Per Goldman: Brazil’s Shocking GDP “Obituary”……..Downturn Has “Mutated Into An Outright Depression”

To be sure, we haven’t exactly been shy about characterizing Brazil’s economic malaise as more akin to a depression than a recession. Here are a few representative headlines:

The problem, you’re reminded, is that Brazil is in the midst of a dramatic economic downturn that’s left the country to suffer through the worst inflation-growth outcome (i.e. stagflation) in more than a decade. Unemployment and inflation are soaring (annual headline IPCA inflation at 10.28%, unemployment at 7.9% in August, up from just 4.7% a year earlier) while output is plunging (IBC-Br monthly real GDP indicator down 6.1% Y/Y in September) and the market is losing confidence in the government’s ability to end a political stalemate on the way to shoring up the fiscal books and hitting primary surplus targets. Last week’s arrest of prominent lawmaker Delcidio Amaral in connection with the ongoing Carwash investigation didn’t help.

Thanks to the above mentioned IBC-Br monthly indicator (which showed an economy in “free fall” to quote Barclays) we already knew Q3 was going to be bad on the GDP front. But this is Brazil we’re talking about, which means that as bad as consensus is, there’s always the distinct possibility that the actual numbers will be far worse than expected and that’s exactly what happened on Tuesday.

Real GDP fell 1.7% Q/Q and 4.5% Y/Y while Q2’s already abysmal -1.9% contraction was revised down to -2.1%.

All of those prints missed expectations and the headline number was worse than all but three estimates from the 44 economists Bloomberg surveyed.

If you dig down a bit further you can begin to see why we’ve been so adamant about calling this a depression. Here’s Goldman with the summary:

Private consumption has now declined for three consecutive quarters (at an average quarterly rate of -8.5% qoq sa, annualized), and investment spending for nine consecutive quarters (at an average rate of -10.0% qoq sa, annualized). Overall, gross fixed investment declined by a cumulative 21% from 2Q2013. The declining capital stock of the economy (declining capital-labor ratio) hurts productivity growth and limits even further potential GDP. The sharp contraction of real activity during 3Q was broad-based: both on the supply and final demand side. Final domestic demand weakened sharply during 3Q2015 (-1.7% qoq sa and -6.0% yoy) with private consumption down 1.5% qoq sa (-4.5% yoy) and gross fixed investment down 4.0% qoq sa (-15.0% yoy). Finally, on the supply side, we highlight that the large labor intensive services sector retrenched again at the margin (-1.0% qoq sa; -2.9% yoy).

Yes, “the services sector retrenched again,” and as WSJ noted earlier, “Brazil’s service sector, including beauty salons, banks and realtors, employs more than any other sector in the country by a wide margin, and represents about 60% of GDP.” Here’s the full breakdown:

“At first read, the report recalls an obituary. There is no room for any growth in the coming quarters. The situation is really, really bad,” according to Andre Perfeito, chief economist at Gradual Investimentos, who spoke to Bloomberg by phone. “It’s a substantial hit coming not only from investment, which has fallen nine quarters in a row, but this year the big change is the substantial drop in consumption. We have not seen such a string of bad numbers for consumption,” Carlos Kawall, chief economist at Banco Safra and former Treasury secretary added.

This of course comes back to a worsening unemployment picture. Remember, employment fell 3.5% Y/Y and real wages slumped a whopping 7.0% in October. As Goldman put it, “the real wage bill of the economy shrank by a large 10.3% yoy in October; the largest decline since October 2003.” The unemployment rate hit 7.9% in August, up from just 4.7% a year ago.

That means people like Rossini Santos, the 43-year old, unemployed steelworker with an $80,000 mortgage and a $17,000 Chevy Prizm note that Bloomberg profiled in October, will have a harder and harder time finding work and thus servicing their debt. “The idea that consumers might not have income to service debt in the years to follow I think is what terrifies them. Even if there is a recovery of sentiment, we believe the labor market will continue suffering throughout the next year, and that will hold down household consumption,” Barclays economist Bruno Rovai said.

Meanwhile, Copom is completely stuck. Inflation is soaring and will likely get worse to lagged FX pass through which means if anything, rates need to rise. As Daniel Weeks, chief economist at Garde Asset Management put in on Tuesday, “the negative GDP may influence BCB, but rising inflation will prevail.” That means that Brazil, much like some of its Andean neighbors will need to consider pro-cyclical policy measures – i.e. Copom will need to hike. 

Bradesco BBI sees two hikes, one in January and one in March. “Although BCB kept Selic unchanged in last meeting, the dissent in the decision (two members voted for a 50 bps hike) and the change in the post-communique text (removing the phrase ‘keeping interest rates unchanged for a sufficient period’) are indicatives that the BCB may change its course of action soon,” the bank says, adding that “given soaring inflation expectations, it is now too much of a risk for the BCB to wait and see if the recession will eventually lead to lower inflation in 2016.”

So with no counter-cyclical maneuverability, the economy (specifically investment, manufacturing, and the credit impulse) will continue to suffer mightily going forward. We’ll close with a quote from Goldman’s Alberto Ramos, Brazilian commentator par excellence:

What started as a recession driven by the adjustment needs of an economy that accumulated large macro imbalances is now mutating into an outright economic depression given the deep contraction of domestic demand.