Recession May Return With a Vengeance in Scandal-Hit Brazil

(Bloomberg) -- Brazil emerged from its deepest recession on record in the first quarter, but fresh political scandal could slam the beleaguered economy right back into its hole.

Gross domestic product expanded one percent in the first three months of 2017 compared with the previous quarter, led by a strong performance of the agricultural sector, and in-line with market expectations. From a year earlier, the economy contracted 0.4 percent, the national statistics institute said in a statement on Thursday.

“It's just an agriculture rebound,” said Jankiel Santos, chief economist at Haitong in Sao Paulo. “We can't base the recovery of Brazil's economy just on agriculture, it doesn't work like that. We need greater contribution from services and consumption.”

The government insists that the quarter marks the beginning of a recovery, supported by its efforts to pass measures aimed at restoring public finances. But a fresh corruption scandal implicating President Michel Temer has since jeopardized his reform agenda, as well as the country's economic prospects. Ratings agencies have warned they may downgrade Brazil, and banks from Goldman Sachs to Itau Unibanco are sounding the alarm of a possible double-dip recession.

Agriculture expanded 13.4 percent in the first quarter, its strongest result in over 20 years. It accounted for three-quarters of output in the period, with the remainder coming from industry, which rose 0.9 percent, said Luciano Rostagno, chief strategist at Banco Mizuho do Brasil. From the standpoint of demand, only imports and exports grew in the quarter, while investment fell 1.6 percent. That dragged Brazil's investment rate further downward, to 15.6 percent of GDP.

“This is why the economy still doesn't have the conditions to sustain this kind of growth rate in the next quarters,” Rostagno said. “The economy is still struggling to gain momentum.”

Rostagno forecasts growth of about 0.3 percent in the second quarter. Newton Rosa, chief economist at Sul America Investimentos, says there could be stagnation, and called the first quarter result “false vigor.”

Reform Uncertainty

Brazilian financial markets sold off when Temer was accused of corruption, and prospects for the approval of his flagship pension reform dimmed. The political uncertainty also prevented the central bank from lowering borrowing costs more aggressively. Policy makers on Wednesday kept the pace of monetary easing and suggested they can be more conservative when cutting rates at their next meeting.

While Temer has denied wrongdoing and refused to resign, he has voiced concern about the future of the economy. “All the immense effort to pull the country from its biggest recession could become useless,” he said in a May 19 televised address. “And we cannot throw so much work for the good of our country into the dustbin of history.”

Even Finance Minister Henrique Meirelles, who has said the economy would reach an annual growth pace of 2.7 percent by the fourth quarter, acknowledged in an e-mailed note sent on Thursday that “there's still a ways to go before we reach full economic recovery.” He previously said delayed approval of the pension overhaul could hurt investor expectations in the short term, with a negative impact on growth this year.

Complicating matters are the roughly 14 million Brazilians that are currently jobless, and the renewed uncertainty means that number won't improve significantly this year, according to Carlos Thadeu de Freitas, a former central bank director. He's forecasting growth this year may still reach 0.5 percent, in-line with the median estimate from economists polled by the central bank, but notes that the scandal's true damage to activity will be felt next year.

“These signs of life will emerge more slowly, and unemployment will continue to drag on,” said Freitas, currently the chief economist at the national commerce confederation. “Next year, growing less will create more difficulties for Brazil's debt dynamics. We can't cut more expenses, we need to grow again.”

--With assistance from Rachel Gamarski and Josue Leonel

To contact the reporter on this story: David Biller in Rio de Janeiro at dbiller1@bloomberg.net.

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Walter Brandimarte, Matthew Malinowski