When It Rains, It Pours
Natural disasters, in the form of excessive rain and mudslides, have now edged out the corruption scandals involving Brazilian companies, to take center stage in the national psyche. As many as 1 million people may be affected by the El Niño floods, 15% of them severely. The government believes the intensity of the disaster will weaken over the next two weeks, though, implying a shorter El Niño than in the previous two strong events in the recent past.
The government has focused assiduously on helping the victims, and repairing major roads and bridges. All cabinet members have been seen working in various affected areas, with members of Congress frequently joining the effort. This has triggered a truce in the recent tense political atmosphere. The planned impeachment of Transportation Minister and First Vice President Martin Vizcarra has therefore been cancelled, though some members of Congress may try to revive it after the emergency ends.
The intensive participation of President Pedro Pablo Kuczynski and his cabinet in addressing the emergency is being viewed positively by the public, and is showing up in the recovery of the president’s approval ratings, until recently in freefall. Still, reconstruction is bound to hit snags and delays – so Kuczynski’s popularity may again experience setbacks.
Preliminary estimates put disaster damages at $3 billion to $4 billion – or 1.5% to 2% of GDP – and are concentrated in infrastructure destruction, and with less intensity on the loss of crops, housing, health centers and schools.
January GDP growth at 4.8% y/y was slightly higher than both our estimate and the consensus (of 4.5%). We are maintaining our forecast for February growth at below 2.0%. But we expect the GDP for March will show the strong effect of El Niño with a growth rate at around1% or less. March inflation is seasonally high, but this year was powerfully augmented by the spike in food prices, when floods and strong mud slides cut off many roads linking Lima with the highlands and the north.
The Central Bank released its latest forecasts for 2017 and 2018 in its quarterly Inflation Report, and included preliminary calculations on the effects of natural disasters. The Bank cut its 2017 forecast to 3.5%, down from the 4.3%. The report stresses the transitory nature of the inflation spike, and maintains its inflation forecast for just under 2.5% for year end, albeit recognizing that the 12-month rate will remain above target, at least during all H1.
We see these forecasts as optimistic. El Niño-driven natural disasters have reinforced the consensus toward greater public spending. The government can comfortably finance the higher deficits, but faces a dire predicament in its ability to quickly spend funds for reconstruction and public investment. We now see an interest rate cut as very plausible.
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