government led the exchange rate to surge in 2002. Inflation, following the exchange depreciation, reduced wages. The Central Bank reacted to the threat of the return of inflation by increasing interest rates. The government, to once again control the economy, reinforced the fiscal adjustment. Wages down, interest rates up and fiscal retraction led to the downfall of domestic demand. Demand decreasing, currency depreciated and growth of productivity in agriculture led to a fabulous foreign adjustment.
Cardoso started his term in a more comfortable situation and could have dealt better with foreign crisis. It is important to note that it was the combination of exchange (foreign exchange operations) and fiscal (growing nominal deficits) policies which made the situation worse when foreign shocks appeared. The exchange policy may have been sustained if the fiscal policies had been more prudent. If the fiscal policies had been anti-cyclical, the deficits in current transactions could have remained around 2%. Facing the crisis and the transition to a fluctuating exchange system could have been smoother. But that is all in the past. President Lula starts his term in a much more difficult position. For a president who promised during his campaign that he would ‘first feed the people and then export the surplus’, what occurred during his first year in office was not easy. In return, the room to grow is even greater than it was in 2000/2001.
There is a data of the Brazilian economy which deserves to be highlighted: the agribusiness boom. The agribusiness boom is a combination of the increase in investments and productivity in a context where domestic demand is retracting and foreign demand expanding. It is interesting to note the effect of the increase in productivity of the agribusiness sector. The increased productivity in a sector of tradable goods leads to an appreciation of the exchange rate and the increase of income. The growth of income increases consumption and the aggregate savings. In this case, if the investment does not grow at the same speed, there is an increase in the trade balance. The increase in productivity of a sector of tradable goods, therefore, allows for the simultaneous growth of domestic consumption and investments and of net exports. If, while productivity grows, domestic demand decreases, the tendency for the trade surplus to increase is even greater. The expressive increase of agricultural productivity is one more factor to turn the recovery even more sustainable, allowing for an increase of consumption and investments, with little impact over foreign accounts.