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A real silver lining

10 February 2016 By Julia Gottlieb

Even downturns can have an upside. Brazil’s external accounts improved in 2015, even as the economy was heading into its deepest recession in decades. The current account deficit may even disappear by 2017.

This depends, of course, on whether the improvement is due to temporarily slower activity – which may fade when the economy recovers – or to a permanent effect resulting from a weaker currency. We think the enhanced competitiveness created by the weaker real, combined with lower unit labor costs, explains most of the improvement.

Sharp correction in 2015

In 2014, Brazil’s current account deficit reached 4.4 percent of GDP. Financing such a large deficit has been challenging, especially when domestic uncertainty is increasing and interest rates in the United States are set to rise.

Reversing the deterioration in external accounts requires an adjustment in relative prices. In 2015, following a 33 percent currency depreciation, the current account deficit improved significantly. The seasonally adjusted annualized three-month moving average dropped from a $110 billion deficit at the end of 2014 to $30 billion one year later.

As for the trade balance, imports declined more sharply than exports in 2015. Imports dropped to $171 billion from $229 billion in 2014 while exports, hurt by lower commodity prices, totaled $191 billion versus $225 billion in 2014. In a recent study, we found that nearly half of the decline in imports during the first half of 2015 was due to the more permanent currency depreciation and half to the temporary fall in activity.

The increased competitiveness spurred by the exchange-rate depreciation, however, has not yet led to an increase in the exported quantity of manufactured items, which remained roughly stable in 2015. One possible explanation is that a weaker currency exerts its influence more quickly on imports than on exports.

Brazil’s service and income accounts also improved, particularly in international travel and profit and dividend remittances. The international travel deficit fell 39 percent. Profit and dividend remittances dropped 33 percent due to the effect of a weaker currency on profit denominated in local currency and the slide in corporate revenue in the face of a tougher economic environment.

The impact of unit labor costs

When Brazil’s unit labor costs rise relative to other countries’, the cost of items produced internally increases relative to its competitors, reducing the country’s capacity to compete in international markets. This decline in external competitiveness is reflected in smaller trade surpluses.

Between 2011 and 2014, Brazil’s unit labor costs increased by 11 percent. We estimated that, if in 2014 they had remained at 2010-11 levels, the trade surplus would have been between 1.2 percent and 1.6 percent of GDP. There was actually a deficit of 0.2 percent of GDP.

Labor costs are now in decline. Along with exchange-rate depreciation, increased competitiveness has contributed to Brazil’s external account improvement and will continue to do so over the next few years.

Recent data, along with our expectations of a more-depreciated currency and weak economic activity, point to further improvements in the coming years. According to our estimates, exchange rates matching our forecasts (4.50 reais per dollar in 2016 and 4.75 in 2017) would lead the current account deficit to zero by 2017. However, if the availability of external financing becomes even more limited, then the current account adjustment would have to be heftier, and the exchange rate would have to depreciate even more.


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