Macro scenario - Brazil

February 10, 2022

Postponed disinflation should drive Selic rate even higher

 The Omicron-related outbreak showed signs of stabilization in some cities in Brazil, after a significant
increase in cases and moderate pressure on hospitals. The risk of new variants remains, and reinforces the
importance of booster shots and of updating vaccines to fight virus mutations.
 We maintained our forecasts for GDP growth at +4.4% in 2021, -0.5% in 2022 and +1.0% in 2023. Data
figures for the end of last year were stronger than we anticipated, but the relative stability of economic activity
seems to endure.
 We revised our forecast for the consumer price index IPCA in 2022 to 5.5% from 5.3%, incorporating higher
inflation for food (following a change in the scenario for agricultural commodities) and services prices. On the
other hand, the improvement in the water situation led us to revise our call for the electricity tariff flag system
at the end of the year, to yellow mode from red mode level 1. Considering greater inertia from this year, we
lifted our estimate for the IPCA in 2023 to 3.5% from 3.3%.
 Fiscal sustainability is still a major challenge. Our estimates for the primary budget deficit worsened to 1.0%
of GDP in 2022 (from 0.8% previously) and to 1.3% of GDP in 2023 (from 1.1%). Gross debt should reach
84% and 87% of GDP in 2022 and 2023, respectively.
 Despite the recent appreciation of the Brazilian real, we maintained our year-end exchange rate forecasts at
BRL 5.50/USD in 2022 and BRL 5.75/USD in 2023. Even with higher interest rates, we reckon that significant
appreciation would depend on the reduction of external and domestic uncertainties.
 In light of the stage of the monetary-tightening cycle and the cumulative effects of the Selic benchmark rate in
significantly contractionary territory, the Copom should reduce the hiking pace going forward. We continue to
expect an increase of 100 bps in the Selic rate at the March meeting, but we now anticipate two additional
moves (50 bps in May and 25 bps in June), finishing the cycle at 12.50%, where it should remain until the end
of the year.

Economic activity: weakening trend is production has room to expand. However, the first
unchanged by better data in late 2021 figures for the sector in January point to a negative
outlook, as vehicle sales (Fenabrave report), vehicle
The strong increase in industrial production in production (Anfavea), and imports of electronic auto
December (+2.9% mom/sa) was the major parts decreased. Our preliminary estimate points to
positive surprise in recent data, but we believe a drop in industrial production in January.
that the weakening trend will persist. The
December increase was led by the auto sector, but
other sectors also showed growth after several
consecutive months of declines (see graph). On the
other hand, demand for industrial goods remains on
a downward trend, which got sharper at the
beginning of this year (see graph). Additionally,
industrial inventories are already near the historical
average. We believe that the downward trend in
demand for industrial goods will consolidate further,
mainly due to high interest rates and receding new
loans. The auto sector is the exception, as
inventories are still at historically low levels and

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Macro scenario - Brazil | February 10, 2022

We revised our year-end estimate for the

Industrial production advanced in December...
unemployment rate to 11.7% from 12.0% at the end
of 2021, while maintaining our call at 13.1% for the
125 200 end of 2022. Formal employment continues to
Seasonally-adjusted
120 2017 = 100 180 expand, but the average real income and the real
160 wage bill have declined in recent months. The drop in
115
140
the average real income is related to high inflation, but
110 could also be a sign of falling productivity in the
120
105 Brazilian economy.
100
100
80 2022 inflation estimate revised upward due to
95
60 higher agricultural commodity prices and
90
Ex-Vehicles 40 inertial items
Vehicles (rhs)
85 20

80 0 La Niña effects and the evolution of

Dec-12
Jun-13
Dec-13
Jun-14
Dec-14
Jun-15
Dec-15
Jun-16
Dec-16
Jun-17
Dec-17
Jun-18
Dec-18
Jun-19
Dec-19
Jun-20
Dec-20
Jun-21
Dec-21

indexed/inertial items at the beginning of the year

prompted us to revise our forecast for consumer
Source: IBGE, Itaú price index IPCA in 2022 to 5.5% from 5.3%. The
lack of rain in the South region of Brazil is behind
lower estimates for soybean and corn crops in the
... but the slide in demand for industrial goods 2021/22 cycle and the consequent increase in the
got sharper in early 2022
prices of these commodities. Therefore, we expect
130 steeper food inflation this year, close to 5.0%. We also
120 incorporated part of the upside risk in inertial items,
such as rent, building maintenance fees, and labor-
110
intensive services. Inflation should remain under
100 pressure in 1Q22, with core measures for industrial
90 and service items still running at high levels.
80
Meanwhile, aggregate reservoir levels in January led
us to change our forecast for the tariff flag system for
70
electricity bills in December 2022 to yellow mode,
60 which intensifies the expected disinflation for the
50 residential electricity item, now at -6.9%.
40 Demand (FGV)
Manufacturing production (PIM)
For 2023, in view of the greater inflationary inertia
30 from the previous year, we revised our IPCA
Jan-18
Apr-18
Jul-18
Oct-18
Jan-19
Apr-19
Jul-19
Oct-19
Jan-20
Apr-20
Jul-20
Oct-20
Jan-21
Apr-21
Jul-21
Oct-21
Jan-22

estimate to 3.5%, from 3.3%. The lagged effects of

the interest-rate hiking cycle and open output gap
Source: FGV, IBGE, Itaú should bring inflation closer to the target going
forward.

Our GDP forecasts point to stability in 4Q21 and a

0.4% growth in 1Q22. Our estimates for 2021 and
2022 remain unchanged at +4.4% and -0.5%,
respectively. The increase in GDP in 1Q22 is driven
by expected growth in agricultural GDP, while GDP
excluding this segment should shrink. Our expectation
of contracting GDP in 2022 is based on the impact of
high interest rates on aggregate demand. In particular,
new loans taken by individuals and new home
mortgages have already started to recede.

2
Macro scenario - Brazil | February 10, 2022
Rising agricultural commodity prices to put
pressure on food inflation this year
80
12m
Soybean, corn and wheat R$ 12m
70 IPCA food at home (rhs.)
60
50
40
30
20
10
0 3
-10
-20
-30
-40
08 09 10 11 12 13 14 15 16 17 18 19 20 21 22
Source: Bloomberg, IBGE, Itaú
Risks of further fiscal deterioration
Risks associated with the adoption of measures
that lead to further fiscal deterioration are
increasing. In the face of persistently high inflation,
there is growing pressure for broad pay raises for public
servants and tax cuts, such as those levied on
manufactured products and fuels, in addition to the
adjustment of the personal income tax table. The fiscal
impact depends on the scope and format of the
measures, but converging toward a structurally
balanced fiscal result would be even more difficult.
Our estimates for the primary budget deficit
worsened to 1.0% of GDP (BRL 90 billion) from
0.8% (BRL 75 billion) in 2022, and to 1.3% of GDP
(BRL 125 billion) from 1.1% (BRL 110 billion) in
2023, incorporating some of these risks. This year,
in addition to the abovementioned risks, spending
increases by states and municipalities, lower
extraordinary revenues for the central government,
disinflation and economic slowdown will lead the
primary budget back to a deficit, after a surplus of 0.8%
of GDP in 2021. In 2023, the public budget – to be
approved after the elections – should still be under the
rules of the recently-expanded constitutional spending
ceiling. However, the government must decide during
the year the fiscal framework that will be effective from
2024 onward.
3
Public debt should climb to 84% of GDP in 2022
and 87% of GDP in 2023. Rising indebtedness, amid
high interest rates, low growth and an unclear fiscal
21 framework, suggests greater risks of a return to an
19 unsustainable fiscal path in the future.
17
15 BRL will remain under pressure, despite
13
recent gains
11
9
Despite the recent appreciation of the Brazilian
7
real, we maintained our year-end exchange rate
5
forecasts at BRL 5.50/USD in 2022 and BRL
5.75/USD in 2023. The Selic rate going back to double
1
digits – well above the levels seen in recent years –
-1
attracts greater dollar inflows to Brazil and explains the
-3
recent appreciation of the Brazilian currency.
-5
Nevertheless, a greater appreciation would depend on
-7
the reduction of external and domestic uncertainties. In
the global scenario, the anticipation of benchmark-rate
increases in the U.S. (to fight sharper inflationary
pressures) is a key factor and has a significant weight
in the dynamics of the BRL. Domestically, questions
surrounding the evolution of public accounts and fiscal
sustainability also tend to put pressure on the currency
in the coming years.
We revised our estimates for external accounts,
incorporating higher average prices for major
commodities exported by Brazil (mainly soybeans
and iron ore). We forecast trade surpluses (according
to MDIC) of USD 67 billion in 2022 (USD 58 billion
previously) and USD 70 billion in 2023 (USD 67 billion
previously). Service and income deficits should remain
at historically low levels (as was the case in 2020 and
2021). We now estimate current account deficits of
USD 19 billion in 2022 (USD 28 billion previously) and
USD 16 billion in 2023 (USD 19 billion).
Copom: smaller hikes ahead, but no
imminent pause
At its February meeting, the Brazilian Central
Bank’s Monetary Policy Committee (Copom)
decided to raise the Selic rate again by 150 bps, to
10.75% p.a., and indicated that, at this moment, it
anticipates slower tightening ahead. According to
authorities, such signaling reflects the stage of the
monetary tightening cycle, whose cumulative effects
will manifest over the relevant horizon.
Macro scenario - Brazil | February 10, 2022

In the minutes of the same meeting, the Copom
indicated that it plans to increase the Selic rate
beyond the 12.00% established by its reference
scenario (which takes into account interest rate
forecasts extracted from the Focus survey). The
monetary authority stated that it maintains the upward
bias for forecasts in the reference scenario, due to the
risk that fiscal developments destabilize inflation
expectations. When this risk asymmetry is considered,
the committee's inflation projections are above the
target for both 2022 and 2023. Thus, the Copom
considers that the monetary tightening cycle should be
more contractionary than the one used in the reference
scenario over the relevant horizon.
We revised our forecast for the terminal Selic rate to
12.50%, where it should remain until the end of 2022.
When addressing the deceleration of the hiking pace,
the committee referred to its “next steps,” in the plural. In
our view, this indicates additional increases after the
March meeting. We continue to expect 100 bps at that
meeting, but now anticipate a 50-bp hike in May and a
final increment of 25 bps in June.
In 2023, we see room for the Selic rate to be reduced
toward less restrictive levels – that is, 8.0% p.a.,
throughout the year. Importantly, room for this
reduction (and possible additional cuts) in interest rates
will depend on future economic policy choices, in
particular those focused on public accounts.

Brazil | Forecasts and Data

2017 2018 2019 2020 2021F 2022F 2023F
Current Previous Current Previous Current Previous
Economic Activity
Real GDP growth - % 1.3 1.8 1.2 -3.9 4.4 4.4 -0.5 -0.5 1.0 1.0
Nominal GDP - BRL bn 6585.5 7,004 7,389 7,468 8,605 8,600 9,287 9,245 10,011 9,932
Nominal GDP - USD bn 2063.3 1,916 1,872 1,447 1,595 1,594 1,676 1,659 1,776 1,762
Population (millions) 206.8 208.5 210.1 211.8 213.3 213.3 214.8 214.8 216.3 216.3
Per Capita GDP - USD 9977 9,189 8,910 6,834 7,476 7,471 7,804 7,724 8,213 8,148
Nation-wide Unemployment Rate - year avg (*) 12.8 12.4 12.0 13.6 13.0 13.1 12.5 12.7 13.3 13.3
Nation-wide Unemployment Rate - year end (*) 12.5 12.4 11.7 14.6 11.7 12.0 13.1 13.1 13.3 13.3
Inflation
IPCA - % 2.9 3.7 4.3 4.5 10.1 - 5.5 5.0** 3.5 3.3
IGP–M - % -0.5 7.5 7.3 23.1 17.8 - 7.3 5.5 4.0 3.5
Interest Rate
Selic - eop - % 7.00 6.50 4.50 2.00 9.25 - 12.50 11.75 8.00 8.00
Balance of Payments
BRL / USD - eop 3.31 3.88 4.03 5.19 5.57 - 5.50 5.50 5.75 5.75
Trade Balance - USD bn 56 47 35 50 61 - 67 58 70 67
Current Account - % GDP -1.1 -2.7 -3.5 -1.7 -1.8 - -1.1 -1.7 -0.9 -1.1
Direct Investment (liabilities) - % GDP 3.3 4.1 3.7 3.1 2.9 - 3.6 3.6 3.7 3.7
International Reserves - USD bn 382 387 367 356 362 - 362 362 362 362
Public Finances
Primary Balance - % GDP -1.7 -1.5 -0.8 -9.4 0.8 0.3 -1.0 -0.8 -1.3 -1.1
Nominal Balance - % GDP -7.8 -7.0 -5.8 -13.6 -4.5 -5.0 -9.2 -9.0 -8.7 -8.7
Gross Public Debt - % GDP 73.7 75.3 74.3 88.8 81.0 81.0 83.7 84.0 86.5 87.1
Net Public Debt - % GDP 51.4 52.8 54.6 62.7 57.7 58.4 62.9 63.4 66.4 67.1
Source: IBGE, FGV, BCB and Itaú
(*) Nation-wide Unemployment Rate measured by PNADC.
(**) figure published in the last scenario review, in January. After the IPCA-15 of January, however, we revised the forecast to 5.3%.

4
Macro scenario - Brazil | February 10, 2022

Macro Research – Itaú

Mario Mesquita – Chief Economist

To access our reports and forecast visit our website:

https://www.itau.com.br/itaubba-pt/macroeconomic-analysis

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