Brazil economic outlook, May 2024
Government efforts to drive revenue and strong consumer spending might fuel eventual growth, as Brazil’s economy deals with debt, tax deficits, and changing export patterns.
For Brazil, real GDP was flat in the second half of 2023, registering a rounded 0.0% growth in both quarters.1 Real GDP in the fourth quarter was still up 2.2% from a year earlier. Strong agricultural output at the beginning of the year allowed for an export surge, which supported economic output for the full year. By the end of the year, however, that support faded. Private consumer spending fell slightly in the fourth quarter, while exports grew by just 0.2%. Government spending grew by 0.9% in that quarter, and gross fixed capital formation—a measure of investment—grew for the first time since the third quarter of 2022.2
Looking ahead though, Brazil’s economy will likely grow. Banco Central do Brasil (BCB), the country’s central bank, has been reducing interest rates, which should support the recovery ahead. At the same time, the labor market remains tight, which has allowed for relatively strong wage growth that is expected to usher in higher consumer spending. However, exports likely weighed on growth for the first quarter of this year, and a relatively tepid global economy may prevent exports from adding much to growth soon. Fortunately, the drag from the agricultural sector is expected to diminish this year, which would put a floor under export levels. In addition, should the federal government miss its fiscal targets, higher taxes or lower federal spending may need to be implemented.
Headline inflation stood at 3.9% in March, considerably lower than the 4.5% inflation in February.3 On a month-to-month basis, prices fell by an annualized 2.9%, reversing strong monthly price growth in the previous three months that was mostly driven by food prices. Core price growth has been even more benign, at just 3.3% from a year ago in March (figure 1)—down from 4.2% in December 2023. Plus, on an annualized monthly basis, core prices were up just 1.1% in March—the third consecutive reading below 3%.4
The BCB is targeting 3% inflation this year, with an upper limit of 4.5%.5 With both headline and core inflation standing within inflation target bands, the central bank cut rates by another 50 basis points in March, bringing the Selic rate—the policy rate used by Brazil—down to 10.75%.6 The BCB is expected to cut rates further this year, as monetary policy remains contractionary even with the recent cuts. We expect the central bank to cut rates by at least another 150 basis points before the end of this year, which would bring the Selic rate down to 9.25% or lower.
With the recent rate cuts, the Brazilian real has weakened to a degree. Its value against the US dollar was 2.5 percent lower during the week ending April 26, compared to a year earlier.7 Much of the weakness is due to expectations that the US central bank will not cut rates as quickly as previously anticipated. More pronounced weakness in the currency could slow the BCB’s rate-cutting pace this year.
The unemployment rate has inched lower for the fourth consecutive month, dropping to 7.4% in March.8 Employment growth has accelerated since October and employment was up 2.5% from a year earlier in March. Tightness in the labor market has kept wage growth strong. Nominal wages were up 8.4% from a year earlier in March, bringing inflation adjusted wages up by 4.0%. Real wage growth had been just 3.1% in December.9
However, not all workers have seen such strong pay growth. Private sector workers with formal contracts saw lower rates of growth. Their real wages were up just 2.7% from a year earlier.10 Similarly, real pay for domestic workers was up just 2.0%. Wage growth was strongest for public sector workers and for those in the private sector without formal contracts, growing 5.0% and 5.9%, respectively.11
Agriculture takes down exports
After falling for three consecutive quarters, real agricultural output in the fourth quarter of 2023 was about where it was the same time a year before. Although this year’s soybean harvest is not expected to reach the highs seen last year, analysts expect it to be just 5% lower.12 That is enough to push agricultural production back up on a sequential basis, allowing it to be a positive contributor to GDP again. However, insufficient rains are threatening to undermine corn plantings and output.13
Weakness in the agricultural sector contributed to a steep decline in exports this year, compared with the lofty numbers achieved last year. For example, agricultural exports were down 20.8% from a year earlier in March, while total exports declined 14.8%.14 Even so, weakness in exports went beyond agricultural products. Mining, manufacturing, and other goods exports were all lower on a year-ago basis.
The relative weakness in the agricultural sector was also reflected in the destinations of Brazil’s recent exports. For example, exports to China plummeted 23.6% in March from a year earlier, though they were still up 9.8% in the first quarter compared with a year ago.15 Meanwhile, exports to the United States were up 21.3% from a year earlier in March (figure 2). The difference in export trajectories to Brazil’s two largest export destinations is due to the product mix sold. Brazil’s exports to China are heavily concentrated in just three products: iron ore, crude petroleum, and soybeans. Indeed, over 70% of Brazil’s exports to China were in those three categories in 2022.16 Exports to the United States are far more diversified. Crude petroleum is generally the top export, but few agricultural exports are destined for the United States as the nation has its own sizable agricultural production domestically.17
Missing fiscal targets
The federal government has targeted a primary balance, which excludes interest payments, of 0% of GDP this year. The primary balance is then supposed to turn into a 0.5% of GDP surplus in 2025 and a 1% of GDP surplus in 2026.18 These targets are meant to stabilize Brazil’s federal debt as a share of GDP. Indeed, federal debt to GDP has grown to 60.1% in 2023. Federal debt was below 40% of GDP as recently as 2014.19 Stabilizing debt is critically important as government spending is increasingly being allocated to interest expense rather than for public goods and services. In addition, market perceptions of a rise in default risk could lead to a drop in the value of the currency, stronger inflation, and higher interest rates.
Unfortunately, the government will likely miss its targets. A survey of economists from the BCB shows a primary deficit of 0.7% of GDP this year and a deficit of 0.6% next year.20 The targeted primary surplus figures come with a tolerance band of 0.25% of GDP, but if surveyed economists are right, the primary deficit will come in below the lower bound of the tolerance bands. As a result, policymakers are already preparing to adjust their target for 2025 to lower.21 To stabilize debt and meet primary balance targets, government will need to cut spending or increase revenue.
Policymakers are keen to raise revenue rather than cut spending. The government already passed a law to greatly simplify its federal, state, and local tax system. Another bill that will be taxing offshore funds at a 15% rate was also passed late last year.22 The administration previously proposed a 20% levy on dividends. However, the policy stalled in congress. A new policy to tax dividends is expected to be proposed again this year.23
Policymakers are also pursuing other ways of collecting revenue. For example, they are eying a backlog of tax disputes that have been held up in court, which could yield a sizable amount of revenue.24 At the urging of President Lula da Silva, government-appointed board members of the state-owned oil company shot down expected extraordinary dividend payouts.25 However, that money may not ultimately go to additional investments that would raise production and therefore tax revenue, as policymakers had hoped.
Even with the challenges of fiscal policy and an uncertain external environment, Brazil’s economy is poised for stronger growth this year. The Banco Central do Brasil is expected to continue easing monetary conditions, which will provide consumers and businesses some breathing room when it comes to their debt burdens. Plus, households are in a relatively strong position to increase spending as the tight labor market has allowed for stronger inflation-adjusted wage growth. Additional disinflation will only benefit the consumer outlook.