Without an External Impulse, the Recession Will be Longer

BRAZIL ECONOMICS - Report 18 May 2015 by Affonso Pastore, Cristina Pinotti and Marcelo Gazzano

Executive Summary

Brazil has entered a recession in which, because of the high inflation and the need for fiscal adjustment, the authorities cannot use counter-cyclical measures. And unlike the recession of 2008-2009, the country cannot count on an impulse from abroad either. With the appreciation of the dollar and deceleration of Chinese growth, the trend for commodity prices is downward, and due to the exhaustion of bilateral trade agreements and integration of world trade in global value chains, the falling GDP growth of countries has led to slower growth of world exports. The upshot is that recovery of Brazilian exports now depends mainly on the real exchange rate.

Since the start of 2011, the real exchange rate measured in relation to the basket of currencies has depreciated by nearly 50%, surpassing the average of the series, which extends from 1988 to 2015, but the movements of the Real have not reached the relative prices between tradables and non-tradables. There is clear evidence that a model of exports using the quotient between the prices of tradables and non-tradables predicts exports much better since 2011 than the conventional model using the basket of currencies as the real exchange rate metric. The failure of exchange rate movements to be reflected in relative prices is due less to the decline of the pass-through of the exchange rate to tradables prices and more to growth of the unit labor cost measured in Reais. Another facet of the loss of competitiveness of Brazilian exports is the fall in its elasticity to the dollar prices of global exports, a trend that has been very strong since 2012.

The conclusion is that recovery of exports will be a much slower process than the recovery from the 2008-2009 crisis. Without exports acting as a driving force for recovery, the current recession will likely be more prolonged than the previous one.

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