Brazil optimism fades as economy shrinks

Brazilian GDP had a bad start to 2019, contracting on a quarter-on-quarter basis. The comparison with the optimism immediately following Jair Bolsonaro’s victory in elections last year is striking.

Hopes for quick progress with reform have been dashed, and the hit to confidence appears to have weighed on investment particularly. However, there is also an impact here from the Brumadinho dam disaster at the start of the year, and we expect a better performance from the economy later in the year.

On a year-on-year basis, growth remained positive but slowed sharply from the previous quarter, to 0.5% from 1.1%. The main reason for this was a decline in investment, which slowed to 0.1% from 0.5%, its weakest since 2017. We ascribe some of this to ongoing uncertainty around pension reform and the impact on confidence.

Pension reform is viewed as key to putting public finances on a sustainable footing and boosting growth. We still expect it to pass later this year, albeit with some dilution of the current proposals.

There has also been a material hit to activity from the Brumadinho dam disaster. The dam is owned by Vale, the world's largest iron ore producer, and its collapse in January killed more than 200 people. The cost to Vale was $4.5 billion, or around 2% of Brazilian GDP. Vale was also ordered by Brazilian courts to cease mining operations elsewhere in Brazil. On its own, the disaster is estimated to have shaved 0.2 percentage points from Brazilian GDP growth in 2019.

Looking ahead, we still expect pension reform to pass this year. The painful part may be that sustained market pressure is needed to compel action, in the form of currency weakness and portfolio outflows. Still, this should see an improvement in confidence in the second half of the year and a consequent pick-up in investment.

It's likely 2019 will be another disappointing year for growth, but 2020 should be a much better time for Brazil.