The sharp rise in Brazilian industrial production in May largely reflects a rebound from the drop in output seen in April. The sector has broadly stagnated over the past couple of months and the fall in June’s manufacturing PMI to below 50 suggests that the outlook for industry is getting worse rather than better.
• On the face of it, at least, today’s industrial production data were actually pretty good. For a start, output rose by a greater-than-expected 1.3% on the month, taking the annual rate of growth to 2.7% y/y (from-1.5% y/y in April). (See Chart 1.)
• What’s more, the breakdown of the contributions to growth looks encouraging too. In particular, capital goods production rose by 1.7% on the month, compared to a more modest increase in the production ofconsumer goods of 1.0% m/m. This is good news given our concerns that Brazil’s economy has become excessively skewed towards consumer spending at the expense of much-needed investment.
• But looks can be deceiving. The reality is that the jump in industrial output in May reflects a bounce from April (when production fell by 1.2% m/m) rather than a fundamental improvement in the outlook for the sector. Over the past couple of months, output has more or less stagnated. More worryingly, perhaps,while industrial production staged a rapid recovery after collapsing in late-2008, it has since struggled to break through its pre-crisis highs (in contrast, for example, with much of Asia). (See Chart 1.)
• What’s more, June’s manufacturing PMI (also released today) suggests that outlook is deteriorating rather than improving.
The headline index fell to 49.0, from 50.8 in May – below the 50-mark, which in theory at least divides expansion from contraction, and well below the 52-mark, which marks the dividing line in practice. (See Chart 2.) Although the relationship with actual activity data is far from perfect, at this level the PMI appears consistent with monthly falls in industrial production of more than 1%.
• The breakdown of the PMI survey shows a sharp fall in the output balance (to 48.8, from 52.4), the new orders balance (to 47.2, from 49.9) and the new export orders balance (to 47.4, from 49.1). Of course, at least some of the slowdown in output and new orders will be related to the temporary impact on global supply chains of the huge earthquake in Japan earlier this year. Note that Brazil is not the only country to report a drop in the manufacturing PMI today. But even so, we suspect that there are more fundamental forces at work, the most important of which is the continued strength of the currency.
• In nominal term, the real (BRL) is now trading at 1.55/$ - a fraction above its pre-crisis high of 1.56/$. But in real trade-weighted terms, Brazil’s currency is now more than 10% stronger than it was prior to the crisis.
The broad stagnation in industry, coupled with the on going boom in consumer facing sectors(notably retail) is the clearest sign that the strength of the real is distorting Brazil’s economy.
• As we’ve been arguing for well over a year now, the policy prescription is simple: fiscal policy must tighten in order to allow monetary policy to loosen (and the currency to fall). But there are obvious political barriers to such action. This raises the risk of a much sharper adjustment in the economy (and the currency) further down the line and we are becoming increasingly concerned about the growth outlook for 2013 on (for now we think growth will slow to 4% in 2012 and perhaps to 2-3% in 2013). In the meantime, we expect industry to continue to lag behind other sectors of the economy.
Neil Shearing Senior Emerging Markets Economist (+44 (0)20 7808 4985, neil.shearing@capitaleconomics.com)
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