December 4, 2015

Brazil’s economy continued to worsen in the third quarter of the year as Latin America’s largest economy faces a perfect storm of high inflation, depressed confidence levels, low prices for export goods and political crisis. GDP tumbled 4.5% in Q3 over the same quarter of last year, which marked the largest contraction since the modern series began in 1996. The result was worse than market analysts’ already pessimistic expectations of a deterioration to a 4.0% decline. In addition, the Statistical Institute revised downward the GDP results from the first half of the year, lowering Q1’s previously-reported 1.6% fall to a 2.0% decline and Q2’s previously-stated 2.6% drop to a 3.0% contraction. On top of this, Brazil’s deterioration was broad-based, with every component of GDP deteriorating in the third quarter.



Q3’s downturn is highlighted by a large drop in private consumption, which contracted 4.5%—the worst result on record. Consumer confidence has fallen to record lows and households have seen their spending power eroded by high inflation and a weak real. Moreover, the unemployment rate has risen to levels not seen since the financial crisis and high interest rates along with the government’s austerity measures have muted borrowing and weighed on households’ income. Fixed investment also plunged at a record rate, falling a substantial 15.0% in Q3 (Q2: -12.9% year-on-year) amid low commodity prices and the grim economic outlook. In addition, government consumption deteriorated from Q2’s 0.3% fall to a 0.4% drop in Q3. President Dilma Rousseff has been trying to drastically cut government spending and comply with the country’s budget laws as collapsing tax revenues squeeze the government’s purse. However, a number of fiscal consolidation measures have been stalled in Congress, where Rousseff is facing elevated opposition.



On the external side of the economy, growth in exports of goods and services slowed from 7.7% in Q2 to 1.1% in Q3. Despite a large depreciation in the real, low prices for commodities and slumping global demand are limiting export performance. Meanwhile, imports deteriorated to the lowest level on record, contracting 20.0% (Q2: -11.5% yoy). The depreciated value of the real has pushed already-subdued demand down even further.



On a quarterly basis, the economy contracted 1.7%, which was a slight improvement from the 2.1% tallied in the previous quarter.



The dismal GDP reading underscores the number of challenges facing Brazil’s government. President Dilma Rousseff’s approval ratings have fallen in tandem with the economy and led to increased political gridlock, stalling effort’s to correct the country’s sinking finances. On 2 December, Congress initiated impeachment proceedings, thus increasing political uncertainty. While the impeachment process can take months and the situation is fluid, in the short term, fiscal consolidation measures and economic reforms will likely take a backseat to the impeachment proceedings. Commenting on this development, Joao Pedro Ribeiro, Latin America strategist at Nomura adds:



“If President Rousseff is indeed impeached, Vice President Michel Temer would take over. Temer is from the centrist PMDB party and is generally known for having a market-friendly agenda. He famously backed a PMDB-based list of policy intentions in recent months, which was interpreted by analysts as guidance to markets of what his policy stance would be in the event of his presidency – containing a market-friendly mix of economic measures. Additionally, we believe it reasonable to assume that Temer could have better conditions in which to govern as the PMDB and other centrist parties would be more likely to support a new administration. “

Brazil’s outlook is grim. The larger-than-expected Q3 contraction bodes poorly for the economy this year. Moreover, increased political uncertainty may depress confidence further and lead to greater policy inaction. LatinFocus Consensus Forecast panelists expect the economy to contract 3.0% in 2015, which is down 0.1 percentage points from last month’s estimate. For 2016, the panel sees the economy remaining in a deep contraction and falling 1.6%, which is down 0.5 percentage points from last month’s forecast.