Morgan Stanley now expects weaker recovery in Brazil

RIO DE JANEIRO, BRAZIL – The indicators that reflect supply showed a stronger recovery of the Brazilian economy early in the year, but may be a “false positive,” according to Morgan Stanley.

Placing greater emphasis on a scenario of weak demand, the bank’s economic team for Brazil countered the latest wave of upward revisions and recently cut its estimate for Gross Domestic Product (GDP) growth this year.

“Despite all the improved data on the supply front, we see weak numbers from a demand standpoint, mainly due to the labor market,” said André Loes, Morgan Stanley’s chief economist for Latin America.

“This is concerning for household consumption, which represents two-thirds of GDP on the demand side, and will impact growth,” he said.

Reviewing the economic scenario for the continent, Loes and his team of economists point out that recovery is on the way. The “notable exception” in the region is Brazil, the bank points out, where the second wave of the pandemic, the delays in the vaccination schedule, and the limited room for fiscal stimulus call for greater caution in the estimates.

The institution expects the country to grow less than the Latin American average this year, whose GDP is expected to rise 4.2%. “Our projections favor countries with better fundamentals, which enjoy a healthier credit profile and are better positioned to benefit from the strong recovery in the U.S. and China,” the economists say. Chile and Mexico would be the Latin American peers that meet these criteria.

In Brazil, consumption will be the major factor for low growth expected for the year, according to Loes, and the bank’s models point to a large contraction in household demand in the first half of the year, only 2.1% over the fourth quarter of 2020.

According to Morgan Stanley, Brazilian consumers seem to be facing a “perfect storm” in the first half of the year, with reduced government income transfers, restrictions on mobility, mainly in March and April, high unemployment and declining labor income.

In February, the employed population was still 8.3% below the pre-pandemic level of February 2020, Loes notes. Real income mass was 5.8% lower.

The trend is for employment data to remain poor in the coming months, given that the worsening of the pandemic and the resulting reduction in mobility decrease job creation, particularly in the informal market, he assesses. According to the bank, employment should only return to higher levels in the third quarter.

In the opposite direction, indexes such as industrial production, retail sales, and volume of services provided signaled greater dynamism in activity, Loes acknowledges. It was these and the Central Bank’s Economic Activity Index (IBC-Br) – the latter with greater capacity to “predict” GDP performance – that were responsible for raising other banks’ growth projections for the year, which are now closer to 4%. But production, sales and services data do not always “communicate very well” with GDP, Loes said.

This loss of consistency can be exacerbated in situations like the current one, in which the seasonality of statistics has been impacted by measures such as anticipating holidays and lockdowns, Loes added.

“I think we will be negatively surprised compared to what the market is projecting. I don’t know if it will be such a big surprise, but I think it is very difficult, with this weakness in the labor market and income issues, not to be disappointed with the first quarter GDP,” he stated.

Due to the expected drop in consumption, Morgan Stanley is working with a technical recession scenario in the first half of the year – when GDP shrinks for two successive quarters, in a seasonally adjusted comparison. On average, the bank estimates that household consumption will grow by only 1.7% in 2021, after dropping 5.4% in 2020.

On the positive side, a more favorable external scenario should sustain a greater increase in investments, which should rise 6.2% within the GDP on average for the year, as well as a positive performance in exports, estimate Loes and economist Thiago Machado.

However, the Brazilian economy is less open, and therefore tends to benefit less than other Latin American peers from the appreciation in commodity prices, they point out.

The fragility of public accounts is another factor hindering growth in Brazil, as it has a negative impact on confidence and reduces the room for government stimulus, Loes adds.

The bank expects a significant reduction in the primary deficit between 2020 and 2021, from 9.4% to 3.8% of GDP, but does not envisage a favorable scenario for the approval of structural reforms.

Regarding the pandemic, Morgan Stanley is not working with a third wave in the country, but that would be a risk for projections, Loes says. “The rolling averages of hospitalizations and cases have stopped declining. We have to pay attention to that.”

The economist does not expect any increase in the vaccination rate, which should remain at the projected 900,000 daily doses until the end of the year, he believes.

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