Brazil’s economy likely avoided contraction in 2023. Real GDP grew by a modest 0.1% in the third quarter compared to the previous quarter, thanks to relatively strong consumer spending and exports, which were able to offset weakness in investment.1 Although we do not yet have the GDP numbers for the fourth quarter, we know that goods exports grew by 8.9% in US dollar terms,2 suggesting that the external position contributed to GDP growth once again. Plus, retail sales perked up at the end of last year, which indicates consumer spending continued to move in the right direction. Although business confidence remains relatively weak, there have been notable improvements since the third quarter of 2023,3 which bodes well for investment spending. The composite purchasing managers’ index for the fourth quarter also perked up, inching slightly above the neutral reading of 50.4
Looking forward to 2024, Brazil should be able to maintain modest real GDP growth—although at a lower rate than in 2023. Falling interest rates and the relative strength of the labor market are the clearest upside risks that could support consumer spending and reverse the fall in investment. But strong export growth seen last year could adjust downward this year as global demand weakens, especially for critical trade partners. Although the outlook for the government budget has partly improved, the risk still exists that the government may fail to convince investors that the budget will be balanced.
A strong consumer has been a clear driver for Brazil’s economy recently. Real consumer spending grew 1.1% over the third quarter of 2023, compared to the second one.5 In November, extended retail sales were up 4.3% from a year earlier in terms of volume.6 Some of the strength was due to a surge in motor vehicles and parts, sales of which were up 16.9% over the same period.7 Falling interest rates likely supported demand for autos. A central bank survey suggests that demand for consumer credit and mortgages has been strong overall.8
Consumers have benefitted from a relatively tight labor market. The unemployment rate fell to 7.5% in November—the lowest seen since 2015.9 The relative tightness of the labor market has pushed wages higher. Wage growth has been stronger than 8.5% on a year-ago basis for the last five months.10 For comparison, headline inflation had been running around 5% year over year during this period.11 As inflation continues to recede, consumers’ purchasing power will increase, allowing spending to continue rising in real terms.
The downside to consumer strength is its potential effect on inflation. After rebounding to 5.2% in September, inflation came back down to 4.6% by December.12 Core inflation—excluding volatile food and energy components—slipped to 4.2% the same month, the lowest rate seen since 2021. Base effects make these numbers look slightly higher than the monthly figures would otherwise suggest. For example, on a six-month annualized basis, core inflation was up by a more modest 3.3% in December. The improved inflation numbers are largely due to disinflation in goods. Strong agricultural output has held down food prices. Inflation for household goods and apparel were both below 3% in December.13
Services inflation has been slower to recede and is still running relatively hot. For example, health services inflation was 9.8% year over year, while recreation services inflation was 6.4%.14 Fortunately, housing inflation fell to 2.8% on a six-month annualized basis despite year-ago numbers not indicating much movement.
Pushing inflation even lower will likely face several challenges this year. Disinflation in goods is largely over, with price gains for numerous products running below Brazil’s central bank’s inflation target. Additional downward pressure among these items is unlikely. Plus, food prices could easily rebound should farm yields fall this year. After all, last year’s yields were extraordinarily strong. Services inflation should continue to come down. However, the progress may be slow due to relatively high wage growth. After adjusting for inflation, wages were still 3.8% higher than a year ago in November.15 For comparison, the average real wage growth in 2018 and 2019 was just 1.1%.
Even if inflation fails to moderate much further, the central bank still has room to make additional rate cuts. Real interest rates remain extremely high (figure 1). With the central bank’s policy rate down to 11.75% in December, the real interest rate was still 7.1% using year-ago headline inflation numbers.16 For comparison, the real rate averaged just 2.6% in 2018 and 2019. The last time the real policy rate was above 7%, the central bank cut rates by 350 basis points over the following nine months.17 The central bank has been taking a relatively cautious approach this time due to elevated interest rates in the United States. Fortunately, many investors expect the US central bank to cut rates by the middle of this year, which will give the Brazilian central bank more room to lower its own.
Falling interest rates have the added benefit of improving the outlook on government finances, which have been a source of concern for many investors. A government-implemented fiscal rule that ties spending to revenue has also helped alleviate some of the worst of those fears. Even so, government debt remains elevated as a share of GDP—so bringing the budget back to balance may take longer than the government anticipates.
More recently, Brazil passed a tax reform bill that is expected to simplify what is widely considered a complicated and burdensome tax regime.18 The current system involves five main tax levies that are collected through numerous levels of government. The new system will simplify this to two value-added levies—one collected at the federal level and one shared between states and municipalities.
The hope is that this tax-system simplification will allow businesses to allocate more resources to more productive parts of their business as resources needed to comply with the current tax law should diminish in the new regime. One major credit rating agency upgraded Brazil’s sovereign rating to two notches below investment grade, partly due to progress on tax reform.19
Although the simplification of the tax system is welcome news for business, its macroeconomic benefits will take a considerable period of time to materialize. The new system, in its entirety, will be phased in over the next five decades.20 Plus, the government will still need to determine what the new value-added tax rate will be. This crucial step will largely determine the financial health of the government. Setting the rate too low poses the risk of government losing revenue and exacerbating its debt levels. Setting the rate too high could weigh too heavily on economic activity.
Brazil’s exports continue to defy expectations for a slowdown amid waning global demand. In previous outlooks, we have discussed how huge crop yields—especially soybeans—have continued to strengthen export growth. We expected that exports would adjust downward thereafter. There had been some weakening in export growth in the third quarter of 2023, but it rebounded in the fourth quarter, with exports growing 6.9% year over year in US dollars.21 Disinflation likely masks the underlying strength of exports. For example, in kilograms, exports were up 14.1% over the same period.22 Agricultural products are still supporting growth, but related goods exports are also rising relatively quickly. Exports of prepared foodstuffs were up 25.2% year over year in the fourth quarter of 2023, while ores, slag, and ash exports were up 47.5%. Although not the largest source of export revenue, cotton exports doubled in December relative to a year ago. It seems that Brazil’s natural resources are the main drivers of its export growth.
Demand for these natural resources and related products is also predominantly coming from China. Vegetable products exports to China were up by a staggering 111.9% from a year earlier in the fourth quarter, while mineral products exports were up 41.3%.23 Some of this growth is flattered by a low base in 2022, when China was still under pandemic-related restrictions. However, China’s demand for Brazilian goods has outpaced the rest of the world even when looking at a longer time horizon (figure 2). For example, goods exports to China were up 62.3% in the last quarter of 2023, compared to the same quarter in 2019. To the rest of the world, exports were up by 52.6%.24
The upside from China in 2023 could present a downside to Brazil this year, however. Brazil’s exports to China are growing much faster than China’s underlying economy. With China’s growth expected to slow further this year, Brazil’s exports could come down along with it.
Aside from the downside risk coming from exports, Brazil seems to be in relatively good shape to keep growing this year. Falling interest rates should encourage more business investment, and a tight labor market will likely maintain much needed support for household spending. Government spending will likely remain restrained by both tax revenue and market perceptions of fiscal health. Still the downside risks are unlikely to outweigh the positives in the outlook.