Analysis: Without significant rain this year, Brazil may face economic stagnation and inflation

RIO DE JANEIRO, BRAZIL – Brazil may enter a stagflation scenario (combination of slow economic growth and rising prices), should it not rain again in the fourth quarter of the year, according to RPS Capital analysts.

In their opinion, the Brazilian economy has absorbed several shocks throughout the year, with the disruption of global production chains and, more recently, increased freight costs, with a new Covid outbreak in China.

“If the rainy season remains poor, we may face complications, and the risk is considerable. The drought scenario needs to end by October, when the transition to a wetter period occurs,” says RPS analyst Gabriel Barros.

The analyst says that the government has taken several measures in the right direction, but they are insufficient to prevent a worrisome scenario in power plant reservoirs.

“What the government has announced is more focused on large consumers, by displacing the industry peak load to smooth the curve,” he says. However, given that the situation is dramatic, a broader energy-saving plan should be implemented.

He recalls that food inflation is still expected to burden household budgets, combined with the increase in energy prices. Inflation measured by the IPCA (National Wide Consumer Price Index) rose 0.96% in July, the highest result for the month since 2002, up 1.19%.

The indicator accumulates a yearly high of 4.76% and a 12-month increase of 8.99%. According to the IBGE (Brazilian Institute of Geography and Statistics), 8 of the 9 surveyed industry groups showed an increase in the month. The greatest pressure came from the 3.10% increase in housing, due to the 7.88% hike in electricity.

In addition, the economy benefited from a boost in vaccination which should drive the service sector in the second half of the year. “These businesses are currently recomposing prices and service inflation has shown that it is alive,” the analyst says.

As the sector reopens, inflation as a whole should also rise. “There are several sequential shocks occurring simultaneously, creating the perfect storm for the Central Bank,” the economist says.

In light of this, if the dry season continues and there is no rain by the end of the year, the likelihood that the economy will not withstand another shock increases, Barros explains. “A more acute drought could produce stagflation.”

Hydroelectric power continues to represent the largest share of the country’s generation park, which once accounted for 90% during the 2001 blackout and is now at around 70%.

With this historic drought, reservoirs have reached critical levels and the government has had to activate more expensive thermal plants to sustain power generation. “The reopening of the economy helps, but energy is needed. Without energy, GDP will drop and inflation will rise next year.”

Growth for 2022, which is being revised downward, may be further undermined with no rainfall. A compulsory load reduction will cut growth, and this directly affects GDP.

According to the latest Central Bank Focus Report, the economy’s growth outlook stands at 2.04% – it was projected at 2.1% a month ago and 2.5% earlier this year.