Brazil’s economy unexpectedly contracted by 0.1 percent in the second quarter of the year. This forced economist to revise down their 2021 growth estimates as fiscal threats and a water crisis loom on the horizon.

An earlier Bloomberg survey estimated a 0.2% growth for Brazil. Only three of the 39 economists surveyed expected a negative number. From the year prior, the economy expanded 12.4%, the national statistics agency reported on Wednesday.

Currently, vaccination campaign advances as more than 60% of the population have been partly immunized. As such, most businesses have resumed activities and services prices are picking up.

Yet, the informal labour market remains sluggish and consumer confidence won’t recover as fast as expected. Recent data show that investments fell 3.6% on the quarter, while agriculture dropped by 2.8% whilst industry slipped by 0.2%. On the other hand, services grew 0.7% and family consumption remained stable.

Challenges with monetary policy

Meanwhile, Adriana Dupita, a Brazilian economist indicated that the economy could not avoid the contraction despite government’s stimulus packages.

“The Brazilian economy lost steam in the second quarter despite some residual policy stimulus and a material advance in vaccinations.

“The small decline illustrates the challenges to come as monetary policy is tightened. A water crisis, fiscal uncertainties and political noise add downside risks to growth through next year. We forecast 5.1% growth for 2021 and 2% for 2022” .
Adriana Dupita

Also, an Economist Alberto Ramos, averred that the GDP numbers reflect how much of the stronger recovery seen earlier in the year was conditional to emergency cash handouts made by the government during the pandemic.

“This is a disappointing print which shows the underlying growth in Brazil is still very weak”.
Alberto Ramos

Consequently, Alberto lowered his growth forecast for this year to 4.9% from 5.4%. this is conditional on the assumption of no major energy supply limitations and a broadly controlled pandemic going forward. Haitong Investment Bank also said it’s revising down its GDP estimates for 2021 and 2022.

Higher Rates, Water Crisis

Brazil’s aggressive monetary tightening campaign is starting to have an impact on economic activity. The central bank has already lifted the benchmark interest rate to 5.25% from an all-time low of 2%. Expectations are that the central bank will increase it to 7.5% by the end of the year.

Meanwhile, inflation shows no sign of abating. It’s running at an annual pace of 9.3%, well above the 3.75% target. With the current developments, economists continue to revise up their forecasts as a severe drought depletes hydroelectric reservoirs and drives electricity prices higher.

Central bank chief, Roberto Campos Neto said the economy’s second-quarter performance was “more or less in line” with the bank’s expectations. He defended the need to keep raising interest rates, saying that runaway inflation would be even worse for growth prospects.

Plans to expand social programs ahead of next year’s elections have also caused concern among investors, fueling expectations for tighter monetary policy. Brazil’s Brazil’s Brazil’s