Brazil economic outlook, November 2024
Brazil’s economy saw strong growth in 2024 despite previous rate hikes to combat inflation. The government must now focus on reducing its deficit to gain investors’ trust.
Brazil’s economy has performed better than expected: Real gross domestic product grew by an annualized 5.9% between the first and second quarter of the year and was up 2.8% from the previous year.1 The strong performance came despite relatively disappointing output in the agricultural sector, which fell 3.2% year on year.2 Consumer spending and business investment were notably strong in the second quarter. Economic growth appeared robust in the third quarter as well. Monthly real GDP was up 4% from a year earlier in August,3 while the central bank’s economic activity index was up 3.9%.4 The September composite purchasing managers’ index—a forward-looking indicator of economic health—increased to 55.2, which indicates strong economic growth.5
All of this is much better than what was anticipated at the start of the year: In January, many forecasters expected Brazil’s economy to grow by just 1.6% for 2024. However, the latest survey shows that the economy is expected to grow by 2.8% this year.6 Even so, the outlook for next year remains relatively modest, with forecasters anticipating just 1.9% real GDP growth.7 Higher interest rates, a relatively restrained government sector, and weaker external demand are likely to keep a lid on growth. Domestic demand from the private sector is expected to remain the engine of growth next year despite clear headwinds.
A hawkish turn for the central bank
The Banco Central do Brasil (BCB)—the nation’s central bank—made early progress on the recent bout of inflation in the economy. This allowed the BCB to lower rates from 13.75% in July 2023 to 10.5% in May 2024.8 However, at the September 2024 meeting, the BCB raised rates by 25 basis points. Headline inflation accelerated to 4.4% in September, which was up from 4.2% in August and just below the upper limit of the BCB’s inflation target range.9 According to meeting minutes, the BCB was concerned that the risks of stronger inflation were mounting, and that a more restrictive monetary policy stance was necessary.10
In September 2024, forecasters expected the BCB to raise rates to 11.75% by the end of this year, and for rates to fall only modestly throughout 2025.11 Despite clear upside risks to inflation, these expectations for interest rates may be overly hawkish. Core inflation was just 3.5% in September—about the same levels seen during the previous two months.12 The tamer performance of core inflation highlights that volatile food prices are one of the main drivers of inflation (figure 1). In addition, base effects are likely contributing to inflationary pressure. Housing goods and communications were among the strongest contributors to inflation numbers in September.13 However, base effects for both sectors are expected to improve notably by January 2025, which will likely limit further inflationary pressures.
There are other reasons backing the expectation that the BCB will limit its rate hikes. For one, a Selic rate of 10.75% is still very restrictive when headline inflation is just 4.4%. Central banks in developed markets, notably in the United States, are also becoming more dovish, which could allow the value of the real to appreciate over the next year. Plus, inflation expectations have come down quickly, even if they remain high. In September, inflation expectations for the next 12 months were 6%—the lowest reading since May 2021—and only slightly above where they were before the COVID-19 pandemic.14
Although the Selic rate is unlikely to rise all the way to 11.75%, the more hawkish stance is likely warranted. The depreciation of the real has created a significantly weaker drag on inflation compared to what had been seen earlier this year. Higher interest rates have slowed the depreciation of the currency.
It is the strong domestic environment that should be of most concern to policymakers trying to get inflation under control. The labor market continues to tighten, with the country’s unemployment rate falling to 6.7% in August 2024—the lowest reading since 2014 (figure 2).15 Meanwhile, the number of employed persons increased by 2.8% from a year earlier in August. Employment growth was also broad based across sectors.16 Labor-market tightness has allowed for very strong wage growth. In August 2024, average earnings were up 9.6% from a year earlier, which was the fourth consecutive month of wage gains above 9%.17
With wages running hot, the volume of retail sales grew by 3.2% from a year earlier in August.18 Consumers are more optimistic about their economic circumstances, with consumer confidence rising to its highest point in 2024 in September.19 Stronger domestic demand is not limited to consumers either. Business confidence experienced a slight dip in September compared with the previous month, but saw an increase of 4.2% from a year earlier.20 Gross fixed-capital formation was up 10.5% from a year earlier in July, driven by strong investments in machinery and equipment.21 Domestic demand is expected to remain robust in the coming quarters.
Government finances remain uncertain
The public sector is also adding to the inflationary environment. After implementing a fiscal framework designed to return the government’s primary balance to surplus in 2025 (after excluding interest payments), the government has had to push back its timeline, expecting a surplus to occur in 2026. Investors are more skeptical. Their latest survey revealed that they do not expect a surplus until 2029.22
The government expects a primary deficit of 28.3 billion reais (US$3.8 billion) this year, which is just barely within the tolerance band of 0.25% of GDP.23 At the same time, the government reversed some of its spending freezes, adding another 1.7 billion reais net to the budget.24 This has caused some investors to worry that the government is not serious about returning the budget to a primary surplus and that policymakers would instead keep running a primary deficit that is within the tolerance band.25 Even if this is true, it will still prevent the government from significantly raising its spending.
Returning the primary balance to a surplus is important because it will allow government debt to stabilize as a share of GDP. Despite the longer timeline to shore up finances, at least one major credit-rating agency believes that Brazil’s government is more creditworthy: Moody’s upgraded Brazil’s sovereign rating from Ba2 to Ba1 in September 2024, largely thanks to a stronger economy.26 This puts the credit rating just one notch below investment grade. However, two other major credit-rating agencies—Fitch and S&P Global—have kept Brazil’s sovereign rating two notches below investment grade.
Government finances represent an ongoing risk to the outlook. A more restrained fiscal position would limit some of the inflationary pressure in the economy and allow the central bank to return to a more dovish monetary policy stance. The good news is that the private sector is performing strongly now and is not yet in need of much more interest rate support. As growth is anticipated to slow next year, the private sector may require more of that support. Fortunately, the BCB is expected to begin cutting rates again next year, which is likely to cushion some of the slowdown.