How long will the rebound last?
We expect growth in Q2 to be very strong, at just below 5% y/y, rising from the low base left by the crippling effects of El Niño and by the corruption scandals surrounding Brazilian construction firms last year. Domestic demand is also recovering powerfully, driven particularly by a surge in mining investment, in response to higher metal prices.
Though we expect growth rates to drop, H2 growth should be 3.6%-3.7%, and just below 4% for 2018, with domestic demand growing by 4.2%, thanks to very high public investment outlays, and private investment growth entering positive territory (up 5%), after a four-year decline. Total investment growth is expected to be 6%. Private consumption will also recover, to more than compensate for lower commodity export growth.
We assume continued good economic performance for 2019, with a similar GDP growth rate. Growth possibly will slow to about 3.7% in 2020 and 2021.
Twelve-month inflation continued to plunge, to 0.4% by March, due to strong reversal of inflationary pressures after El Niño, but started to increase since then with for 1.4% in June. We expect inflation to reach the midpoint of the Central Bank’s target range (1%-3%) by yearend. For 2019 and on, we expect the 12-month headline number to run at 2% to 2.5%, with mild depreciation and a lower output gap exerting upward pressure.
The Central Bank starting in the beginning 2017 has cut its policy rate by 150 bp, to 2.75% (only 0.5% in real terms) given low inflationary expectations, and has cut reserve requirements. We don’t foresee further cuts for 2018, barring a fall in investment or economic activity in H2. Rather, rate hikes could start by mid-2019.
Higher mineral export prices and the slowdown in domestic demand drove the current account deficit down to just 1.3% of GDP. We expect it to rise to 1.5% of GDP in 2018, but don’t see it exceeding 2% through 2021.
Though President Martin Vizcarra’s assumption of power has been surprisingly smooth, significant uncertainty remains, as his government lacks its own support base in Congress, and even some of the small congressional representation ex-president Kuczynski had has declined, with several members abandoning the party. Another source of concern is the premature drop in Vizcarra’s popularity rating, down nearly 20 percentage points, though still around 30%- 40%. This is viewed as not only hindering his ability to govern, but as a harbinger of confrontation with Congress, as 2021 elections near. On the positive side, Vizcarra, an engineer by training, is seen as an honest and hardworking individual.
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