Is Brazil’s potential GDP already higher than economists’ estimates?

Is Brazil’s potential Gross Domestic Product (GDP), the capacity of the country’s economy to grow without causing inflationary pressures, already higher than estimated by most economists?

This question has been asked since the IBGE released the National Accounts data in September, which showed a 1.2% growth in GDP in the second quarter of 2022, once again above market projections.

Since then, the Minister of Economy, Paulo Guedes, has been beating the drum that the models used by economists are outdated or that there is an anti-government political bias in the projections.

In early November, an Informative Note from the Economic Policy Secretariat (SPE) at the Ministry suggested that there are already indications in several economic indicators that there has been a change in the growth trend of the Brazilian GDP.

Among the factors pointed out is the fact that the annualized growth of the economy in recent quarters is at a level not seen before, except in periods of recovery after recessions.

The recovery of the investment rate and the better allocation of employment, with the evolution of formal jobs and the increasing contribution of the services sector – which has better productivity per worker – were also mentioned.

A recent XP Macro Special report, signed by economist Rodolfo Margato, proposed to evaluate these assumptions and concluded that Brazil’s potential GDP has already experienced a structural improvement and, under current conditions, the annual expansion capacity is 1.8%.

By comparison, Margato says estimates for the 2018-2019 period pointed to a potential economic growth of around 1.1%.

Margato admits that part of the recent developments may be related to cyclical issues, but it is clear that there have already been more profound changes.

“We have to wait and see what cyclical recovery, which is not necessarily a structural gain is, but in our reading, maybe it is a combination,” he said.

INVESTMENT RATE

Rafaela Vitoria, the chief economist at Banco Inter, also believes that there are indications that the Brazilian economy has greater growth potential, as already seen in the last six quarters.

“Two factors brought good growth news in the last year and a half: one was the services sector, which is growing faster than we expected. The other point is the return on investment,” she says.

In this last point, Rafaela remembers that there was growth in civil construction and machines and equipment.

For him, some part of this is linked to the cycle of higher commodity prices, but there is also a contribution from the gains with the recent regulatory milestones, from the concession auctions, and the natural expansion of the electric sector.

The XP report indicates the GDP’s higher potential, exactly the increase in the net capital stock, which started to grow again in 2021 after more than three years of a downward trend.

The investment rate – Gross Fixed Capital Formation (GFCF) in relation to total GDP – increased from approximately 15.5% in 2019 to around 19% in 2021.

According to the study, the expansionary monetary policy in the last two years allowed for a sharp growth in both apparent consumption of capital goods and construction, despite some influence of the change in relative prices on the investment rate.

Even admitting that the new moment of tight monetary conditions tends to reduce this consumption of capital goods in the quarters ahead, the report states that it is feasible that the investment rate reaches around 18% of GDP in a long-term scenario.

“This expectation is based on important advances observed in recent years, such as the deepening of the capital market and the modernization of regulatory frameworks that attract investments to infrastructure sectors,” the text says.

The SPE’s Informative Note brought a timeline of these macro and microeconomic reforms implemented since 2019 and that brought gains in the business environment, such as the New Sanitation Framework, the Gas Framework, the Law of State-Owned Enterprises, the 20% reduction of the Common External Tariff (TEC) and the reduction of the Additional Freight for the Renovation of the Merchant Marine (AFRMM), which raised the cost for imports.

PROJECTION ERRORS

But why was this not anticipated by analysts? Margato does not agree that the models used are outdated but admits that some assumptions may not have been better designed.

“One hypothesis is that some factors have been disregarded, such as some impact of the Labor Reform, besides the macroeconomic effect of the regulatory frameworks in sectors where it is difficult to extract impacts,” he says.

“Yes, we made a mistake. The models did not capture this higher growth. Even when considering a favorable conjunctural scenario for commodities, specific domestic sectors grew more than expected,” agrees Rafaela.

TAX REFORM

For these gains of the last few years to be maintained, Rodolfo Margato and Rafaela Vitória defend the continuity of the reform agenda, with Tax Reform emerging as the most important.

For Banco Inter’s chief economist, the current tax simplification proposal has a qualitative benefit. “It could bring many benefits to the productive sector, including potential GDP,” she predicts.

“It is the factor that can make the country grow more relevantly. Our system is the most complex in the world,” agrees XP’s economist.