Schroders: Brazilian and Indian growth paths diverge

Brazil:

Brazilian GDP contracted 0.9% year-on year-in the second quarter, or 0.6% in quarter-on-quarter terms. Following a quarterly contraction of 0.2% in the first quarter, the economy has entered technical recession.

A look at the breakdown of GDP shows the weakness was concentrated in investment, which fell 19.6% year-on-year. Government expenditures were also slightly down, while net exports and consumer spending both grew.  On a sector basis, manufacturing and construction dragged down industrial growth. Such poor performance from investment suggests firms have little confidence in the future, and with a global recovery underway, this seems likely to reflect domestic concerns. In particular, firms facing government intervention over pricing will be unwilling to invest, while uncertainty over taxation and the cost of credit will also weigh on decisions. Of course, even with good policies, the high interest rate makes investing difficult, but it would be much easier to plan with greater policy certainty.

As hinted above, cheaper credit is only part of the answer for restoring growth in Brazil. Arguably a period of deleveraging is needed for the consumer in any event. For growth, both in the short and long term, Brazil needs to get its firms investing again. More orthodox economic policies would help, including reduced intervention on pricing, and government support for infrastructure, both financial and political. But the main thing is that firms should have confidence in the government’s economic credentials and intentions.

GDP is a lagging indicator so in many ways this just confirms what we already knew, the Brazilian economy is in dire need of new policies. It should serve to weaken President Dilma Rousseff’s position ahead of October’s election, and certainly the market reaction suggests that is what investors believe. Whether this matters to Dilma’s voters, on the other hand, is questionable. Arguably any voter concerned with economic growth would have jumped ship some time ago to either the Neves or Campos (now Silva) camp. But the number certainly does not help Dilma, and will strengthen the hand of any candidate arguing for more orthodox policy.

India:

Indian GDP surged back in the second quarter to 5.7% year-on-year, beating market expectations of a 5.5% rise and well above the 4.6% number printed in the first quarter.

The number received a big boost from government expenditure and investment, but consumption and net exports contributed less than in the first quarter. Given the need for investment, particularly in infrastructure, we would regard the mix as positive overall. It is also a sign that investor sentiment has been boosted by Prime Minister Narendra Modi’s election and the hopes for reform. Whilst the new prime minister is not quite living up to the pre-election hype, we still think good progress is being made, and expect further healthy growth for the economy this year.

Key to watch, with regards to growth in India, is the progress of the new Modi government in implementing reform. Not only can reforms provide practical boosts to the economy via facilitating investment and greater efficiency, they can also boost sentiment among investors and consumers alike.  We think the latter is probably the more powerful of the two effects so far, with the government pushing ahead on several fronts, but less rapidly than some had hoped. Opposition is coming both from the Congress party and within the government. The recent action by India in blocking a World Trade Organization deal in order to defend their food subsidies is a disappointing sign that the government is planning on placating, not facing down, this opposition.

The risk to Indian growth this year then is whether disappointment over reform efforts translates into declining sentiment and reduced investment, but given the strenuous efforts being made to keep the project pipeline flowing, this seems a relatively minor risk for now.  Finally, the stronger GDP print will also reduce pressure on the central bank to cut rates in support of growth, and confirms our view of no rate hike until late 2015.