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Published by BUSINESS MONITOR INTERNATIONAL LTD

BUSINESS FORECAST REPORT

Q2 2013www.businessmonitor.com

BRAZILINCLUDES 10-YEAR FORECAST TO 2022

On The Road To A Modest Recovery

ISSN 1744-8875Published by Business Monitor International Ltd.

Copy Deadline: 18 January 2013

2 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013 B

RA

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2012

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es: e

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Gen

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3Business Monitor International Ltd www.businessmonitor.com

Contents

Executive Summary ................................................................................................................................. 5Core Views ......................................................................................................................................................................................5Major Forecast Changes ................................................................................................................................................................5Key Risks To Outlook ....................................................................................................................................................................5

Chapter 1: Political Outlook .................................................................................................................... 7SWOT Analysis .......................................................................................................................................................... 7BMI Political Risk Ratings ........................................................................................................................................ 7Domestic Politics ...................................................................................................................................................... 8Rising Violence Highlights Operational And Security Risks .....................................................................................................8

The recent increase in crime and violence in São Paulo highlights the continued spread of the Primeiro Comando da Capital gang in recent years, as well as the relative fragility of the security situation in some of the country's urban areas. Moreover, with anti-crime programmes likely to ramp up in both São Paulo and Rio de Janeiro over the coming quarters, we see potential for operational and security risks to head higher as well.

TABLE: POLITICAL OVERVIEW ............................................................................................................................................................................ 8

Long-Term Political Outlook .................................................................................................................................. 10Significant Policy Challenges Ahead .........................................................................................................................................10

President Dilma Rousseff's administration faces myriad tough policy choices over the next few years, and many of these may not be addressed until after the 2014 general elections. The country's impressive economic performance under President Luiz Inácio Lula da Silva has significantly raised the bar for any future administration, and Rousseff now faces a delicate combination of policy objectives, from continuing to improve living standards and addressing widening domestic economic imbalances to meeting security and infrastructural challenges ahead of the FIFA World Cup in 2014 and the Rio de Janeiro Olympic Games in 2016.

Chapter 2: Economic Outlook ............................................................................................................... 13SWOT Analysis ........................................................................................................................................................ 13BMI Economic Risk Ratings ................................................................................................................................... 13Economic Activity ................................................................................................................................................... 14Upswing In 2013, But No Return To Boom Years ......................................................................................................................14

Following Brazil's unexpectedly-weak Q312 growth data, which showed that both fixed investment and the banking sector continue to drag down economic activity, we have revised down our average real GDP growth forecast for 2012 to 1.0% (from 1.5% previously). That said, we anticipate a significant pickup in economic activity in 2013, as we expect a backlog of infrastructure projects and a modest uptick in private consumption will boost growth to 3.5% in 2013.

TABLE: ECONOMIC ACTIVITY ............................................................................................................................................................................. 14

Monetary Policy ....................................................................................................................................................... 16Economic Recovery And Price Pressures Underpin Modest Rate Hike .................................................................................16

While we believe that a slow economic recovery and significant pressure on households is likely to keep Brazilian interest rates on hold for the majority of 2013, we maintain our view for a 25-basis-points hike by end-year, bringing the Selic rate to 7.50%. This comes as inflation expectations have headed higher in recent months and we believe significant currency depreciation and other supply-side price pressures will keep headline inflation elevated as well.

TABLE: MONETARY POLICY ............................................................................................................................................................................... 17

Exchange Rate Policy ............................................................................................................................................ 19BRL: Inflation Concerns To Limit Currency Weakness ............................................................................................................19

Since our last currency forecast update, the Brazilian real has continued to trade broadly sideways. While a sell -off in late 2012, which brought the unit to a low of BRL2.1384/US$ in early December, initially made us think that the Banco Central do Brasil (BCB) might allow a weaker currency, the unit's subsequent rally confirmed that the real is likely to range trade over the coming months. As such, we expect the unit to continue trading within a tight band of BRL2.0000/US$ and BRL2.1000/US$ over the coming months, forecasting an average exchange rate of BRL2.0700/US$ this year, slightly stronger than our previous forecast of BRL2.1300/US$.

TABLE: CURRENCY FORECAST ......................................................................................................................................................................... 20

Balance of Payments .............................................................................................................................................. 21Stronger Trade Outlook Underpins Current Account Improvement .......................................................................................21

Following a substantial trade slowdown in 2012, we expect a modest recovery in exports, due to favourable base effects and a cyclical upswing in Chinese growth, will bolster the current account in 2013. Mean while, although we expect the financial account surplus to

4 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

remain off its recent highs, we believe it will continue to comfortably offset the current account deficit.

TABLE: CURRENT ACCOUNT .............................................................................................................................................................................. 21

Fiscal Policy ............................................................................................................................................................. 23Expenditures To Keep Fiscal Deficit Substantial In 2013 .........................................................................................................23

While we see some upside for revenue growth in 2013 following a significant slowdown in 2012, we believe expenditures will head higher as well, meaning that we anticipate no improvement in Brazil's nominal fiscal deficit this year. Moreover, with the government indicating that it is looking to loosen Brazil's fiscal framework, we believe the administration will miss its primary balance target in 2013.

TABLE: FISCAL POLICY .......................................................................................................................................................................................23

Regional Economic Activity .................................................................................................................................. 25What If We Are Wrong On Chinese Growth? Assessing The Regional Implications ............................................................25

Signs of a recovery in China's economy present substantial upside risks to our current 'hard landing' scenario. Higher-than-anticipated economic growth in China over the coming years would have profound implications for Latin America's economic trajectory, and we highlight Chile and Peru, and Brazil to a lesser extent, as most affected in the event of stronger growth in Asia's biggest economy. 25

TABLE: CHINA'S CONSUMPTION OF SELECTED COMMODITIES, % OF GLOBAL CONSUMPTION ........................................................... 25

Chapter 3: 10-Year Forecast .................................................................................................................. 31The Brazilian Economy To 2022............................................................................................................................. 31Imbalances To Unwind, Three Potential Scenarios ..................................................................................................................31

Vast natural resources and strong domestic demand will keep investor interest rooted in Brazil over the coming decade. However, there is a pressing need for the authorities to address some of the country's deeply- rooted structural issues, stemming from too much consumption and not enough production, which is likely to lead to slower growth and a weaker currency at some point over the next 10 years.

TABLE: LONG-TERM MACROECONOMIC FORECASTS ................................................................................................................................... 31

Chapter 4: Business Environment ........................................................................................................ 35SWOT Analysis ........................................................................................................................................................ 35BMI Business Environment Risk Ratings ............................................................................................................. 35Business Environment Outlook ............................................................................................................................. 36Institutions ............................................................................................................................................................... 36TABLE: BMI BUSINESS AND OPERATION RISK RATINGS .............................................................................................................................. 36

Infrastructure ........................................................................................................................................................... 37TABLE: BMI LEGAL FRAMEWORK RATING ....................................................................................................................................................... 37TABLE: LABOUR FORCE QUALITY ..................................................................................................................................................................... 38

Market Orientation ................................................................................................................................................... 39TABLE: LATIN AMERICA – ANNUAL FDI INFLOWS .......................................................................................................................................... 39

Operational Risk ...................................................................................................................................................... 40TABLE: TRADE AND INVESTMENT RATINGS .................................................................................................................................................... 40

Chapter 5: Key Sectors .......................................................................................................................... 43Autos ....................................................................................................................................................................... 43TABLE: BRAZIL AUTOS SALES BY SEGMENT – HISTORICAL DATA AND FORECASTS, 2010 – 2017 ....................................................... 45TABLE: FOOD CONSUMPTION INDICATORS – HISTORICAL DATA & FORECASTS, 2010-2017 .................................................................. 50

Other Key Sectors ................................................................................................................................................... 53TABLE: INFRASTRUCTURE SECTOR KEY INDICATORS ................................................................................................................................. 53TABLE: PHARMA SECTOR KEY INDICATORS ................................................................................................................................................... 53TABLE: TELECOMS SECTOR KEY INDICATORS ............................................................................................................................................... 53TABLE: DEFENCE AND SECURITY SECTOR KEY INDICATORS ..................................................................................................................... 54TABLE: FREIGHT SECTOR KEY INDICATORS ................................................................................................................................................... 54

Chapter 6: BMI Global Assumptions .................................................................................................... 55Global Outlook ......................................................................................................................................................... 55Growth May Be Turning The Corner ..........................................................................................................................................55TABLE: GLOBAL ASSUMPTIONS ........................................................................................................................................................................ 55TABLE: DEVELOPED STATES, REAL GDP GROWTH FORECASTS ................................................................................................................ 56TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS (%) ......................................................................... 56TABLE: EMERGING MARKETS, REAL GDP GROWTH FORECASTS ............................................................................................................... 57

5Business Monitor International Ltd www.businessmonitor.com

Executive Summary

Core Views Following a massive slowdown in 2012, we expect the Brazilian

economy to rebound in 2013. This view is underpinned by our projec-

tion that fixed investment will pick up over the coming quarters as the

government pushes through projects in advance of the expiration of

the PAC II growth acceleration programme and FIFA World Cup in

2014. That said, we continue to expect that a period of household

deleveraging will constrain private consumption growth in coming

years, in line with our forecast for average real GDP growth of 3.5%

between 2012 and 2017.

Given our view for economic activity to remain below-trend in the next

few years, we believe the monetary authorities will prefer to keep

the policy rate accommodative, implying that low interest rates are

here to stay. However, with inflation expectations having increased

in recent months and supply-side pressures likely to remain elevated

over the coming months, we forecast 25 basis points of hikes by

end-2013, bringing the Selic target rate to 7.50%.

We maintain our view that fiscal consolidation will remain off the cards

for Brazil until after 2014 at the earliest. This is underpinned by our

expectation of substantial spending related to the second phase of

the country's growth acceleration programme and the 2014 general

election, fiscal stimulus aimed at bolstering near-term growth, and

indications the President Dilma Rousseff's government is looking

to relax Brazil's fiscal regulations.

Major Forecast Changes We have downgraded our 2012 real GDP growth estimate to 1.0%

and our 2013 forecast to 3.5% as we believe Brazil's economic

recovery is progressing more slowing than we initially anticipated.

That said, we continue to anticipate a substantial uptick in economic

activity this year, as a rebound in fixed investment boosts growth.

We anticipate that a modest recovery in exports on the back of the

current cyclical upswing in Chinese growth, favourable base effects

and strong agricultural harvests will bolster Brazil's external accounts

this year. As such, we forecast the current account deficit will come

in at 2.2% of GDP in 2013, a modest improvement from an estimated

2.3% of GDP deficit in 2012. In addition, while we continue to believe

financial inflows will remain off their previous highs, we expect the

financial account surpluses will still comfortably cover the current

account shortfalls for the foreseeable future.

We believe an uptick in expenditures will offset a modest increase in

revenues in 2013, meaning that the nominal fiscal deficit will remain

substantial at 2.6% of GDP this year. Moreover, in line with recent

statements by members of President Dilma Rousseff's administra-

tion, we now believe the government will miss its 2013 primary fiscal

balance target of 3.1% of GDP, as it looks to have done in 2012.

Key Risks To Outlook Downside Risks To Growth Forecast: Should fixed investment

disappoint in 2013 on the back of project delays, as it did in 2012,

economic activity could remain weaker than we currently expect in

the coming quarters. Such a scenario would pose major downside

risks to our 2013 real GDP growth forecast of 3.5%.

Downside Risks To Interest Rate Forecast: Given our expectation for

economic activity to pick up over the coming quarters, while supply-

side price pressures remain elevated, we forecast 25 basis points of

hikes by end-2013, bringing the Selic rate to 7.50%. However, the

central bank's rhetoric continues to indicate that rates will remain

on hold at the current 7.25% level. Should growth pick up more

modestly than we currently anticipate over the coming months, we

could see the monetary authorities hold the policy rate at 7.25% or

even cut this year.

Brief Methodology

7Business Monitor International Ltd www.businessmonitor.com 7Business Monitor International Ltd www.businessmonitor.com

SWOT Analysis

Strengths President Dilma Rousseff has largely followed in the footsteps of her

predecessor Luiz Inácio Lula da Silva, maintaining market-friendly

policies and ensuring broad policy continuity. Such developments

underscore the country's democratic credentials ahead of the 2014

general election as well.

Although corruption scandals plague the political landscape, Rouss-

eff's crackdown on corrupt officials has boosted confidence in the

executive's commitment to tackling the issue.

Weaknesses Rousseff's 'house cleaning' of allegedly corrupt officials in recent

years means she must focus on maintaining a workable coalition to

push ahead with important reforms prior to the 2014 general election.

Opportunities The recently passed 'barrier' electoral law, which restricts federal

campaign financing for smaller parties, may help improve Brazil's

highly fragmented party environment by fostering coalition building.

Brazil's growing political influence in the region may pave the way for

the country to assume the role of regional leader, pioneering closer

integration among Latin American countries.

Threats The smaller members of the ruling legislative coalition could stir up

trouble for Rousseff if they feel she has assigned too many cabinet

posts to other parties or disagree with her policy trajectory. This

would be particularly problematic for the president heading into the

2014 general election.

BMI Political Risk RatingsBrazil's political risk profile remains highly stable and continues to place

Latin America's largest economy among the higher ranks of social stabil-

ity and broad policy continuity in the region, buoying the country in our

proprietary political risk ratings. We highlight, however, that the region

as a whole does not instil the same degree of confidence in our political

risk assessment, suggesting that rising political risk and social tensions

in Argentina, Venezuela, Bolivia and some Central American countries,

will present some degree of 'spill-over' risk going forward.

Chapter 1: Political Outlook

S-T Political Rank TrendChile 76.7 1 +Uruguay 74.8 2 -Colombia 72.5 3 =Costa Rica 72.5 3 =Panama 71.9 5 =Brazil 70.8 6 +Peru 67.5 7 =Mexico 65.6 8 =El Salvador 57.9 9 =Nicaragua 55.2 10 -Ecuador 55.0 11 -Bolivia 50.6 12 +Argentina 50.2 13 =Venezuela 48.1 14 -Guatemala 47.5 15 =Paraguay 45.6 16 =Honduras 43.8 17 -Regional ave 61.3/Global ave 65.5/Emerging Markets ave 63.1

L-T Political Rank TrendChile 84.2 1 =Costa Rica 71.8 2 =Uruguay 71.4 3 =Panama 67.9 4 =Mexico 67.1 5 =Brazil 66.5 6 =Colombia 62.8 7 =Argentina 61.9 8 =Peru 61.5 9 =Paraguay 60.4 10 =El Salvador 58.9 11 =Honduras 53.3 12 =Ecuador 50.6 13 =Venezuela 48.8 14 =Guatemala 45.8 15 =Nicaragua 44.7 16 =Bolivia 44.2 17 =Regional ave 61.3/Global ave 63.2/Emerging Markets ave 59.6

8 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Domestic Politics

Rising Violence Highlights Operational And Security Risks

BMI VIEWThe recent increase in crime and violence in São Paulo highlights the

continued spread of the Primeiro Comando da Capital gang in recent

years, as well as the relative fragility of the security situation in some

of the country's urban areas. Moreover, with anti-crime programmes

likely to ramp up in both São Paulo and Rio de Janeiro over the coming

quarters, we see potential for operational and security risks to head

higher as well.

Crime has surged in the state of São Paulo in recent months,

reportedly on the back of a confrontation between police and the

Primeiro Comando da Capital (PCC) gang in May. This increase

in violence highlights the fragility of security in some of Brazil's

urban areas, as well as increased potential for violence to spread

outside of the state. Furthermore, with anti-crime initiatives

likely to ramp up in São Paulo and Rio de Janeiro in the lead

up to the 2014 FIFA World Cup and 2016 Olympic Games in

Rio de Janeiro, we see potential for operational and security

risks in the country to head higher as police increasingly come

into conflict with gangs.

Local media report that 102 police officers were killed in the

city of São Paulo in 2012, more than double the number killed

in 2011. The surge in violence recalls a period of deadly con-

frontation between the PCC and police in 2006, during which

the gang allegedly organized a series of attacks that killed about

TABLE: POLITICAL OVERVIEW System of Government Parliamentary democracy, universal suffrage: 513-seat Chamber of Deputies (four-year

term). Executive power rests with president.

Head of State President (Dilma Rousseff), one four-year term

Head of Government President Dilma Rousseff

Last Election Parliamentary – October 1 2010

Presidential – October 31 2010

Composition of Current Government Coalition comprising Partido dos Trabalhadores, Partido Comunista do Brasil, Partido Republicano Brasileiro, Partido Socialista Brasileiro, Partido do Movimento Democrático Brasileiro, Partido Liberal, Partido Progressista and Partido da Mobilização Nacional

Key Figures Vice President – Michel Temer (Partido do Movimento Democrático Brasileiro), Chief of Staff – Gleisi Hoffmann (Partido dos Trabalhadores), Defence Minister – Celso Amorim (Partido do Movi-mento Democrático Brasileiro), Finance Minister – Guido Mantega (Partido dos Trabalhadores)

Main Political Parties (number of seats in parliament) Partido dos Trabalhadores (88 seats): Left-wing social-democratic party founded in 1980 by a group of intellectuals and workers at the Colégio Sion in São Paulo. The party was led by former president Luiz Inácio Lula da Silva since its formation until 1994. The party is currently led by Rui Falcão.

Partido do Movimento Democrático Brasileiro (78): A centrist party, succeeding its predecessor the Brazilian Democratic Movement in 1981. The party is largely made up of liberals and former guer-rillas of the MR-8 group. The party is currently led by Michel Temer.

Partido da Social Democracia Brasileira (54): One of the largest and most prominent Brazilian par-ties, it is the party of former president Fernando Henrique Cardoso. The social-democratic party is associated with the Third Way movement in Brazilian politics. The party was founded in 1988 and is currently led by Sérgio Guerra.

Democratas (Partido da Frente Liberal) (43): Considered to be the main centre-right party in Brazil, it is the party of the former military regime which ruled Brazil between 1964 and 1985. The party was founded in 1985 as the Liberal Front after splitting from the Democratic Social Party. The party's leader is José Agripino Maia.

Partido Progressista (41): This centre-right party was founded in 1995 as the Brazilian Progressive Party and is regarded as conservative. The party changed its name to Progressive Party in 2003. It is currently led by Francisco Dornelles.

Other parties represented in parliament include: Partido da República, Partido Socialista Brasileiro, Partido Democrático Trabalhista, Partido Trabalhista Brasileiro, Partido Popular Socialista, Partido Verde, Partido Comunista do Brasil, and Partido Social Cristão.

Next Election Parliamentary – 2014

Presidential – 2014

Key Relations/ Treaties Brazil is member of Mercosur, which includes Argentina, Paraguay and Uruguay. Associate mem-bers of the economic bloc include Chile, Ecuador, Peru, Bolivia and Colombia. Brazil has increas-ingly strong ties with the EU.

BMI Short-Term Political Risk Rating 70.8

BMI Structural Political Risk Rating 66.5

Source: BMI

9Business Monitor International Ltd www.businessmonitor.com

POLITICAL OUTLOOK

200 people in retaliation against a government programme de-

signed to isolate leaders of the PCC in prison. The most recent

conflict between the two groups has resulted in the deaths of

numerous police officers, particularly those in the force's lower

ranks. Despite government efforts to cut down on crime and

gang activity in some of country's most notorious slums, the

most recent surge in violence highlights the fragility of security

in urban areas.

Anecdotal evidence also suggests that the PCC's grip on the

Brazilian prison system continues to grow – the group was

formed as a union to defend prisoners' rights in 1993 – and local

press report that the PCC is an important force in the majority

of São Paulo's prisons, using them as bases from which to run

the gang's operations. In addition, while São Paulo and neigh-

bouring states remain the PCC's main power base, the gang

reportedly has a presence in 21 of the country's 27 states, and

gang membership continues to rise.

The PCC has also expanded its narco-trafficking operations in

recent years. According to the UN, federal cocaine seizures have

more than tripled in Brazil since 2004 to reach 27 tons in 2010,

and perceived cocaine usage has continued to grow since then.

Bolivian anti-narcotics authorities have stated that the PCC is

present in Bolivia as well and obtains much of its cocaine from

the country. Bolivia's Interior Minister, Carlos Romero, high-

lighted in October 2012 that 54% of Brazilian cocaine comes

from Bolivia, underscoring links between the drug trade in both

countries. There is also evidence that Brazil's narco-traffickers,

including the PCC, have infiltrated neighbouring Paraguay in

recent years, as the country is a regional narcotics transshipment

point and a marijuana producer. The PCC's growing presence

beyond São Paulo and its increasingly important role in the drug

trade implies that the risk of violence between the police and the

gang spreading outside of São Paulo is greater than in previous

years. While this is not our core view, we will be watching the

situation closely for any potential trigger events, which could

see violence spread. Indeed, such a situation would likely see us

downgrade the security component of our short-term political

risk rating for Brazil.

In addition to the surge in violence in São Paulo in recent months,

we highlight potential for the highly visible police pacification

programme ongoing in Rio de Janeiro's favelas to result in

significant confrontations between police and gangs over the

coming quarters. Indeed, the current programme utilizes raids

and increased law enforcement presence by special police forces

to rid the favelas of narcotics traffickers and local militias in

an attempt to reduce violence. As these initiatives continue we

anticipate that rising violence between the police and gangs,

such as the Comando Vermelho, could pose increased risks to

firms' operating in the city.

Assessing The Implications Of Gang ViolenceThe surge in violence in São Paulo, as well as the relative

tenuousness of the security situation in some urban areas has

important implications for political and business environment

risk in Brazil. Indeed, with conflicts between the police and

gangs likely to increase over the coming quarters, we see po-

tential for firms to be impacted on the operational and security

fronts. While we believe most investment is likely to go ahead

in spite of these risks, we note that signs of violence spreading

Strong Rating At Risk?Latin America – Short-Term Political Risk Ratings

20

40

60

80

Policy-making process

Social stability

Security/external threats

Policy continuity

BrazilColombiaPeruMexico

Source: BMI

Potential For DeteriorationLatin America – Short-Term Political Risk Ratings

62

64

66

68

70

72

74

Colombia Brazil Peru Mexico

Source: BMI

10 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

into more affluent areas could make foreign investors wary.

Moreover, should we see signs that the influence of the PCC

or Comando Vermelho is rapidly increasing outside of Brazil's

urban areas in the fashion of the Mexican drug cartels, this

could weigh heavily the country's investment outlook over the

medium to long term.

Long-Term Political Outlook

Significant Policy Challenges Ahead

BMI VIEWPresident Dilma Rousseff's administration faces myriad tough policy

choices over the next few years, and many of these may not be ad-

dressed until after the 2014 general elections. The country's impressive

economic performance under President Luiz Inácio Lula da Silva has

significantly raised the bar for any future administration, and Rousseff

now faces a delicate combination of policy objectives, from continuing

to improve living standards and addressing widening domestic eco-

nomic imbalances to meeting security and infrastructural challenges

ahead of the FIFA World Cup in 2014 and the Rio de Janeiro Olympic

Games in 2016.

The 2000s for Brazil are likely to be associated with the country's

ascent as a global economic force as a result of its rich natural

resources, a burgeoning consumer sector and broader macroeco-

nomic stability. The emergence of Brazil as a regional economic

heavyweight enabled the government of former president Luiz

Inácio Lula da Silva to pull millions of households out of pov-

erty and helped to steer the economy out of recession in 2009.

Yet while the turbulent days of hyperinflation, endemic finan-

cial market volatility and poor investor confidence appear for

now to be a thing of the past, future administrations in Brazil

will carry the burden of higher voter expectations and frequent

comparisons with the seemingly untouchable image of Lula.

We therefore expect immense pressure on President Dilma

Rousseff and any future president to live up to expectations over

the coming decade. In our view, the growing need for reforms

to tackle many unaddressed policy issues in Brazil could lead

to a significant polarisation of the electorate.

Key Challenges To Governance And StabilityClosing The Income Gap: Since the emergence of a vibrant

consumer segment, the political landscape has become increas-

ingly geared towards a social development agenda, ensuring

that a growing number of Brazilians have access to affordable

housing and retail goods via cheaper credit. While we expect this

trend to slow somewhat over the coming years, consolidation

of a rising middle class and its ambition to close the 'income

gap' with Western economies will remain of paramount politi-

cal importance. This will place a considerable straightjacket on

future policy efforts to unwind public spending programmes

initiated under Lula, such as 'Bolsa Familia' and the Growth

Acceleration Programme, restricting the room available to plug

the government's fiscal holes and potentially making the eventual

reduction of the government's role in the economy that much

more painful when it does come.

Rising Fiscal Uncertainty: Enormous public spending commit-

ments and a highly inefficient tax collection system will further

challenge the capacity of Brazilian authorities to rein in the fiscal

shortfall over the coming years. Therefore, a pick-up in economic

activity does not automatically guarantee a narrowing of the budget

deficit, suggesting that more will need to be done on the spend-

ing side. Indeed, our long-term political risk rating for Brazil is

weighed down primarily by a poor rating in the 'scope of state'

category, largely due to the large size of public spending as a

percentage of GDP. Reforming Brazil's highly complex and often

conflicting tax code will be another enormous challenge for any

future government, and we believe that a tangible improvement

in tax collection will remain unattainable until the latter end of

our forecast period, and possibly beyond.

High Labour Market Rigidity: Brazil has some of the highest

hiring costs in the world, forcing employers to commit large

sums to pension funds and pay enormous penalties for firing

workers. This places an additional burden on the public sector

to ensure high employment numbers, as an inflexible labour

market will have private-sector employers thinking twice before

re-hiring after a recession. Moreover, we caution that a large

grey economy will exacerbate the country's tax collection inef-

ficiency, in turn prolonging the government's fiscal woes over

the coming years.

High Entry Barriers: Although Brazil has plenty to offer

to foreign investors, we highlight that the country remains a

challenging market in which to invest. High entry barriers are

manifested through conflicting regulatory frameworks across

different states, high taxes, significant local content and hiring

requirements, and local companies aided by state subsidies.

Moreover, some of Brazil's largest and most successful businesses

remain firmly in state hands, further raising entry barriers for

11Business Monitor International Ltd www.businessmonitor.com

POLITICAL OUTLOOK

foreign companies looking to set up shop in the country. Given

the proximity of highly competitive regional economies with

strong growth outlooks, Brazilian policymakers may ultimately

risk alienating non-portfolio investors, undermining the long-

term growth potential for Brazilian businesses.

Regulating Offshore Reserves: The discovery of vast offshore

subsalt oil deposits in the Santos basin has turned Brazil into a

potential petroleum exporting giant. Policymakers will be under

enormous pressure to draw up a suitable regulatory framework

for the offshore reserves. Regulating these vast reserves formed

an important basis of the ruling Partido dos Trabalhadores (PT)

election campaign in 2010. However, with the government using

the record share issuance by state oil giant Petrobras to increase

its control over the company, we caution that the country risks

losing out on international investment. Foreign oil companies

will likely operate under a production sharing agreement under

this proposal, meaning that overcoming the technological chal-

lenges of bringing the oil and by-products efficiently to market

will remain a major policy challenge. In addition, significant

local capital requirements and hiring restrictions mean that

Brazil's oil industry may continue to be plagued by capacity

constraints for years to come.

Tackling Deforestation: Brazil possesses the largest stretch

of the Amazon rainforest. The Brazilian government will

increasingly come under international and domestic politi-

cal pressure to ensure the preservation of the Amazon and to

restrict uncontrolled deforestation. The policy implications of

overseeing logging activity and illegal deforestation will be

an enormous challenge for any future administration, as the

sheer size of Brazil's rainforest presents significant practical

challenges for any legal response. Additionally, the highly

lucrative timber industry takes on considerable political dimen-

sions in the affected regions, as local governors, who often

bring a strong local electorate to the negotiating table, tend

to benefit from the proceeds of the logging, cattle and soy

cycle responsible for much of the unregistered deforestation

activity in the country.

Cracking Down On Gang Violence: High levels of gang activity

will come under the spotlight over the coming decade, as Brazil

hosts high-profile sports events such as the FIFA World Cup

in 2014 and the 2016 Olympic Games in Rio de Janeiro. Rio

in particular is home to favelas dominated by notorious gangs

and often the location of drug-related violence and killings.

Despite previous efforts, the federal government has virtually

no control over the affected areas. Moreover, with the influence

of São Paulo's Primeiro Comando da Capital (PCC) gang on the

rise, we anticipate increased anti-crime initiatives there as well.

As such, we believe gang violence will become an increasingly

prominent challenge for the Brazilian authorities to overcome

ahead of both the FIFA World Cup and the Olympic Games.

Much attention will focus on the ability of security forces to

establish federal control over these areas to guarantee security

for visitors and athletes.

Drug Trafficking Risk To Stability: While Brazil traditionally

experiences little or no insurgent and paramilitary activity on its

territory compared with neighbouring Colombia and Peru, the

regional drug trade continues to weigh heavily on the political

risk profile of Latin America. The illicit drug trade has helped

finance guerrilla groups such as the Fuerzas Armadas Revolucion-

arias de Colombia (FARC) and the Sendero Luminoso (Shining

Path) in Peru, severely exhausting federal government efforts

to crack down on these illegal organisations. In Mexico's case,

drug cartels look set to be a major challenge for the incoming

administration of president-elect Enrique Peña Nieto. In addi-

tion, with Brazilian narcotics traffickers increasingly expand-

ing their operations into Bolivia and Paraguay, we believe the

destabilising potential of the regional drug trade suggests that

neighbouring countries may require the assistance of the Brazil-

ian government to avert deeper political crises. While not our

core scenario, the heightened political risk profile of the region

certainly suggests that a concerted regional effort may be a key

policy objective in the 2010s.

Consolidation Over, What Now?Since taking office in January 2011, Rousseff has asserted her

authority by clamping down on corruption, which resulted in

significant changes in the composition of the cabinet, much

of which was a legacy of her illustrious predecessor. The next

few years will be crucial in determining not only the electoral

fortunes of her party in 2014, but also the political and economic

trajectory of Brazil beyond the next electoral cycle.

No Let-Up In Spending Commitments: In keeping with

our long-held view, we expect policy continuity to be the key

theme of Brazilian politics over the medium term. We do not

envision a sharp unwinding of existing public spending commit-

ments anytime soon, despite pronouncements by the Rousseff

administration of the need for fiscal consolidation, since slower

global and domestic growth, as well as the need to secure capital

investment ahead of the FIFA World Cup and Olympic Games

will see continued reliance on institutions such as the Banco

Nacional do Desenvolvimento.

12 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Bottlenecks Hinder Growth: Despite its immense potential,

Brazil's growth trajectory remains constrained by structural

weaknesses, most notably in the form of a highly regulated la-

bour market, an overly complex and burdensome tax system and

dearth of access to long-term credit. Our worst-case scenario is

that these bottlenecks – coupled with country's underdeveloped

infrastructure – sour the taste in foreign investors' mouths over

the coming years. We believe that under such a scenario Brazil

would begin to slip from investors' radar screens and risk losing

out to more competitive investment destinations in the region.

13Business Monitor International Ltd www.businessmonitor.com

SWOT Analysis

Strengths The government's commitment to primary fiscal surpluses has in-

stilled confidence in the economy in recent years and bolstered the

country's sovereign credentials.

Weaknesses Large-scale social spending programmes have seen the govern-

ment's fiscal balance deteriorate at an alarming rate. Increased

use of populist rhetoric in the face of weaker global growth could

destabilise the public coffers for a prolonged period.

High levels of labour market rigidity and an enormous public sector

threaten to jeopardise Brazil's economic growth, as employers will

be less keen to hire new workers.

Opportunities Brazil's massive mineral and oil wealth combined with solid sovereign

dynamics will ensure continued foreign investment into the country.

The successful bid to host the 2016 Olympic Games in Rio de Janeiro,

only two years after the FIFA World Cup in Brazil, should also keep

investor interest in Brazil firmly anchored.

A recently passed public sector pension bill, which limits monthly

payouts to retirees, may help limit the country's substantial public

sector spending commitments over the long term.

Threats The country's major economic imbalances, namely too much con-

sumption and not enough production, are untenable in the long

term. Moreover, we believe that their unwinding poses major risks to

Brazil's growth story in the medium term, which are not adequately

appreciated by investors at present.

The inability of successive governments to implement successful

economic reforms, such as an overhaul of the tax system, which

places a heavy burden on business and industry, and reform of the

inflexible labour market are key threats to Brazil's economy. Should

President Dilma Rousseff's government fail to make progress on

these fronts over the coming years, it would impede long-term

competitiveness of the Brazilian economy and potentially cap foreign

direct investment.

BMI Economic Risk RatingsThough Brazil's extensive commodity wealth and a large consumer

base are likely to keep investor interest rooted in the country over the

coming years, there is a pressing need for the authorities to address

major structural imbalances in the economy. These stem in large part

from a very strong consumer and a weak manufacturing sector, which

have fostered an increased reliance on foreign capital in recent years.

While our core scenario calls for these imbalances to unwind through

a weakening of the currency over the coming years, we do not rule out

the possibility of a more rapid unwind or a delayed rebalancing followed

by a sharp adjustment thereafter.

Chapter 2: Economic Outlook

S-T Economy Rank TrendChile 79.2 1 +Mexico 76.2 2 =Peru 75.8 3 +Uruguay 73.1 4 =Brazil 68.1 5 -Panama 66.9 6 =Colombia 64.6 7 =Bolivia 63.5 8 -Ecuador 58.3 9 =Guatemala 58.1 10 =Costa Rica 55.4 11 =Paraguay 51.9 12 +El Salvador 51.7 13 – Honduras 50.0 14 =Argentina 47.5 15 -Nicaragua 44.0 16 -Venezuela 32.9 17 =Regional ave 58.1/Global ave 55.3/Emerging Markets ave 53.5

L-T Economy Rank TrendBrazil 73.6 1 -Chile 71.7 2 +Peru 71.0 3Uruguay 70.5 4 -Mexico 67.6 5 =Colombia 67.3 6 =Argentina 66.6 7 -Panama 65.5 8 =Costa Rica 61.6 9 =Bolivia 60.4 10 =Guatemala 55.6 11 =Ecuador 52.5 12 +Paraguay 50.2 13 -El Salvador 48.5 14 +Venezuela 44.0 15 =Honduras 41.9 16 =Nicaragua 38.6 17 =Regional ave 56.8/Global ave 53.8/Emerging Markets ave 51.3

14 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Economic Activity

Upswing In 2013, But No Return To Boom Years

BMI VIEWFollowing Brazil's unexpectedly-weak Q312 growth data, which

showed that both fixed investment and the banking sector continue to

drag down economic activity, we have revised down our average real

GDP growth forecast for 2012 to 1.0% (from 1.5% previously). That

said, we anticipate a significant pickup in economic activity in 2013, as

we expect a backlog of infrastructure projects and a modest uptick in

private consumption will boost growth to 3.5% in 2013.

Macro StrategyWe have downgraded our 2012 real GDP growth forecast for

Brazil to 1.0% (from 1.5% previously), as recently released

Q312 growth data indicates that the economic recovery is pro-

gressing more slowly than we expected. Both fixed investment

underperformance and slimmer profit margins for the banking

sector, due to government pressure on commercial banks to

reduce lending rates, have long been themes in our analysis,

though they weighed on economic activity more significantly

than we were expecting in Q312. While growth looks to come

in at the weakest level since the 2009 recession in 2012, we

continue to anticipate a significant pickup in economic activity

in 2013. Indeed, we forecast real GDP growth of 3.5%, a slight

downward revision from our previous 3.7% forecast, as we

expect a construction backlog to bolster growth, and continued

stimulus measures to modestly boost activity in the consumer

and manufacturing sectors.

Expenditure BreakdownPrivate Consumption – Weaker Consumer The New Nor-mal: Our core view for relatively weak private consumption

remains in play. Indeed, high household debt levels and weaker

purchasing power, on the back of the real's 10.9% depreciation

in the year to date is likely to constrain private consumption

growth considerably over the coming quarters. As such, we

forecast private consumption to contribute 0.8 percentage

points (pp) to headline real GDP growth in 2012, implying

real growth of 1.3%.

We expect private consumption to pick up modestly 2013,

Not Yet Moving In The Right DirectionBrazil – Interest Rates & Credit Growth

30

35

40

45

50

55

60

65

70

75

9

14

19

24

29

34

39

44

49

54

Jan-

05Ju

n-05

Nov

-05

Apr-

06Se

p-06

Feb-

07Ju

l-07

Dec

-07

May

-08

Oct

-08

Mar

-09

Aug-

09Ja

n-10

Jun-

10N

ov-1

0Ap

r-11

Sep-

11Fe

b-12

Jul-1

2

Individual Credit Growth (% chg y-o-y) LHS

Average Preset Consumer Interest Rates (%) RHS

Source: BMI, BCB

Starting To Turn The CornerBrazil – Real GDP Growth By Expenditure, % chg y-o-y

-4

-2

0

2

4

6

8

10

-20

-10

0

10

20

30

40

50

Q10

6Q

206

Q30

6Q

406

Q10

7Q

207

Q30

7Q

407

Q10

8Q

208

Q30

8Q

408

Q10

9Q

209

Q30

9Q

409

Q11

0Q

210

Q31

0Q

410

Q11

1Q

211

Q31

1Q

411

Q11

2Q

212

Q31

2

Private Consumption (LHS)Public Consumption (LHS)Gross Fixed Capital Formation (LHS)Real GDP Growth (RHS)

Source: BMI, IBGE

TABLE: ECONOMIC ACTIVITY2007 2008 2009 2010 2011 2012e 2013f 2014f 2015f 2016f

Nominal GDP, BRLbn [1] 2,661.3 3,032.2 3,239.4 3,770.1 4,143.0 4,344.7 4,741.3 5,140.2 5,607.8 6,106.5

Real GDP growth, % y-o-y [2] 6.1 5.2 -0.3 7.5 2.7 1.0 3.5 3.7 4.0 4.2

GDP per capita, US$ [2] 7,201 8,622 8,384 10,987 12,576 11,175 11,023 11,202 11,375 12,422

Population, mn [3] 189.8 191.5 193.2 194.9 196.7 198.4 200.1 201.7 203.3 204.8

Industrial production index, % y-o-y, ave [4] 5.9 3.0 -6.8 10.8 0.4 -2.7 2.5 5.1 4.6 4.1

Unemployment, % of labour force, eop [4] 7.4 6.8 6.8 5.3 4.7 5.5 5.4 5.5 5.5 5.6

Notes: e BMI estimates. f BMI forecasts. Sources: 1 IBGE, IMF; 2 IBGE/BMI calculation; 3 World Bank/UN/BMI; 4 IBGE.

15Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

growing by 3.2% in real terms, and contributing a more signifi-

cant 2.1pp to headline growth, as fiscal and monetary stimulus

increasingly feed through to the domestic market. However,

we highlight that weaker credit growth will help keep private

consumption growth off its recent highs. As we highlighted

above, a significant uptick in household debt levels has brought

the household debt servicing ratio (expected household debt

servicing payments/disposable income) to 22.0 in September,

marking several months near record high levels, and implying

that a period of deleveraging is necessary over the coming

quarters. We have seen consumer default rates rise in tandem in

recent months, remaining elevated at 7.9% of the total portfolio

in October, indicating that consumers remain stretched to make

loan payments despite a tight labour market. We expect both

of these factors, combined with private sector banks' continued

reticence to aggressively expand their loan portfolios, will limit

credit growth over the coming quarters, weighing on private

consumption.

Fixed Investment – Backlog To Drive Strong Growth: Follow-

ing a poor performance in Q312, we have significantly revised

down our 2012 fixed investment forecast. We now forecast

gross fixed capital formation to subtract 0.5pp from headline

growth in 2012, implying a 2.5% contraction in real terms, down

from 0.3% real growth previously. Our Infrastructure team has

long highlighted that Brazil is plagued by a number of issues,

which have put a ceiling on growth. Indeed, construction costs

remain substantial due to prohibitive local content requirements,

while high tariffs and complex tax, human resources, legal and

capital structures are weighing on profitability and access to

heavy industry. Moreover, a weak regulatory environment has

resulted in many projects being held up, or even re-tendered,

for reasons ranging from bidding irregularities to inadequate

environmental impact assessments. Ineffective institutions have

hindered government funding of infrastructure projects, which

comprises the majority of the government's growth accelera-

tion programme (PAC II), while a poor business environment

is deterring the private sector.

However, with the 2014 World Cup coinciding with a general

election and the final year of the PAC II, our Infrastructure

team expects a boost to construction industry growth in 2013

and 2014 similar to that seen in 2010 (without the base effects

from 2009's recession). Accelerating activity will be driven

by an expected improvement in funding disbursement and the

awarding of contracts, as a raft of new concession tenders and

projects has started to hit the market in H212. Moreover, with

infrastructure crucial to supporting the expansion of the oil &

gas, agribusiness and mining sectors, we believe the Brazilian

government will likely push through projects crucial to catalys-

ing this growth potential. Given these factors, we forecast gross

fixed capital formation to contribute a more significant 1.5pp

to real GDP growth in 2013, implying real growth of 7.7%.

Government Consumption – Heading Higher On Pre-Election Spending: We maintain our forecast for government

consumption to contribute a relatively moderate 0.2pp to headline

growth in 2012, implying real growth of 0.8%. Indeed, despite

numerous fiscal stimulus measures implemented in the year-

to-date, we have not seen a significant pickup in expenditure

growth. Rather, given that most of these measures have come in

the form of tax breaks, we have seen revenue growth fall instead,

a trend we expect to continue through year-end.

Pressure On Households Remains HighBrazil – Household Debt & Non-Performing Loans

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

15

16

17

18

19

20

21

22

23

Jan-

05Ju

n-05

Nov

-05

Apr-

06Se

p-06

Feb-

07Ju

l-07

Dec

-07

May

-08

Oct

-08

Mar

-09

Aug-

09Ja

n-10

Jun-

10N

ov-1

0Ap

r-11

Sep-

11Fe

b-12

Jul-1

2

Seasonally-Adjusted Household Debt Servicing Ratio LHSIndividual Non-Performing Loans (% total portfolio) RHS

Source: BMI, BCB

A Lot In The PipelineBrazil – PAC II (2011-2014) Investment Programme, BRLbn

Cidade Melhor

(Better City), 57.1

Comunidade Cidada (Citizen

Community), 23

Minha Casa, Minha Vida (My House,

My Life), 278.2

Agua e luz Para Todos (Water and Light for all),

30.6

Transport, 104.5

Energy, 461.6

Source: Brasil.gov

16 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

However, we maintain our view for a pickup in government con-

sumption in 2013, forecasting real growth of 2.1%, contributing

a more sizeable 0.4pp to real GDP growth. Indeed, with a general

election coming up in October 2014, and the PAC II programme

scheduled to expire that year as well, we believe public spending

will pick up significantly over the coming quarters.

Net Exports – External Account Weakness To Continue: Given significant continued weakness in trade data in recent

months, we have downgraded our exports and imports outlooks

for Brazil to reflect real growth of just 1.0% (from 4.0% previ-

ously) in 2012, and we forecast net exports to subtract 0.8pp

from headline real GDP growth.

Due to downgrades to our export and import data for 2013, in

line with our view that weaker Chinese demand for commodi-

ties will continue to impact Brazil's external accounts, we now

forecast net exports to subtract 0.5pp from headline growth,

slightly more than our previous forecast of -0.4pp.

Lower-Trend Growth To Continue Beyond 2013Over the medium term, we believe slowing private consumption

and the end of the China-led commodity boom will contribute to

average Brazilian real GDP growth of 3.5% between 2012 and

2017. Indeed, we believe that Brazil's consumer story is in for

a period of more moderate growth in the next few years due to

reduced consumer purchasing power, on the back of continued

currency weakness, and high household indebtedness.

In addition, we foresee a supportive, but bifurcated, investment

picture going forward (see our online service, October 11 2012,

'Lower-Trend Growth Ahead'). While a massive growth ac-

celeration programme and significant commodity wealth will

continue to support one of the region's largest infrastructure

project pipelines, our view for China's economy to rebalance

has important implications for Brazil. As Chinese investment

comes off the boil, we anticipate that the slowdown in economic

activity will feed through to lower average prices for base met-

als and iron ore, squeezing firms' margins and forcing them to

re-evaluate their capital expenditure programmes in major com-

modity producing countries. As such, we expect that investment

inflows related to the commodity sector are likely to moderate,

feeding through into slower headline growth in Brazil.

Risks To OutlookShould Brazil's construction backlog clear more slowly than

we currently expect, resulting in only a moderate improvement

in fixed investment growth over the coming quarters, growth

is likely to be relatively moderate in H113. Such a scenario,

combined with little pick up in private consumption due to

persistently high indebtedness and rising labour market uncer-

tainty, would pose major downside risks to our 2013 real GDP

growth forecast of 3.5%.

Monetary Policy

Economic Recovery And Price Pressures Underpin Modest Rate Hike

BMI VIEWWhile we believe that a slow economic recovery and significant pres-

sure on households is likely to keep Brazilian interest rates on hold for

the majority of 2013, we maintain our view for a 25-basis-points hike

by end-year, bringing the Selic rate to 7.50%. This comes as inflation

expectations have headed higher in recent months and we believe sig-

nificant currency depreciation and other supply-side price pressures

will keep headline inflation elevated as well.

We maintain our view that interest rates in Brazil will remain

near record lows in 2013, as the monetary authorities seek to

lessen the burden on a highly leveraged household sector, bolster

private consumption growth and economic activity. That said,

with inflation expectations edging higher and our forecast for

a significant uptick in real GDP growth to 3.5% in 2013, we

maintain our view that the Banco Central do Brasil (BCB) will

hike the benchmark Selic target rate by 25 basis points (bps)

to 7.50% by end-2013 (see our online service, July 20 2012,

A Massive SlowdownBrazil – Total Export And Import Growth, % chg y-o-y

-60

-40

-20

0

20

40

60

80

Jan-

07Ap

r-07

Jul-0

7O

ct-0

7Ja

n-08

Apr-

08Ju

l-08

Oct

-08

Jan-

09Ap

r-09

Jul-0

9O

ct-0

9Ja

n-10

Apr-

10Ju

l-10

Oct

-10

Jan-

11Ap

r-11

Jul-1

1O

ct-1

1Ja

n-12

Apr-

12Ju

l-12

Exports Imports

Source: BMI, BCB

17Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

'Interest Rates To Head Lower'). Nevertheless, given that the

Brazilian economy's recovery remains nascent and the country's

policymakers are likely to continue placing pressure on both

lending rates and the currency over the coming quarters, we

acknowledge that there are significant risks to this view.

Aggressive Rate Cuts Achieved Several GoalsWe have long argued that the BCB's 525 basis points (bps) of

cuts to the Selic rate between August 2011 and November 2012

sought to achieve several different goals, including stimulating

growth in the slowing economy, weakening the overvalued

real and bringing down the country's restrictively high interest

rates. At present, the monetary authorities look to have been

relatively successful, achieving at least two out of the three

objectives and fundamentally altering interest rate expectations

over the coming years.

Indeed, the real depreciated by 8.8% in 2012 on the back of

lower interest rates and government intervention, and continues

to trade below the BRL2.0000/US$ level despite rallying in

recent days. This has fed through to a slightly weaker real ef-

fective exchange rate as well, a long-held concern for the BCB

given the sharp slowdown in industrial production since 2011.

As such, while we believe the real will remain weak over the

next several years, averaging BRL2.1600/US$ between 2013

and 2015, we have recently tempered our forecasts for depre-

ciation to reflect what we see as important BCB concerns over

FX weakness. In addition to eroding consumer purchasing

power, continued real weakness, will also mean that imported

inflationary pressures will remain a salient concern over the

coming quarters, particularly given that Brazil's consumer price

basket is heavily weighted towards food and fuel (see 'Supply

Shocks And Stimulus Biggest Inflation Risks', August 24 2012).

In addition, interest rate expectations for a multi-year period have

changed dramatically in recent quarters, as the January 2014 DI

futures contract is currently trading at 7.2%, down from 10.4%

at the beginning of 2012. Moreover, the January 2021 contract

is trading at 9.3%, significantly lower than 11.0% at the start

of last year, implying a shift in rate expectations at the longer

end of the interest rate futures curve as well.

TABLE: MONETARY POLICY2009 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f

Consumer prices, % y-o-y, eop [2] 4.3 5.9 6.5 5.3 5.3 4.5 4.7 5.1 4.4

Consumer prices, % y-o-y, ave [3] 4.9 5.0 6.6 5.4 5.5 5.0 5.0 4.8 4.6

M1, BRLbn [4] 248.1 280.1 285.4 348.2 379.5 428.8 476.0 518.8 560.3

M1, % y-o-y [5] 10.5 12.9 1.9 22.0 9.0 13.0 11.0 9.0 8.0

M2, BRLbn [4] 1,169.3 1,360.7 1,617.5 1,876.3 2,176.5 2,394.1 2,585.7 2,792.5 3,015.9

M2, % chg y-o-y [5] 8.9 16.4 18.9 16.0 16.0 10.0 8.0 8.0 8.0

Central Bank policy rate, % eop [4] 8.75 10.75 11.00 7.25 7.50 8.00 7.50 6.50 5.50

Lending rate, %, eop [4] 34.3 35.0 37.0 30.0 32.5 34.5 35.0 33.0 30.0

Lending rate, %, ave [5] 37.3 34.9 38.9 33.5 31.2 36.3 34.8 34.0 31.5

Real lending rate, %, eop [1,5] 30.0 29.1 30.5 24.7 27.2 30.0 30.3 27.9 25.6

Real lending rate, %, ave [1,5] 32.4 29.8 32.4 28.2 25.8 31.3 29.8 29.2 26.9

3-month money market rate, % [5] 8.7 11.6 10.4 - - - - - -

Real 3-month money market rate, %, eop [1,5] 4.4 5.7 3.9 -5.3 -5.3 -4.5 -4.7 -5.1 -4.4

3-month money market rate, %, ave [5] 9.8 10.3 11.7 - - - - - -

Real 3-month money market rate, %, ave [1,5] 4.9 5.2 5.2 -5.4 -5.5 -5.0 -5.0 -4.8 -4.6

Notes: e BMI estimates. f BMI forecasts. 1 Real rate strips out the effects of inflation. Sources: 2 IBGE; 3 IBGE/BMI calculation; 4 BCB; 5 BCB/BMI calcu-lation.

FX Provides Some ReliefBrazil – Real Effective Exchange Rate Index

40

50

60

70

80

90

100

110

120

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: BIoomberg, BIS

18 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Furthermore, given our view for private consumption growth to

remain relatively moderate in 2013, as neither household debt

levels nor non-performing loans have seen a major improve-

ment in recent months, we anticipate that rates will remain near

historical lows this year and do not rule out further government

pressure on commercial banks to reduce their lending rates.

Indeed, although average preset consumer lending rates have

fallen from 50.3% to 38.0% between January and November

2012, credit growth has remained relatively moderate, coming

in at 10.0% y-o-y in September. As such, we do not rule out

further cuts to commercial banks' reserve requirements either,

as was the case in September and December 2012, in order to

further stimulate loan growth and bolster private consumption.

While the BCB was likely able to avoid a more aggressive slow-

down in 2012 by slashing the benchmark interest rate, growth

has yet to rebound strongly. As Q312 data showed, this was

partly due to its own policies, as the service sector suffered on

the back of a poor performance from financial services (see 'Ser-

vices And Investment Disappoint Highlighting Downside Risks

To Growth', December 3 2012). Nevertheless, while we expect

private consumption growth to remain relatively moderate on

the back of the above factors, we anticipate a significant uptick

in fixed investment growth in 2013 as projects are increasingly

pushed through in advance of the expiration of the govern-

ment's PAC II growth acceleration programme and FIFA World

Cup in 2014 (see 'Upswing In 2013, But No Return To Boom

Years', December 18 2012). That said, we maintain our view

that real GDP growth will remain below pre-crisis levels over

the coming years, averaging 3.7% between 2013 and 2017, on

the back of a continued deleveraging process and a supportive,

but bifurcated investment picture (see 'Lower-Trend Growth

Ahead', October 11 2012).

A Delicate Balance Between Stimulating Growth And Stoking InflationWhile we believe that significant pressure on households, as well

as a still nascent economic recovery will keep rates on hold for

the majority of 2013, we maintain our view for a 25bps hike to

the Selic rate by year-end. This comes as we expect supply-side

price pressures to remain significant through H113, and continue

to anticipate a substantial boost in economic activity in 2013

largely on the back of stronger fixed investment.

Data Points To Stronger Growth And InflationBrazil – Economic Activity, Selic Rate and Consumer Price Inflation

-5

-3

-1

1

3

5

7

9

11

5

7

9

11

13

15

17

19

Jan-

04Ju

n-04

Nov

-04

Apr-

05Se

p-05

Feb-

06Ju

l-06

Dec

-06

May

-07

Oct

-07

Mar

-08

Aug-

08Ja

n-09

Jun-

09N

ov-0

9Ap

r-10

Sep-

10Fe

b-11

Jul-1

1D

ec-1

1M

ay-1

2O

ct-1

2

Selic Rate (%) LHSConsumer Price Inflation (% chg y-o-y) RHSEconomic Activity (% chg y-o-y) RHS

Source: BMI, BCB

Worst Is In The PastBrazil – Real GDP Growth, % chg y-o-y

-4

-2

0

2

4

6

8

10

-20

-10

0

10

20

30

40

50

Q10

6Q

206

Q30

6Q

406

Q10

7Q

207

Q30

7Q

407

Q10

8Q

208

Q30

8Q

408

Q10

9Q

209

Q30

9Q

409

Q11

0Q

210

Q31

0Q

410

Q11

1Q

211

Q31

1Q

411

Q11

2Q

212

Q31

2

Private Consumption (LHS)Public Consumption (LHS)Gross Fixed Capital Formation (LHS)Real GDP Growth (RHS)

Source: BMI, IBGE

Rates To Remain LowBrazil – January 2014 DI Futures Contract, %

6.6

6.8

7.0

7.2

7.4

7.6

7.8

8.0

8.2

Jun-

12

Jul-1

2

Aug-

12

Sep-

12

Oct

-12

Nov

-12

Dec

-12

Source: Bloomberg

19Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

Indeed, given the run-up in global grains prices in 2012, our

Commodities team believes that food price inflation is likely

to remain elevated through H113, keeping headline inflation

in Brazil on the rise. In addition, high likelihood of a domestic

fuel price hike this year means that supply-side pressures are

unlikely to ease substantially in the near future (see 'Moody's

Downgrades Petrobras, But Prospects For Fuel Price Changes

Provide Optimism', December 20 2012). These factors, combined

with our view for stronger economic activity and a pick-up in

government spending before the 2014 general election, underpins

our view for inflation to average 5.5% this year, slightly above

our estimated average of 5.4% for 2012. This view is broadly

in line with the weekly central bank economists' survey, which

has seen end-2013 inflation expectations increase from 5.4% on

November 30 to 5.5% on January 4. As such, we maintain our

view that the trend will be for higher rates over the coming years.

Risks To OutlookGiven that Brazil's economy remains in the early stages of a

recovery, we acknowledge that there are significant risks to

our view for a modest interest rate hike this year. Should fixed

investment remain a drag on growth in early 2013 on the back

of continued project delays and investor concerns over high

costs and red tape, we believe the BCB could cut rates in order

to bolster growth. That said, we do not rule out the possibility

of additional easing leading to a hiking cycle, should inflation

head back towards the upper limit of the central bank's target

band, potentially posing an upside risk to our end-2013 interest

rate outlook.

Exchange Rate Policy

BRL: Inflation Concerns To Limit Currency Weakness

BMI VIEWSince our last currency forecast update, the Brazilian real has con-

tinued to trade broadly sideways. While a sell -off in late 2012, which

brought the unit to a low of BRL2.1384/US$ in early December, initially

made us think that the Banco Central do Brasil (BCB) might allow a

weaker currency, the unit's subsequent rally confirmed that the real

is likely to range trade over the coming months. As such, we expect

the unit to continue trading within a tight band of BRL2.0000/US$ and

BRL2.1000/US$ over the coming months, forecasting an average ex-

change rate of BRL2.0700/US$ this year, slightly stronger than our pre-

vious forecast of BRL2.1300/US$.

Core ViewWe maintain our view for further currency weakness in Brazil

over the coming years on the back of a more moderate domestic

growth story, easing investment inflows due to slowing growth

in China and our expectation that the central bank will remain

supportive of a weak real. That said, we have revised our

multi-year exchange rate outlook to reflect a slightly stronger

currency, with the unit averaging BRL2.1567/US$ between

2013 and 2015, as compared to BRL2.2783/US$ previously.

This revision follows what we see as increasing concerns by

the central bank over the inflationary impact of significant FX

weakness, as well as potential for other supply-side pressures to

drive inflation higher in 2013 tempering the bank's growth bias.

While we are expecting a significant pickup in economic activ-

ity in Brazil in 2013, forecasting real GDP growth to accelerate

from an estimated 1.0% in 2012 to 3.5% in 2013, we maintain

our long-held view that a period of lower-trend growth is on the

cards over the coming years (see our online service, October 11

2012, 'Lower Trend Growth Ahead'). While we believe the 2013

growth spurt will be driven in large part by a pickup in fixed

investment related to the expiration of the government's PAC II

growth acceleration programme and FIFA World Cup in 2014,

we believe the investment picture will remain bifurcated. This

is underpinned by our view that some mining and infrastructure

investment will remain vulnerable to weaker external demand.

In addition, we expect Brazil's consumer story to experience a

period of more modest growth in the next few years due to a

period of consumer deleveraging following a run-up in house-

hold debt levels in 2011 and 2012 (see 'Upswing In 2013, But

BRL To Remain Range Bound For NowBrazil – Exchange Rate, BRL/US$ (Daily) & 200-Day Moving Average

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

2.2

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Apr-

11

Jun-

11

Aug-

11

Oct

-11

Dec

-11

Feb-

12

Apr-

12

Jun-

12

Aug-

12

Oct

-12

Dec

-12

Source: BMI, Bloomberg

20 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

No Return To Boom Years', December 18 2012). With Brazilian

growth unlikely to return to its recent highs for the foreseeable

future, interest rates to remain near record lows (we forecast

one 25 basis points hike by end-2013, bringing the benchmark

Selic interest rate to 7.50%), we see little upside for the real

over the coming quarters (see 'Economic Recovery And Price

Pressures Underpin Modest Rate Hike', January 9).

In addition, our view for China to undergo a period of domestic

rebalancing over the coming years – long a theme in our Asia

Country Risk analysis – has important implications for the Brazil-

ian real. Indeed, we expect the Chinese economy to increasingly

move away from a heavily investment-led growth model to one

in which private consumption plays a greater role, implying that

Chinese demand for commodities is likely to weaken over the

coming years (see 'Emerging Markets: Beyond China's Hard

Landing', September 27). As such, we believe that investment

inflows are likely to ease over the coming quarters, as firms

increasingly re-evaluate their capital expenditure plans on the

back of lower average metals prices.

Moreover, we continue to believe that the BCB will remain

supportive of a weaker real over the coming quarters in order to

continue aiding the ailing manufacturing industry, as industrial

production has not posted sustained gains since 2010. That said,

with the weekly central bank economists' survey showing end-

2013 inflation expectations increased from 5.4% on November

30 to 5.5% on January 4, and potential for a domestic fuel price

increase and food price inflation to keep headline inflation el-

evated in 2013, we believe the BCB is likely to limit significant

currency weakness over the coming quarters, underpinning our

view for only moderate depreciation.

Risks To OutlookWe maintain that the central bank's exchange rate policy will

be a major driver of the real over the coming quarters, mean-

ing that policy changes pose the largest risk to our multi-year

exchange rate outlook. Indeed, should inflation spike on the back

of higher food price pressures than we currently expect and a

significant domestic fuel price increase, we could see the BCB

allow the unit to appreciate to above the BRL2.0000/US$ level,

posing major risks to our average and end-2013 exchange rate

forecasts of BRL2.0700/US$ and BRL2.1500/US$ respectively.

Investors Continue To Price In DepreciationBrazil – BRL/US$ 1-Year Offshore Non-Deliverable Forward Contract

& 200-Day Moving Average

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

2.4

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Source: Bloomberg

Downtrend To Remain In PlaceBrazil – Exchange Rate, BRL/US$ (Monthly)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: BMI, Bloomberg

TABLE: CURRENCY FORECASTSpot Short-Term 2013 2014

BRL/US$, ave 2.0391 2.0500 2.0700 2.1750

BRL/EUR, ave 2.6666 - 2.5254 2.6100

BCB Selic Rate, % eop 7.25 - 7.50 8.00

Source: BMI, January 9 2013

21Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

Balance of Payments

Stronger Trade Outlook Underpins Current Account Improvement

BMI VIEWFollowing a substantial trade slowdown in 2012, we expect a modest

recovery in exports, due to favourable base effects and a cyclical up-

swing in Chinese growth, will bolster the current account in 2013. Mean

while, although we expect the financial account surplus to remain off its

recent highs, we believe it will continue to comfortably offset the current

account deficit.

We maintain our long-held view that Brazil's external account

deficit will remain substantial in the next few years on the back

of more moderate export growth, due to still weak global growth

and a structural shift in China's economy. As such, we forecast

the current account deficit to come in at 2.2% of GDP in 2013,

a slight improvement from an estimated 2.3% of GDP in 2012

(see our online service, September 26 2012, 'Weakening Trade

Account Dampens Current Account Outlook'). While we expect

structurally weaker growth in China will temper investment

inflows into Brazil over the coming quarters, as cost constraints

impact firms' capital expenditure plans, we believe the financial

account surplus will continue to comfortably offset the current

account deficit.

Trade Balance To Head Higher As Exports RecoverBrazilian exports fell off sharply in 2012 as domestic growth

slowed and exports to China headed into negative territory,

and we expect only moderate upside in 2013. Indeed, we have

revised our 2012 estimate to reflect a 4.7% contraction in exports

last year (from a 2.0% contraction previously) and forecast a

relatively modest 4.5% expansion in 2013.

Brazilian exports are weighted heavily towards manufactured

goods and primary products (84.2% of exports during the first

11 months of 2012), and our view for the cyclical upswing in

Chinese economic activity to continue through H113 means that

rising demand for steel and iron ore will be supportive of export

growth (exports to China were 17.1% of total exports between

January and November 2012). Moreover, our Agribusiness team

is expecting strong sugar, coffee and soybean production to come

online over the coming months, bolstering exports as well. That

said, while exports to Argentina are a fairly small proportion of

total exports – 7.5% between January and November 2012 – we

believe they are unlikely to see a significant pickup, underpinned

TABLE: CURRENT ACCOUNT2009 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f

Goods imports, US$bn [2] 127.7 181.8 226.2 223.5 230.0 242.0 260.0 290.0 320.0

Goods imports, % of GDP [3] 7.9 8.5 9.1 10.0 10.0 10.2 10.3 10.5 10.4

Goods exports, US$bn [2] 153.0 201.9 256.0 244.0 255.0 270.0 300.0 335.0 375.0

Goods exports, % of GDP [3] 9.4 9.4 10.4 11.0 11.1 11.4 11.9 12.1 12.2

Goods exports, % of imports [3] 119.8 111.1 113.2 109.2 110.9 111.6 115.4 115.5 117.2

Balance of trade in goods, US$bn [2] 25.3 20.1 29.8 20.5 25.0 28.0 40.0 45.0 55.0

Balance of trade in goods, % of GDP [3] 1.6 0.9 1.2 0.9 1.1 1.2 1.6 1.6 1.8

Services imports, US$bn [2] 47.0 62.6 76.3 79.5 70.0 75.0 65.0 65.0 67.0

Services imports, % of GDP [3] 2.9 2.9 3.1 3.6 3.1 3.2 2.6 2.3 2.2

Services exports, US$bn [2] 27.7 31.8 38.4 40.3 29.0 29.3 29.1 29.0 29.0

Services exports, % of GDP [3] 1.7 1.5 1.6 1.8 1.3 1.2 1.2 1.0 0.9

Goods and services exports, US$bn [3] 180.7 233.7 294.5 284.3 284.0 299.3 329.1 364.0 404.0

Goods and services exports, % of GDP [3] 11.2 10.9 11.9 12.8 12.4 12.6 13.0 13.1 13.2

Balance of trade in goods and services, US$bn [3] 6.0 -10.6 -8.1 -18.7 -16.0 -17.7 4.1 9.0 17.0

Balance of trade in goods and services, % of GDP [3] 0.4 -0.5 -0.3 -0.8 -0.7 -0.7 0.2 0.3 0.6

Net income, US$bn [2] -33.7 -39.5 -47.3 -36.0 -37.0 -38.0 -38.0 -34.1 -33.9

Income account balance, % of GDP [3] -2.1 -1.8 -1.9 -1.6 -1.6 -1.6 -1.5 -1.2 -1.1

Net transfers, US$bn [2] 3.3 2.8 2.8 4.3 3.2 3.2 3.2 3.3 3.3

Net transfers, % of GDP [3] 0.2 0.1 0.1 0.2 0.1 0.1 0.1 0.1 0.1

Current account, US$bn [2] -24.3 -47.5 -52.6 -50.4 -49.8 -52.5 -30.6 -21.8 -13.6

Current account, % of GDP [3] -1.5 -2.2 -2.1 -2.3 -2.2 -2.2 -1.2 -0.8 -0.4

Openness to international trade, % [1,3] 17.3 17.9 19.5 21.0 21.2 21.6 22.2 22.6 22.7

Notes: e BMI estimates. f BMI forecasts. 1 Imports plus exports, % of GDP. Sources: 2 BCB; 3 BCB/BMI calculation.

22 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

by our view for a devaluation of the Argentine peso in 2013, as

well as sharp deceleration in real GDP growth to 0.9% this year.

Following an estimated 1.2% contraction in 2012, we forecast

only a moderate recovery in import growth this year to 2.9%

(a slight downgrade from our previous forecast of 4.8%). In-

termediate goods and raw materials, as well as capital goods,

comprised 66.5% of total imports during the first 11 months of

2012, and import growth correlates closely with the industrial

production index.

While we expect industrial production to rebound in 2013,

aided by increased competitiveness on the back of continued

real weakness and the continuation of several stimulus pro-

grammes targeted at the manufacturing sector, we forecast an

average expansion of just 1.5%, following an estimated 2.7%

contraction in 2012. As such, while we believe favourable base

effects and a modest pickup in the manufacturing sector will

prompt imports to return to growth this year, we expect them

to remain off their recent highs.

In addition to a moderate improvement in the trade balance, our

expectation that the income account deficit will be constrained

by less significant profit repatriation by foreign firms, also un-

derpins our view for an improvement in the current account this

year. Indeed, we have seen the income account deficit moder-

ate in recent months and expect this trend to continue as firms'

profit margins remain under pressure due to weak domestic

and global growth.

Investment Inflows To EaseOn the investment side, we maintain our long-held view that

Brazil's financial account surplus will remain off its recent highs

in the next few years, although it will be more than sufficient to

fund the current account deficit. This view is underpinned by

our expectation that a structural shift in the Chinese economy

will precipitate more modest demand and prices for industrial

metals in particular, prompting major mining firms to re-evaluate

their capital expenditure plans in light of this new environment.

In addition, with Brazil's growth story having slowed substan-

tially over the last 12 months, and unlikely to return to pre-2011

growth rates in the near future, we expect portfolio investment

to remain more moderate as well, in line with the recent trend.

That said, given Brazil's substantial infrastructure project pipe-

line, as well as its massive commodity wealth, we believe the

country will remain one of the foremost investment destinations

in Latin America over the next five to 10 years.

Risks To OutlookWe recently explored the potential impacts of a more sustained

uptick in Chinese economic activity on Brazil and the region's

other major metals exporters through 2013 (see 'What If We're

Wrong On Chinese Growth? Assessing The Regional Impli-

cations', December 27 2012). Such a scenario would bolster

export growth on the back of a sustained pickup in demand

and prices for steel and iron ore, posing potential upside risks

to our 2013 and 2014 export and current account forecasts. In

addition, stronger economic activity in China would likely result

in stronger investment inflows than we currently expect as firms

are likely to continue boosting their capital expenditure plans.

Imports Linked To Industrial ProductionBrazil – Goods Imports & Industrial Production Index, % chg y-o-y

-20

-15

-10

-5

0

5

10

15

20

25

-60

-40

-20

0

20

40

60

80

100

Jan-

07M

ay-0

7Se

p-07

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Intermediate Products And Raw Materials LHSCapital Goods LHSIndustrial Production RHS

Source: BMI, BCB

Heading Into Positive TerritoryBrazil – Goods Exports, % chg y-o-y

-60

-40

-20

0

20

40

60

80

100

120

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Total Primary products Manufactured goods

Source: BMI, BCB

23Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

Fiscal Policy

Expenditures To Keep Fiscal Deficit Substantial In 2013

BMI VIEW While we see some upside for revenue growth in 2013 following a sig-

nificant slowdown in 2012, we believe expenditures will head higher as

well, meaning that we anticipate no improvement in Brazil's nominal

fiscal deficit this year. Moreover, with the government indicating that it

is looking to loosen Brazil's fiscal framework, we believe the adminis-

tration will miss its primary balance target in 2013.

We maintain our view that significant fiscal consolidation is off

the cards in Brazil until after the 2014 general election at the

earliest. While we expect a gradual winding down of the tax

cuts enacted in late 2011 and 2012 as economic activity picks

up, meaning some upside for revenue growth over the coming

quarters, we believe that spending related to the government's

PAC II growth acceleration programme and the 2014 general

election will see total expenditures head higher in 2013. As

such, we forecast the nominal fiscal deficit to come in at 2.6%

of GDP this year, marking no improvement from our 2012 es-

timate (see our online service, September 25 2012, 'Continued

Stimulus Means Fiscal Consolidation Will Remain Elusive').

Similarly, as the government continues to prioritise economic

growth over fiscal consolidation, we expect it to miss its primary

fiscal balance target of 3.1% of GDP in 2013, with the primary

balance coming in at 2.8% of GDP. Indeed, in line with recent

government statements, we believe it is highly likely that the

administration technically missed the target in 2012, and will

instead exclude certain investments and tap the country's sov-

ereign wealth fund to meet it.

Revenues To Head HigherWhile revenue growth remained weak for the majority of 2012,

due in part to a major slowdown in tax inflows, we expect some

upside in 2013 as economic activity recovers. Moreover, we

Financial Account Surplus To Remain Off Its Recent Highs

Brazil – FDI & Portfolio Investment, US$mn

-10,000

-5,000

0

5,000

10,000

15,000

20,000

25,000

30,000

Jan-

08Ap

r-08

Jul-0

8O

ct-0

8Ja

n-09

Apr-

09Ju

l-09

Oct

-09

Jan-

10Ap

r-10

Jul-1

0O

ct-1

0Ja

n-11

Apr-

11Ju

l-11

Oct

-11

Jan-

12Ap

r-12

Jul-1

2O

ct-1

2

FDIPortfolio Investment

Source: BMI, BCB

More Upside AheadBrazil – Tax Revenue & Economic Activity, % chg y-o-y

-6

-4

-2

0

2

4

6

8

10

12

-20

-10

0

10

20

30

40

Jan-

06M

ay-0

6Se

p-06

Jan-

07M

ay-0

7Se

p-07

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Tax Revenue (LHS)Seasonally-Adjusted Economic Activity Index (RHS)

Source: BMI, BCB

TABLE: FISCAL POLICY2009 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f

Fiscal revenue, BRLbn [1,5] 737.1 917.3 987.2 1,056.3 1,151.4 1,278.0 1,431.4 1,603.1 1,795.5

Revenue, % of GDP [1,6] 22.8 24.3 23.8 24.3 24.3 24.8 25.5 26.2 26.9

Fiscal expenditure, BRLbn [2,5] 699.9 840.8 897.2 995.9 1,130.3 1,288.6 1,430.3 1,580.5 1,722.7

Expenditure, % of GDP [2,6] 21.6 22.3 21.7 22.9 23.8 25.0 25.4 25.8 25.9

Budget balance, BRLbn [3,5] -106.2 -93.7 -108.0 -113.0 -124.2 -128.9 -112.5 -110.2 -86.6

Budget balance, % of GDP [3,6] -3.3 -2.5 -2.6 -2.6 -2.6 -2.5 -2.0 -1.8 -1.3

Primary balance BRLbn [3,5] 64.8 101.7 128.7 99.9 132.8 154.6 174.3 202.1 233.2

Primary balance % of GDP [4,6] 2.0 2.7 3.1 2.3 2.8 3.0 3.1 3.3 3.5

Notes: e BMI estimates. f BMI forecasts. 1 Central Government Revenues; 2 Central Government Expenditure; 3 General Government Budget (Accumu-lated Current Prices); 4 Fiscal balance stripping out interest payments on government debt. Sources: 5 BCB; 6 BCB/BMI calculation.

24 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

forecast total central government revenue to expand by 9.0%

in 2013, after estimated growth of 7.0% in 2012. This comes as

we have already begun to see a modest recovery in tax revenue

in recent months, posting 4.7% y-o-y growth in November, well

above its 2012 low of -6.9% y-o-y.

Our view for revenues to expand at a modestly stronger pace in

2013 is underpinned by our expectation of a gradual winding

down of the tax cuts implemented in recent quarters, as well as

a pickup in economic activity. Indeed, the former is exemplified

by the government's recent announcement that it will gradually

increase the industrial products tax (IPI) over the coming months,

phasing out a tax cut targeted at the Autos sector (see ' Gov-

ernment To Stagger Tax Cut Reduction ', December 20 2012).

While we believe the elimination of tax breaks will be gradual,

given the government's growth bias, we believe slightly higher

tax rates are likely to bolster revenues this year. Moreover, we

expect revenue growth to get a boost from stronger economic

activity as well, in line with our forecast for real GDP growth to

accelerate to 3.5% in 2013, a significant increase from estimated

1.0% growth in 2012 (see 'Upswing In 2013, But No Return To

Boom Years', December 27 2012).

PAC II And Election To Boost ExpendituresOn the expenditures side, we continue to see scope for government

spending to head higher over the coming quarters, forecasting

total central government expenditures to expand by 13.5% in

2013, up from an estimated 11.0% in 2012.

This view is supported by our expectation that both the expira-

tion of the government's PAC II growth acceleration programme

in 2014, as well as the general election that year will see both

current and capital expenditures tick up. Indeed, our Infra-

structure team anticipates that after significant project delays

in 2012, the government will increasingly push through public

investment projects over the coming quarters. In addition to the

programme's expiration in 2014, the general election provides a

further impetus for President Dilma Rousseff's government to

ramp up promised spending on infrastructure and social housing,

underpinning our view for higher expenditure growth.

Changing The Fiscal Paradigm ?The Brazilian government's decision to forgo its primary fiscal

balance target of 3.1% of GDP in 2012, indications that the

government may miss it again in 2013 (our core view), as well

as proposed changes to the country's fiscal responsibility law

underscore our view that the current administration is moving

towards a looser fiscal framework. Indeed, given the economy's

success in managing its public finances in recent years, we

believe that an increasing focus on the nominal fiscal deficit,

rather than the primary surplus, is apt. While we acknowledge

that relaxing the country's hallmark fiscal responsibility law

could be a slippery slope, the ability to reduce Brazil's substantial

tax burden – one of the proposed changes – will be essential

to increasing investment and improving the country's business

environment over the medium to long term. Indeed, Brazil

scores 154 out of 185 economies in the 'paying taxes' portion

of the World Bank's Doing Business 2013 report, due to both a

69.3% total tax rate and a burdensome 2,600 hours to file taxes.

Given that we expect both more moderate real GDP growth over

the coming years, as well as an increasingly important role for

fixed investment in Brazil's economy, a more investor-friendly

tax regime is essential in the next few years.

Risks To OutlookThe risks to our 2013 fiscal outlook lie to the downside. Should

real GDP growth disappoint over the coming quarters on the

back of a more moderate expansion in fixed investment that we

currently anticipate, we could see both more moderate revenues

and higher expenditures. Weaker than expected economic activity

could see the government fail to phase out certain tax breaks,

seeing what modest additional revenue growth we foresee this

year disappear. Moreover, we expect that expenditures are likely

to pick up even if economic activity does not as the government

attempts to stimulate growth and moves forward with some public

investment projects ahead of the PAC II deadline and general

election in 2014. Such a scenario would pose major downside

risks to our primary and nominal fiscal forecasts this year.

Uptrend To ContinueSelected Components Of Central Government Expenditures, BRLbn

0

20

40

60

80

100

120

Jan-

08Ap

r-08

Jul-0

8O

ct-0

8Ja

n-09

Apr-

09Ju

l-09

Oct

-09

Jan-

10Ap

r-10

Jul-1

0O

ct-1

0Ja

n-11

Apr-

11Ju

l-11

Oct

-11

Jan-

12Ap

r-12

Jul-1

2O

ct-1

2

Capital and Current ExpendituresSocial securities benefitsPayroll and Social Charges

Source: BMI, BCB

25Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

Regional Economic Activity

What If We Are Wrong On Chinese Growth? Assessing The Regional Implications

BMI VIEWSigns of a recovery in China's economy present substantial upside

risks to our current 'hard landing' scenario. Higher-than-anticipated

economic growth in China over the coming years would have profound

implications for Latin America's economic trajectory, and we highlight

Chile and Peru, and Brazil to a lesser extent, as most affected in the

event of stronger growth in Asia's biggest economy.

Regular readers of BMI's Latin America Country Risk ser-

vice will be acutely aware of our below-consensus economic

growth outlook for much of the region, despite forecasting

stronger average real GDP growth in 2013. In particular, we

have maintained a subdued growth outlook for countries with a

high dependence on commodity exports, as they are particularly

exposed to declining external demand. As part of our key mac-

roeconomic themes for 2013 for Latin America, we have singled

out industrial metals exporters, such as Chile and Peru, as most

vulnerable to a deceleration in economic growth in China (see

our online service, 'Our Key Themes For 2013', December 12

2012), which has become a dominant consumer of global base

metal production in recent years.

With BMI remaining substantially below consensus expectations

on Chinese growth, in light of an ongoing structural rebalancing

process in the coming years, metals exporters in Latin America

will be directly affected by the drop in housing activity and fixed

investment in China. Having said that, we highlight growing

upside risks to this view, with recent economic data showing

signs of 'green shoots' in the Chinese economy.

Back in October, our Asia team identified the possibility of

a cyclical upturn in Chinese economic growth, as part of a

drawdown in inventory levels (see 'Growth: Upside Risks

Amid Structural Downturn', November 12 2012). This view has

since materialised, presenting noteworthy upside risks to our

China growth forecast, which we recently revised up to 7.5%

from 7.1% for 2013. While we currently maintain that the lat-

est batch of positive data is temporary and cyclical within in

a structural downtrend, we explore the possibility of China's

economy performing closer to current consensus expectations

over the next two years, and how this will affect our outlook

for Latin America.

In our baseline scenario, we see Latin America's weighted aver-

age real GDP growing by 3.4% in 2013, up from 3.0%, which

we expect for 2012. Based on the existing weightings used in

our calculations for regional GDP, a stronger growth scenario

in China, which aligns more closely with consensus expecta-

'Hard Landing' Scenario Is Still Out Of ConsensusChina – Real GDP Growth Forecasts, %

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

2010 2011 2012f 2013f 2014f

Bloomberg Consensus BMI

Source: BMI, Bloomberg

TABLE: CHINA'S CONSUMPTION OF SELECTED COMMODITIES, % OF GLOBAL CONSUMPTION Aluminium Copper Lead Nickel Tin Zinc Corn Rice Wheat Oil Coal

2002 16.1 18.2 14.3 7.1 19.4 17.9 20.1 33.4 17.5 6.7 27.4

2003 18.6 20.1 17.1 10.6 23.9 21.2 19.8 32.1 18 7.2 30.6

2004 19.9 20.2 19.7 11.5 27.9 26.2 19 32.1 16.8 8.1 35.2

2005 22.2 21.9 25.5 15 33.5 28.6 19.4 31.1 16.5 8.3 37

2006 25.2 21.2 27.7 17.1 31.6 29 20 30.4 16.5 8.8 37.8

2007 32.7 26.8 30.7 24.2 37.5 31.8 19.4 29.9 17.3 9.1 38.6

2008 33.3 28.4 38.6 25.5 41 36 19.5 30.5 16.6 9.3 40.5

2009 40.7 39 44.5 43.1 45.7 43.5 20.2 30.8 16.5 9.7 43.6

2010 39.1 38.2 43.7 34.4 41.6 42.9 21.2 30.4 16.9 10.6 46.2

2011e 41.2 40.6 46.5 43.1 47.2 43.5 21.9 30.6 17.5 11.1 50

Source: BMI, USDA, WBMS

26 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

tions of 8.1% real GDP growth versus our forecast of 7.5% in

2013, we estimate that Latin America's GDP would expand by

3.7% in real terms, 0.3 percentage points (pp) above our current

estimates for the region. Moreover, i n 2014, we would see scope

for Latin America's economy to expand by 4.1% in real terms, as

opposed to our current baseline expectation for 3.7% real GDP

growth, in the event that a hard landing is avoided and China's

economy grows more in line with consensus expectations of

8.0% against our current projection for 6.7% real GDP growth.

In the event that we turn out to be overly pessimistic on China's

economic outlook (ie, no immediate rebalancing of the economy),

the stronger growth outlook for the region is primarily based

on the impact this would have on growth in Brazil, Chile and

Peru, which we believe to be most directly affected by China's

economic performance over the coming two years. However,

we also include indirect factors on regional growth, such as

stronger investor confidence, improved liquidity conditions and

an increase in private sector investment in the region, which

would help to push Latin America's real GDP growth higher.

Brazil : A More Supportive External Environment Would Delay Domestic Rebalancing While Brazil is less heavily exposed to China's growth story than

the region's major metals exporters, due to a lesser reliance on

exports (exports were 11.9% of GDP in 2011, compared with

18.0% in Peru) and a more diverse commodity mix, we believe

China's economic rebalancing will have important implications

for the Brazilian economy, including more moderate investment

inflows and a weakening currency (see ' Lower-Trend Growth

Ahead ', October 11 2012). Although we are forecasting a

significant uptick in economic activity in 2013, with real GDP

growth accelerating from 1.0% in 2012 to 3.5% in 2013, on the

back of continued stimulus measures and a significant construc-

tion backlog, we believe that Brazil is in for a period of more

moderate growth over the coming years (see 'Upswing In 2013,

But No Return To Boom Years', December 18 2012). This is

underpinned by our view that a period of consumer deleveraging

is on the cards, and while investment will be broadly support-

ive, it will be bifurcated, as some mining investment remains

vulnerable to weaker Chinese metals demand.

Conversely, we believe that a sustained bounce in Chinese

economic activity in 2013 and 2014 would feed through to a

pickup in export growth – exports to China averaged 17.8% of

total exports between January and July 2012 – on the back of

rising demand and more favourable prices for steel and iron

ore. As such, we believe net exports would be a more positive

contributor to growth over the coming years. However, the

impact would be less notable, given that Brazil's growth outlook

for the next two years is in large part based on fixed investment

and existing stimulus efforts. This is reflected in the smaller

divergence between BMI's and Bloomberg consensus forecasts

for real GDP growth in Brazil – despite our substantially lower

growth outlook on China, our Brazil growth forecast is only

slightly below consensus.

Having said that, we would expect investment inflows to pick

up in the event of stronger Chinese economic growth, which

would likely stave off further monetary easing measures by the

central bank. The central bank has recently grown more con-

Export Sector Still Looking To ChinaBrazil – Exports To China

-100

-50

0

50

100

150

200

250

300

-10

-5

0

5

10

15

20

25

30

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Brazilian Exports To China (% total) LHSBrazilian Exports To China (% chg y-o-y) RHS

Source: IMF, Bloomberg, BMI

Scope For A V-Shaped Recovery?Latin America – Real GDP Growth Forecast, % y-o-y

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

2010

2011

2012

f

2013

f

2014

f

BMI baseline scenarioStronger Chinese growth scenario

Source: BMI

27Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

cerned about the impact of a weaker real on the economy and

its inflation fighting credentials. With the prospect of stronger

global commodity prices in the event of a stronger Chinese

growth scenario, a normalization of monetary policy could oc-

cur sooner than under our current core view. Although we see

the central bank raising the Selic target rate to 7.50% from the

record-low of 7.25% by end-2013, the central bank may seek to

bolster the real's carry appeal and stave off capital outflows which

have seen the currency become one of the worst-performing FX

majors in the region in 2012.

Nevertheless, while an upturn in China would provide a more

supportive external environment for Brazil to recover from

the sharp slowdown seen in 2011 and 2012, boosting headline

growth, we do not believe that more robust Chinese growth

would fundamentally alter Brazil's economic rebalancing, but

would simply delay it.

Chile: Potentially A Very Different Economic TrajectoryWe expect that a sustained recovery in Chinese economic

activity would bolster the Chilean economy significantly.

Stronger Chinese demand, we believe, would have both first-

and second-order effects on the economy, which would likely

include stronger real GDP growth, a smaller current account

deficit, and a stronger peso.

The primary effect of a stronger-than-expected Chinese economy

in 2013 would be a return to relatively strong growth in Chilean

exports, which have contracted by 4.2% y-o-y in the year-to-

date in November. Indeed, Chilean exports to China constitute

roughly 25% of all Chilean exports, so we believe that an uptick

would likely boost export volumes, supporting net exports and

pushing real GDP higher.

While 25% is a significant portion of exports to send to one

country, the year-to-date contraction is not attributable solely

to China. Indeed, for much of 2012 Europe was a greater drag

on year-on-year export growth than China. As such, we believe

that, as long as Europe remains weak, a moderate strengthen-

ing in China would not be sufficient to bring Chile back to the

strong commodity growth of recent years.

The composition of Chile's exports leads us to believe that the

gains of a stronger Chinese economy would be fairly concentrated

among the country's sizeable mining industry. Chilean exports

to China are roughly 80% copper, and we would expect higher

profits in the mining industry. Higher profits could lead to higher

capital expenditure via reinvestment or encourage long-overdue

investment in the country's supporting industries, such as power

generation and transmission, investments that would likely have

positive spill-over effects for the rest of the economy.

In addition to the real economic benefit of a stronger net export

picture, we see other areas that would be affected by a surge in

Chinese economic activity leading to a rise in Chilean goods

exports. Chief among these is the current account, where we

believe greater export volumes would narrow our forecast for

a 2.2% of GDP current account deficit in 2013.

That said, we have long maintained that Chile is in a funda-

Feeding The DragonChile – Goods Exports By Destination, US$mn

0

5

10

15

20

25

30

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Jan-

03Ju

l-03

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Exports To China (FOB), US$mnExports ex China (FOB), US$mnExports To China As Percent Of Total (RHS), 3mma %

Source: BCC, BMI

China Hard Landing Has Minor Impact On Forecast Outlook

Brazil – Real GDP Growth Forecasts, %

0

1

2

3

4

5

6

7

8

2010 2011 2012f 2013f 2014f

Bloomberg Consensus BMI

Source: BMI, Bloomberg

28 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

mentally stable position with regard to its current account, so

while noteworthy, a slightly smaller current account deficit for

a year is unlikely to have a substantial real economic impact.

Another area of likely impact is the exchange rate, which in our

core view will depreciate slightly in 2013 on the back of weaker

global copper prices. We believe a likely result of an upsurge

in Chinese growth would be higher metals prices in general,

such that Chile's terms of trade would improve substantially.

Higher average prices for copper, which constitutes over half of

all Chilean exports, would likely see a period of peso strength,

particularly if high prices lead to an increase of FDI in the sector.

While we believe such a development would raise the politi-

cal opposition of manufacturing and agricultural exporters –

something we saw during the summer of 2012 – a stronger

peso would facilitate greater private consumption growth and

stronger purchasing power, enabling a rebalancing away from

reliance on export-driven growth over the long term.

Higher commodity prices on the back of stronger-than-expected

Chinese growth would likely increase inflationary pressures in the

Chilean economy. As such, and in light of our expectation that

such a scenario would see stronger real GDP growth, we believe

the Banco Central de Chile (BCC) would not cut its monetary

policy rate from 5.00% to 4.50% in 2013, as is our core view, but

would likely hold or even hike rates. Higher interest rates would

reinforce the peso appreciation we describe above, as an attractive

carry trade would bring more speculative dollars into the country.

Highly Exposed To A Hard LandingPeru – Exports To China

-50

-30

-10

10

30

50

70

90

110

130

150

-10

-5

0

5

10

15

20

25

30

Q10

6Q

206

Q30

6Q

406

Q10

7Q

207

Q30

7Q

407

Q10

8Q

208

Q30

8Q

408

Q10

9Q

209

Q30

9Q

409

Q11

0Q

210

Q31

0Q

410

Q11

1Q

211

Q31

1Q

411

Q11

2Q

212

Exports To China (% total) LHSExports To China (% chg y-o-y) RHS

Source: IMF, Bloomberg, BMI

China Is A Major Factor In Chile's Growth OutlookChile – Real GDP Growth Forecasts, %

3.5

4.0

4.5

5.0

5.5

6.0

6.5

2010 2011 2012f 2013f 2014f

Bloomberg Consensus BMI

Source: BMI, Bloomberg

Copper Demand Key To External SectorChile – Exports To China, US$mn

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

Jan-

03Ju

l-03

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Copper Exports To China (FOB), US$mnNon-copper Exports To China (FOB), US$mn

Source: BCC, BMI

Not All About ChinaChile – Contribution To Goods Export Growth By Destination, pp

-60

-40

-20

0

20

40

60

80

Jan-

04Ju

n-04

Nov

-04

Apr-

05Se

p-05

Feb-

06Ju

l-06

Dec

-06

May

-07

Oct

-07

Mar

-08

Aug-

08Ja

n-09

Jun-

09N

ov-0

9Ap

r-10

Sep-

10Fe

b-11

Jul-1

1D

ec-1

1M

ay-1

2O

ct-1

2

Europe China All Other Asia ex China Americas

Source: BCC, BMI

29Business Monitor International Ltd www.businessmonitor.com

ECONOMIC OUTLOOK

Peru: Far-Reaching Implications Of Rising ExportsSimilar to Chile, we believe that stronger Chinese growth is

most likely to feed through to the Peruvian economy by way

of a strong uptick in exports, due to rising Chinese demand

for Peru's mining exports, higher base metals prices, and more

robust investment inflows than we currently expect. Indeed,

Peruvian exports to China averaged 19.7% of total exports in

H112, and growth in exports has trended downward in recent

quarters. Moreover, mining exports comprised more than half of

total exports during the first three quarters of 2012, with copper

alone making up 22.6%.

As such, a sustained, multi-quarter bounce in the Chinese

economy, briefly staving off economic rebalancing pressures

would likely translate into a significant uptick in Peru's exter-

nal accounts. We would therefore expect net exports to be a

less substantial drag on real GDP growth in 2013 and 2014,

likely bringing headline growth closer to 2012 levels, which

we forecast to come in at 6.1%, rather than our current forecast

of 5.2% growth in 2013.

Stronger economic activity in China, and higher base metals

prices would also impact Peru through the investment channel.

Indeed, our Mining team has long highlighted that weaker prices

for copper, as well as other base metals, are likely to result in

major mining firms cutting back on their capital expenditure

plans (see 'Capital Expenditure To Slow', October 29 2012). This

is a particular threat in Peru, given rising costs and significant

business environment risks stemming from continued protests.

A sustained uptick in Chinese growth could see investment

inflows into Peru remain stronger than we currently expect over

the coming quarters, bolstering the financial account surplus

and placing continued appreciatory pressures on the currency.

A stronger external account picture, a more significant rise

in investment inflows in 2013 and 2014 and more robust real

GDP growth in Peru would have important implications for our

monetary policy and exchange rate outlooks as well.

Indeed, given our view for growth to moderate in 2013, as well as

declining inflation and a significant appreciation of the Peruvian

nuevo sol in recent quarters, we forecast the Banco Central de

la Republica del Peru (BCRP) to cut the policy rate by 25bps

Major Implications From Upside China Growth Risks

Peru – Real GDP Growth Forecasts, %

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

2010 2011 2012f 2013f 2014f

Bloomberg Consensus BMI

Source: BMI, Bloomberg

China The Largest ConsumerPeru – Lead Exports By Destination, %

China45%

South Korea24%

Canada18%

Belgium7%

Germany2%

Japan2%

Morrocco2% Others

1%

Source: Ministry of Mines, BMI

High Trade ConcentrationPeru – Cooper Exports By Destination, %

China37%

Japan14%Germany

8%

South Korea6%

Italy6%

Brazil5%

Spain5%

Others19%

Source: Ministry of Mines, BMI

30 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

to 4.00% by end-2013. However, we have long highlighted

that a stronger domestic growth outlook, and a more favourable

external environment, could lead the government to keep rates

on hold over the coming quarters, choosing to utilise banks'

reserve requirements to adjust credit conditions, rather than the

policy rate, as has been the case in recent months.

Moreover, we anticipate modest sol weakness over the coming

quarters, and forecast the unit will fall to PEN2.6600/US$ in

2013, down from PEN2.6360/US$ in 2012, due to monetary

easing and continued central bank intervention to weaken the

currency (see 'PEN: Weakness In 2013, But Appreciation Over

The Medium Term', December 5 2012). However, more robust

investment inflows than we currently expect could place sizeable

appreciatory pressures on the unit, posing major upside risks to

our multi-year exchange rate outlook.

31Business Monitor International Ltd www.businessmonitor.com

Chapter 3: 10-Year Forecast

The Brazilian Economy To 2022

Imbalances To Unwind, Three Potential Scenarios

BMI VIEW Vast natural resources and strong domestic demand will keep investor

interest rooted in Brazil over the coming decade. However, there is

a pressing need for the authorities to address some of the country's

deeply- rooted structural issues, stemming from too much consumption

and not enough production, which is likely to lead to slower growth and

a weaker currency at some point over the next 10 years.

Over the coming decade, a lot of attention will be focused on

Brazil as an engine of regional economic growth, and increas-

ingly as a key political actor on the international stage. Economic

policy credibility, solid institutions, rising incomes and a vast

array of commodities will underpin the country's growing im-

portance as a destination for global investors. However, several

of the economic imbalances that we have long been highlighting

– a very strong consumer and an ailing manufacturing sector

– need to be addressed. The longer these imbalances remain

unaddressed, the more painful the adjustment will be when it

comes. We therefore outline three potential scenarios for these

imbalances to play out over the next decade:

• Currency depreciation through 2015 helps unwind the

imbalances.

• The authorities utilize their massive toolkit to stave off any

substantial changes until after the 2014 presidential election.

• A substantial and sustained currency sell-off hits the con-

sumer and the banking sector hard.

Unwinding Imbalances Change The Shape Of Growth – 50% ProbabilityWe have long highlighted that Brazil's economic imbalances

are largely the cause of cheap, free-flowing credit and rampant

currency strength driven by robust capital inflows. Strong pur-

chasing power and increasing access to financing have bolstered

the Brazilian consumer and driven demand for relatively inex-

pensive imports in recent years. On the other hand, the country's

manufacturing sector has been weakened by rising labour costs,

import substitution policies and a lack of export competitiveness.

These dynamics have seen the current account flip into deficit in

recent years, fostering a reliance on foreign investment in order

to cover the external account shortfall. Given the diminishing

returns of continued fiscal and monetary stimulus, as well as

the still rising cost of domestic production, we believe these

imbalances are untenable in the long term.

Our core scenario calls for these imbalances to unwind over the

coming years through a weakening of the currency. The real's

break through long-term trendline support in May caused us to

call for more substantial depreciation in coming years, with the

unit reaching BRL2.2500/US$ by end-2015 from BRL2.0500/

US$ in end-2012. The slowdown in private consumption will

also be painful, impacted by both a reduction in purchasing

power as the currency weakens, as well as households' delev-

eraging as credit growth slows. Moreover, the improvement

on the manufacturing side is likely to be more drawn out, as

substantial private investment and a reduction in the govern-

TABLE: LONG-TERM MACROECONOMIC FORECASTS2015f 2016f 2017f 2018f 2019f 2020f 2021f 2022f

Nominal GDP, US$bn [1] 2,527.41 2,770.80 3,063.63 3,412.21 3,851.24 4,408.95 5,065.92 5,675.23

Real GDP growth, % y-o-y [2] 4.0 4.2 4.3 4.3 4.2 4.4 4.5 4.5

Population, mn [3] 203.3 204.8 206.3 207.7 209.1 210.4 211.7 212.9

GDP per capita, US$ [2] 12,432 13,527 14,850 16,426 18,417 20,952 23,929 26,653

Consumer prices, % y-o-y, ave [2] 5.0 4.8 4.6 4.5 4.6 4.5 4.5 4.4

Current account, % of GDP [4] -1.2 -0.8 -0.4 -0.2 -0.1 0.2 0.4 0.5

Exchange rate BRL/US$, ave [5] 2.22 2.21 2.17 2.12 2.05 1.95 1.85 1.80

Notes: f BMI forecasts. Sources: 1 IBGE, IMF; 2 IBGE/BMI calculation; 3 World Bank/UN/BMI; 4 BCB/BMI calculation; 5 BMI calculation.

32 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

ment's import substitution policies are also necessary to make

the industry more dynamic.

This shift away from a consumption-based growth model towards

greater fixed investment is what Brazil needs to put the economy

on a more sustainable long-term trajectory. Investment will be

driven by the 2014 FIFA World Cup, the Olympic Games in Rio

de Janeiro in 2016, the PAC II growth acceleration programme,

as well as the country's substantial infrastructure deficit. These

will provide enormous incentives for widespread infrastructure

upgrades across the country in which private firms (Brazilian

and foreign) will be keen to participate. Furthermore, the ex-

ploration and development of the country's massive offshore oil

reserves will remain a major driver of investment, in line with

our Oil & Gas team's forecast for net oil exports to increase to

1,086.7100b/d in 2022, from a deficit of 55.9100b/d in 2012.

However, for private companies to invest we need to see a

significant reduction in the cost of doing business, otherwise

the government will be left holding the bill.

While this will mark a major change to Brazil's growth story,

we do not foresee a significant drop in headline growth, in line

with our average real GDP growth forecast of 3.9% between

2012 and 2022. While this forecast encompasses a moderate

slowdown over the next few years, as the weaker currency and

slower credit growth impact the economy, we anticipate a pick

up between 2017 and 2022, when we expect growth to average

4.4%. Meanwhile rising capital inflows and a more competitive

Brazilian economy will help return the real to its appreciatory

trend, ending 2021 at BRL1.7500/US$.

Quick Fixes Prolong Imbalances, Sharp Adjustment After 2014 – 35% ProbabilityGiven the Brazilian authorities' massive toolkit and demonstrated

willingness to use it, we do not rule out the current economic

imbalances to continue over the coming years. This risk to

our core scenario is particularly acute given the 2014 general

election, implying that the appeal of using massive fiscal and

monetary stimulus to support growth remains high.

Should the government choose to continue substantial tax cuts for

industry and the consumer implemented in 2011, while walking

a fine line between aggressive monetary stimulus and eroding

the central bank's inflation fighting credentials, we believe the

authorities would be successful in boosting growth over the com-

ing years. However, this would result in a sharp adjustment after

2014. The removal of massive government stimulus would see

private consumption fall substantially, bringing down headline

growth as well. Furthermore, several additional years of strong

credit and money supply growth would make the consumer

deleveraging process even more painful. In addition, given the

unchecked rise of these imbalances, the potential for a sharp

currency sell-off on the back of investors' re-evaluation of their

attitudes towards the economy remains high.

Substantial Sell-off Batters Consumer and Banking Sector – 15% ProbabilityIn our opinion, the worst case scenario, and no doubt the most

painful for Brazil over the short term would entail a substantial and

sustained sell-off in the real, likely sending it to the BRL2.5000/

US$ level, on the back of a major change in investor sentiment

towards the economy. This would represent a significant break

out of the unit's long-term appreciatory trend, with massive

implications for the country's growth story.

Such a significant reduction of Brazilians' purchasing power

would translate into a slump for private consumption, dragging

down headline growth with it. In addition, tepid consumption

would hit the service sector hard, translating into rising unemploy-

ment, a major drag on growth as it currently employs the more

than twice the number of workers than the manufacturing sector.

A significant currency sell-off would also increase the likelihood

of a banking sector crisis and a supply side liquidity crunch. We

have long expressed concern about the sector's risky financing

practices, including small banks selling their loan books to

larger firms, and a growing reliance on external debt issuance

due to a favourable exchange rate. A sustained sell-off in the

real would create potential for a currency mismatch on banks'

balance sheets, while their debt servicing costs would increase

substantially. However, they would also be hit on the assets side,

as rising unemployment would precipitate a sharp deterioration

in credit quality, meaning that some lenders would be unable

to cover these rising costs. While we believe the government

would be able to cover the cost of a bank bailout, it would pull

the nominal fiscal deficit further into the red, leaving the gov-

ernment with an even larger debt overhang.

Such a scenario would clearly precipitate a rapid change in

investors' perceptions of the economy, implying that the coun-

try's substantial net international investment liabilities position

could become a major risk to external account stability. Though

foreign direct investment has ticked up in recent months, a large

proportion of these liabilities are still in the form of shorter-term

investments, which could head rapidly for the exit in the event

33Business Monitor International Ltd www.businessmonitor.com

10-YEAR FORECAST

of a substantial re-evaluation of Brazil's growth prospects. The

subsequent dearth of capital would not only exacerbate the

downturn, but could cap growth for many years to come.

BMI's long-term macroeconomic forecasts are based on a variety of quantitative and qualitative factors. Our 10-year forecasts assume in most

cases that growth eventually converges to a long-term trend, with economic potential being determined by factors such as capital investment,

demographics and productivity growth. Because quantitative frameworks often fail to capture key dynamics behind long-term growth determinants,

our forecasts also reflect analysts' in-depth knowledge of subjective factors such as institutional strength and political stability. We assess trends in

the composition of the economy on a GDP by expenditure basis in order to determine the degree to which private and government consumption,

fixed investment and the export sector will drive growth in the future. Taken together, these factors feed into our projections for exchange rates,

external account balances and interest rates.

35Business Monitor International Ltd www.businessmonitor.com

SWOT Analysis

Strengths A stable political regime has anchored investor interest in Brazil in the

last decade, and we expect this trend to remain in place throughout

the forecast period.

A large population and a growing middle class present mean that

Brazil's consumer sector provides significant long-term opportunities

for firms.

The Brazilian economy is one of the largest in the world and benefits

from a rich abundance of agricultural and mineral resources.

Weaknesses Despite economic liberalisation, significant trade barriers, labour

market rigidity and a complex customs system increase business

risk

Opportunities Commitments to upgrade physical infrastructure should continue to

be boosted by the successful bid to host the 2016 Olympic Games

in Rio de Janeiro and the 2014 FIFA World Cup, as well as the PAC

II growth acceleration programme.

Recent onshore and offshore oil discoveries could help Brazil become

a global oil giant. This will help the country attract a wide range of

investors and businesses over the long term.

Threats Tax reform and new labour legislation are needed to simplify the very

complex, onerous tax system and highly inflexible labour market.

Government intervention in the domestic banking sector and lax

regulation distort Brazil's financial system. Combined with massive

fiscally fuelled credit, there is potential for significant misallocation of

resources. This could undermine the overall business environment

and lead to a more prolonged economic slump.

BMI Business Environment Risk RatingsSeveral physical, institutional and regulatory challenges continue to

weigh on Brazil's business environment profile. At the same time,

however, long-term opportunities will likely continue to keep foreign

investment anchored, particularly in light of a series of sovereign credit

ratings upgrades, the awarding of the 2014 FIFA World Cup and 2016

Olympic Games to Rio de Janeiro, and the country's massive commodity

wealth. For the time being, however, a rigid labour market, high barriers

to entry and endemic corruption threaten to stall robust progress for the

country's investment profile.

Chapter 4: Business Environment

Business Environment Rank TrendChile 64.0 1 +Uruguay 59.8 2 +Mexico 53.8 3 +Brazil 53.7 4 +Peru 53.5 5 +Colombia 52.6 6 +Costa Rica 52.1 7 +Panama 51.6 8 =Argentina 48.3 9 -Paraguay 43.2 10 +El Salvador 42.0 11 -Guatemala 40.9 12 +Nicaragua 40.3 13 +Ecuador 38.4 14 +Bolivia 37.5 15 +Honduras 36.3 16 -Venezuela 32.6 17 +Regional ave 45.7/Global ave 48.6/Emerging Markets ave 45.2

36 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Business Environment Outlook

IntroductionWith an abundance of agricultural and mineral resources and a

government that is actively courting foreign investment, Brazil

poses an attractive investment environment. Furthermore, Presi-

dent Dilma Rousseff's ambitious infrastructure investment plans

should unlock opportunities across all major sectors, not least

with the successful bid to host the 2016 Olympic Games in Rio

de Janeiro – two years after the FIFA World Cup will take place

in Brazil. Over-regulation, corruption and gang crime, however,

represent the key threats to the business environment, in our view.

Institutions

Legal Framework The Brazilian legal system is becoming increasingly sophisticated

in order to complement an expanding and diverse economy. The

upshot of this has been a more dynamic and more competitive

legal market. While the system is now well structured by Latin

American standards, inefficiencies still slow the judicial process,

and this has contributed to a major backlog in cases.

The legal system is mainly based on Portuguese law and is

underpinned by the terms of the Federal Constitution, effective

since 1988. Judicial power is divided between the state and

federal branches. Each state is divided into judicial districts

(comarcas). These comarcas have trial courts acting as the court

of first instance. Some districts also have extra courts to rule

on family and bankruptcy issues. Crimes against the person

are heard by a jury; otherwise, most cases are heard by a judge

only. Judgments from these courts can be appealed against in

the courts of second instance.

Property Rights Property rights protection is reasonably sound. In the 2012 In-

ternational Property Rights Index report, Brazil is placed 62nd

out of 130 countries surveyed, rising from 81st in 2009. It ranks

18th out of 22 countries in the region. That said, property rights

are still a relatively abstract concept in the slums (favelas) of

major cities and rural areas at the periphery.

Intellectual Property Rights Brazil is a member of the World Intellectual Property Organi-

sation (WIPO) and has signed several relevant WTO accords.

Enforcement remains patchy, a state of affairs that has drawn

criticism from the country's main trading partners. However, the

overall intellectual property rights situation has improved consid-

erably. Several court cases concerning trademark infringements

have been successfully brought by international companies.

A 1996 industrial property law generally brought patent and

trademark legislation up to international standards. In addition, a

TABLE: BMI BUSINESS AND OPERATION RISK RATINGSInfrastructure Rating Institutions Rating Market Orientation Rating Business Environment

Argentina 55.8 44.8 44.4 48.3

Brazil 60.9 53.3 47.0 53.7

Chile 53.4 68.1 70.4 64.0

Colombia 51.6 56.4 49.8 52.6

Costa Rica 55.1 51.1 50.0 52.1

Dominican Republic 38.6 45.8 49.6 44.6

El Salvador 42.4 43.1 40.5 42.0

Guatemala 39.2 37.2 46.4 40.9

Guyana 36.9 46.8 46.7 43.5

Honduras 32.0 32.6 44.5 36.3

Jamaica 42.1 49.7 37.5 43.1

Mexico 52.1 51.9 50.1 51.4

Nicaragua 34.6 38.0 48.5 40.3

Panama 48.6 54.2 51.9 51.6

Peru 49.4 50.2 60.8 53.5

Trinidad & Tobago 44.9 47.3 61.0 51.0

Uruguay 63.5 66.2 49.7 59.8

Venezuela 40.9 24.6 32.5 32.6

Source: BMI. Scores out of 100, with 100 representing the best score available for each indicator

37Business Monitor International Ltd www.businessmonitor.com

BUSINESS ENVIRONMENT

1998 law brought copyright protection legislation up to interna-

tional standards, although piracy of copyrighted materials (such

as music and videos) and trademarks remains a problem. Brazil

has ratified the WIPO Treaties on Copyright and Performances

and Phonograms. Brazilian patents, copyrights and trademark

laws are generally considered to meet international standards.

Corruption With a score of 43 (and a ranking of 69th out of 174 countries),

Brazil's 2012 performance in Transparency International's Cor-

ruption Perceptions Index saw the country's rank decline slightly

from the previous year. We believe this highlights deterioration

in corruption perceptions since the start of the decade, at which

point the country fared markedly better. The authorities are,

at least, ostensibly trying to eradicate endemic corruption: the

country has signed the OECD Anti-Bribery Convention. While

federal government authorities generally investigate allegations

of corruption, there are inconsistencies in the level of enforce-

ment among individual states.

Infrastructure

Physical Infrastructure Brazil possesses well-developed agricultural, mining, manu-

facturing and service sectors. Development in infrastructure is

being driven by public-private partnerships (PPP), whereas the

Brazilian construction industry is being spurred by strong gov-

ernment investment. Private-sector interest in the construction

segment has been increasing, which is evident in the growing

number of public offerings on the stock exchange. Indeed, we

expect this trend to gain new momentum as economic activity

remains strong and the country gears up for the 2014 FIFA

World Cup and the 2016 Olympic Games in Rio de Janeiro.

The leading construction companies are well entrenched in the

country and are significant players outside Brazil. The federal

government's Growth Acceleration Programme (Programa de

Aceleração do Crescimento, PAC) was unveiled in January 2007,

with the aim to facilitate faster turnaround of construction projects

in the pipeline. The programme has already funded projects in the

oil and gas, transportation and sanitation sectors, and aimed to

spur BRL500bn (US$235bn) of infrastructure development during

2007-2010. Infrastructure upgrades included the expansion and

modernisation of the country's main international airport, Guarul-

hos, at a cost of US$832mn. The government has also announced

the allocation of funds for various states for urbanisation, slum

rehabilitation and sanitation, among other developments. The

second PAC programme, estimated at BRL1tn (US$544.5bn),

is aimed at continuing social programmes and increasing public

sector investment in infrastructure between 2010 and 2014.

TABLE: BMI LEGAL FRAMEWORK RATINGInvestor Protection Score Rule of Law Score Contract Enforceability

ScoreCorruption Score

Argentina 26.0 46.3 64.0 56.8

Brazil 42.5 69.8 55.4 52.4

Chile 61.9 90.2 53.7 72.2

Colombia 67.1 64.3 8.7 36.9

Costa Rica 31.5 79.4 38.7 89.5

Dominican Republic 42.4 37.2 42.8 44.7

El Salvador 28.0 24.7 49.2 68.6

Guatemala 24.1 42.0 27.6 46.1

Guyana 41.2 48.5 50.9 50.5

Haiti 5.8 9.6 35.9 42.7

Honduras 26.4 41.3 20.4 22.9

Jamaica 38.9 53.6 23.1 70.5

Mexico 51.9 55.5 54.8 30.8

Nicaragua 23.1 33.8 64.0 43.2

Panama 61.1 60.9 20.1 47.4

Peru 53.6 41.1 49.2 44.8

Trinidad & Tobago 48.1 63.1 17.8 64.8

Uruguay 60.6 85.0 52.3 84.9

Venezuela 4.2 17.1 38.1 20.8

Source: BMI. Scores out of 100, with 100 representing the best score available for each indicator

38 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Nevertheless, the nation's transport infrastructure suffers from

inadequate funding and lack of focus, leading to slow progress

in the development of roadways and port terminals. Private

investment generated through PPPs has been beneficial only

at the regional level. The laws regarding foreign companies

are not liberal, and stipulate that they either have a Brazilian

partner or be established in Brazil in order to provide construc-

tion services. The government is also considering revising its

existing toll tariffs system, but we expect protracted negotiations

on this front. The current set of concessions has been in place

since 1996, when the country's macroeconomic fundamentals

were riskier and high tariffs were required to recover roads in

a deplorable condition.

Labour Force Brazil has a labour force of approximately 90mn people out of

a total population of some 198mn, although inaccurate census

information makes these figures extremely approximate. Around

65% work in the service sector, 20% in agriculture and 15% in

industry. Unemployment averaged 6.0% in 2011, with this figure

falling to a recent low of 4.7% in December 2011. Wages are

generally relatively low, though a 14% increase to the minimum

wage in January 2012 has brought it to BRL622.0, implying a

substantial increase in wage-related benefits as well. Furthermore,

up to a third of employers' labour costs can be accounted for by

various taxes and other charges.

The high numbers employed in the services and industrial sectors

reflect the changing shape of Brazilian society, as the country's

urbanisation continues apace. The proportion of working women

is also growing, approaching half of the labour force. According

to some estimates, more than a third of all workers still operate

in the informal market and so do not pay taxes or receive em-

ployment benefits. Average real wages, which had been falling

over a number of years, started to nudge upwards again from

2005. However, huge disparities exist between the amount of

earnings and types of employment, as well as regional variations.

Brazil's labour code, based on the Consolidated Labour Laws, is

comprehensive, with fairly extensive labour benefits. Workers

receive an annual bonus, based on overall earnings, at least 30

days of vacation annually and are entitled to recompense when

dismissed without cause. The 1988 constitution establishes a

44-hour working week and overtime pay of 50% of base pay.

Labour courts exist to hear routine employment cases, involving

wage disputes, unfair dismissal, and working conditions, etc.

Despite federal efforts to speed up the system, the backlog of

such cases stretches back several years in some instances. These

courts are effectively empowered to arbitrate on employer-union

negotiations by imposing an agreement if talks break down and

one side seeks a legal resolution. Greater flexibility in labour

relations recently has resulted in less recourse to the courts

for dispute resolution in this manner. Unions are often strong,

with membership running at more than 10% of the workforce

TABLE: LABOUR FORCE QUALITYLiteracy Rate,% Labour Market Rigidity Score Female Labour Participation, %

Argentina 97.6 21.0 52.4

Brazil 89.6 46.0 60.1

Chile 96.4 18.0 41.8

Colombia 92.3 10.0 40.7

Costa Rica 95.8 39.0 45.1

Dominican Republic 88.8 21.0 50.5

El Salvador 83.6 24.0 45.9

Guatemala 72.5 28.0 48.1

Guyana 91.8 19.0 44.7

Haiti 61.0 10.0 57.5

Honduras 82.6 57.0 40.1

Jamaica 85.5 4.0 56.1

Mexico 91.7 41.0 43.2

Nicaragua 80.1 27.0 47.1

Panama 93.2 66.0 48.4

Peru 88.7 39.0 58.2

Trinidad & Tobago 98.6 7.0 55.1

Uruguay 97.8 18.0 53.8

Venezuela 93.0 69.0 51.7

Source: BMI/World Bank/ILO. Labour Market Rigidity score from Ease of Doing Business report, 1 = highest score

39Business Monitor International Ltd www.businessmonitor.com

BUSINESS ENVIRONMENT

directly and representing many more through their role in col-

lective bargaining. Unions are obliged to represent all workers

in their sector or region, whether they are members or not. There

are estimated to be more than 15,000 unions operating across

Brazil. Employers' federations are also powerful players in

workplace negotiations. More sophisticated labour-management

negotiations have led many firms to overhaul their practices

and hire more skilled negotiators, in many cases resulting in

improved relations.

Market Orientation

Foreign Investment Policy In terms of market openness, Brazil is a front runner in Latin

America and a major recipient of foreign capital. Total FDI

inflows of US$66.6bn in 2011 were almost double the amount

Brazil attracted in 2007 and, in nominal terms at least, higher

than flows attracted at the beginning of this decade when the

government's privatisation campaign was in full swing.

The foreign investment framework has been an evolving process

over the past few decades. For instance, foreigners have been

able to invest in the stock market since 1991. A series of rules

and constitutional amendments introduced in 1995-2000 gave

foreign investors the same opportunities as domestic investors

in most sectors. That said, the catalyst for recent FDI activity

has undoubtedly been a loosening of regulation under the Lula

administration. Foreign suitors, satisfied with the improved level

of economic and political stability, have been taking advantage

of the country's extensive privatisation programme. A landmark

reform took place in December 2004 when Brazil's senate ap-

proved the Public-Private Investment Bill, allowing private firms

to invest jointly with the government in projects backed by a

state guarantee. Companies taking up the contracts must invest

at least BRL20mn for five to 35 years. One aim is to speed up

infrastructure development, including roads, railways and water

systems. The bill also introduces improved levels of transpar-

ency. Foreign water companies have expressed concerns that

their sector still needs stronger regulation and a more developed

institutional framework before it becomes sufficiently attractive

to bring in large FDI flows.

Brazil has eight free trade zones (FTZs) in total, of which the

most important for foreign investors is the Manaus FTZ, which

covers nearly 4,000 square miles in the middle of the Amazon

basin. Here, goods originating outside the country enter without

attracting customs levies or any import taxes. Goods may also

be exempt from certain other taxes.

Foreign Trade Regime Brazil joined the WTO in 1995. It was a founding member of

the Mercosur free trade area in 1991 with Argentina, Paraguay

and Uruguay (Bolivia and Chile have observer status). Merco-

sur and the neighbouring Andean Community (Peru, Bolivia,

Ecuador and Colombia) signed a pact in October 2004 under

which the two trading blocs agreed to phase out import tariffs

over 15 years.

Mercosur is in the process of negotiating a trade agreement with

the EU and also with the US and others through the proposed Free

Trade Area of the Americas. Separately and through Mercosur,

Brazil has been strengthening bilateral ties with other countries,

notably India, for which Brazil is its biggest Latin American

trading partner. Brazil and India have set a target of bilateral

trade of US$10bn in the short term.

TABLE: LATIN AMERICA – ANNUAL FDI INFLOWS2009 2010 2011

US$bn Per Capita US$bn Per Capita US$bn Per Capita

Argentina 4.0 100.3 7.1 174.6 7.2 177.7

Brazil 25.9 134.3 48.5 248.8 66.7 339.0

Chile 12.9 760.1 15.4 898.3 17.3 1001.7

Colombia 7.1 156.3 6.9 149.0 13.2 282.0

Mexico 16.1 143.9 20.7 182.6 19.6 170.3

Peru 6.4 223.6 8.5 290.8 8.2 280.0

Trinidad & Tobago 0.7 530.6 0.5 409.6 0.6 426.3

Venezuela -2.5 -88.9 1.2 41.7 5.3 180.1

Source: UNCTAD, BMI

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BRAZIL Q2 2013

Tax Regime The tax regime is highly complex, making the overall burden

difficult to predict. Rates are among the highest in Latin America.

Reform of the regime has been high on the government's agenda,

though substantial progress has yet to be made.

Corporate Tax: Effectively 34%. Companies pay corporate

income tax, income surtax and a social contribution. Corporate

income tax is 15%. The income surtax is 10% on profits above

BRL240,000 per year. The social contribution is charged at 9%.

Resident companies pay tax on global income. Non-resident

firms pay tax on Brazilian-sourced income only. In August 2007,

legislation (Complementary Law 127/2007) was introduced

aimed at simplifying the tax regime for small businesses.

Individual Tax: Rises progressively to 27.5%. Residents are

taxed on global income. Non-residents are taxed on Brazilian-

sourced income only.

Indirect Tax: Brazil has separate VAT regimes run by the

federal and state governments, which are not harmonised;

however, an 18% rate is used in some of the most developed

states. Recent reforms have included invoice taxes to VAT. An

attempt to harmonise VAT failed in 2003. Further efforts are

now being made to do so.

Capital Gains: gains of companies are taxed as income in most

cases. Individuals are taxed on gains at 15%. Capital gains made

by non-residents on investments registered with the central bank

are generally subject to a 15% withholding tax.

Operational Risk

Security Risk The most serious threat to domestic security in Brazil comes from

organised crime, in our view. This risk is particularly widespread

in drug trafficking, which is largely controlled internally by the

criminal gangs of Rio de Janeiro and São Paulo. The strongest

of these groups are the Primeiro Comando da Capital (PCC) in

São Paulo and the Comando Vermelho (CV) in Rio de Janeiro,

which have started to explore joining forces in order to expand

their regional power at a national level. Their influence has

grown to such an extent that in many parts of Rio de Janeiro

they are seen as a parallel power to the state.

Although the Colombian border attracts the most attention, drug

trafficking is a problem along all sections of Brazil's frontier,

especially given increasing production in Peru and Bolivia. New

drug-smuggling routes are opening up across the Peruvian and

Bolivian borders into the states of Acre, Rondônia and Mato

Grosso. These borders are heavily forested, difficult to patrol and

TABLE: TRADE AND INVESTMENT RATINGSOpenness To Investment Score Openness To Trade Score

Argentina 58.5 20.2

Brazil 64.7 9.4

Chile 44.0 68.5

Colombia 53.9 9.3

Costa Rica 66.0 63.6

Dominican Republic 62.8 44.4

El Salvador 19.3 66.0

Guatemala 42.2 45.3

Guyana 60.5 87.8

Haiti 47.5 44.6

Honduras 54.9 61.8

Jamaica 21.4 32.9

Mexico 63.4 38.7

Nicaragua 56.9 73.4

Panama 46.4 81.4

Peru 76.8 49.1

Trinidad & Tobago 37.4 70.5

Uruguay 45.7 38.0

Venezuela 36.8 20.0

Source: BMI. Scores out of 100, with 100 representing the best score available for each indicator

41Business Monitor International Ltd www.businessmonitor.com

BUSINESS ENVIRONMENT

have yet to gain increased attention from the Brazilian armed

forces and federal police. Indeed, local news sources report

than an unprecedented 24 tonnes of cocaine were confiscated

in 2009, compared with 15 tonnes in 2005. Moreover, recent

media reports have suggested that between 60% and 80% of

Bolivian cocaine is destined for Brazil, underscoring the coun-

try's growing consumer base.

Brazil is the second-largest producer and exporter of small arms

and ammunition in the Americas after the US, with both civilian

and military production. Brazil also has one of the highest rates

of death by firearms in the world, with around 90% of these be-

ing murders. The main increases in murders have occurred in

the urban capitals, such as Rio de Janeiro and São Paulo. The

majority of illegal weapons seized by the security forces are

locally manufactured handguns and ammunition.

Although Brazil has no active domestic insurgent groups, there

are growing concerns about the presence of illegal armed and

organised crime groups in the Tri-Border Area on the border

with Argentina and Paraguay. In particular, there are anxieties

that Islamist terrorists are using organised crime to fund activi-

ties in South America and abroad.

43Business Monitor International Ltd www.businessmonitor.com

Chapter 5: Key Sectors

Autos

Executive SummaryPassenger car sales in Brazil decreased 5.2% y-o-y in Septem-

ber, to 214,351 units. Over the first nine months of 2012, sales

in this segment have increased 7.2% y-o-y, to 2,100,365 units.

BMI has long maintained that passenger car sales in Brazil will

increase 3.9% over the course of the year. We maintain this

view for now, as we believe sales in this segment will moder-

ate over the remainder of the year, and drop in line with our

forecast. Earlier in 2012, car sales were boosted significantly

through stimulus measures aimed at boosting investment and

consumption, including cheaper credit for vehicle loans and

tax breaks for domestically produced vehicles. Although the

stimulus measures are in place until the end of October, we be-

lieve their effects were felt the most in the June-August period,

and that their impact will be more subdued in the latter stages.

We believe that greater access to credit for vehicle loans will

provide some modest increase in sales over the remainder of

the year, but not substantially so.

Over the long term, we maintain a bullish outlook for the

passenger car segment in Brazil, and expect to see strong and

sustained growth over the remainder of our 2017 forecast period.

Vehicle production in Brazil increased 8.2% y-o-y in Sep-

tember, 282,540 units. Over the first nine months of the year,

production declined 5.7% y-o-y, to 2,462,873 units. In July, we

revised down our vehicle production forecast, to a 5% decrease

in 2012, predicated on our belief that the Brazilian economy,

with its industrial and vehicle production, will pick up in the

second half of the year. This view is continuing to play out, and

we maintain our forecast for now.

BMI believes that despite weak Q212 growth, we will see a

modest pick-up in economic growth in coming quarters, in

line with our 2012 real GDP growth forecast of 1.0%. The

July industrial production reading recorded the most moderate

contraction since March, at 2.9% y-o-y. We believe, however,

this will resurge somewhat in H212. This has informed our

belief that vehicle production will have picked up in this time.

BMI also sees little to suggest substantial further appreciation

for the Brazilian real in the short term. Rather, we believe cen-

tral bank intervention, both through monetary easing, as well as

directly purchasing US dollars, will mute any upside potential

for the currency. An appreciation of the currency would pro-

vide further downside risk to our forecast, as this would make

exports less competitive.

Over the longer term, we maintain our bullish outlook for the

autos production sector, predicated on government policy bearing

fruits, our view of resurging domestic sales, and the potential

for Brazil to become a regional production hub. On the back

of this bullish outlook, over the short and long term, we expect

to see significant investment from international automotive

manufacturers in the Brazil autos sector.

Market OverviewSuppliers: It is BMI's long held view that government policy in

Brazil to boost domestic automotive production would bear fruits,

and that the segment will see considerable ongoing investment over

the medium term. Indeed, automotive manufacturers continue to

invest in production facilities in the country, and this is begetting

growth across the supply chain. Indeed, on the back of govern-

ment policy mandating local content requirements for autos parts,

domestic suppliers are benefiting massively from these increases

in investment. We expect this trend to continue as the production

market, and the domestic supply chain, continues to develop.

According to 2008 estimates, the industry boasts of a strong

network of 470 automotive companies, which together operate

some 650 plants across the country. Details of some of the leading

international names are listed below. The list is not exhaustive.

Segment Developments: In October, South Korean automaker

Hyundai Motor's components subsidiary Hyundai Mobis

plans to establish large-scale distribution centres in the Brazil

in 2013, amongst other emerging market economies. The move

is in line with the carmaker's global expansion of vehicle pro-

duction facilities and the development of its aftermarket parts

business. The carmaker is set to increase its global distribution

bases to 35 by end 2012.

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BRAZIL Q2 2013

In September, Automotive technology and systems manufacturer

Denso announced that it will begin production of engine con-

trol units (ECUs) in Brazil. The company will initially supply

Toyotaplants in Brazil. Toyota recently opened its third auto

production plant in Brazil, currently employing some 4,000

workers, and recently announced plans to build an engine pro-

duction plant in the country.In addition to Toyota, Denso aims

to supply ECUs made in Brazil to other Japanese automakers,

including Nissan which plans to bring a new plant online in

2014. In the first quarter of FY2012, Denso's sales in the Latin

American region reached JPY14bn (US$176.3mn), an 11.4%

y-o-y decrease. In the Q112 period, vehicle sales in both Brazil

and Argentina – key regional markets for the company – de-

creased, but picked up over the Q212 period in Brazil, and BMI

expects this growth to continue for the remainder of the year.

We remain somewhat more bearish about vehicle production

and sales in Argentina, however, forecasting an 18% drop in this

segment in 2012. Denso hopes to nearly double its sales in the

Latin America region to US$1.4bn by 2015, taking advantage of

automakers' plans to increase their parts procurement in Brazil.

In August, German auto parts manufacturer Continental launched a new technical centre in Brazil. The move is line

with the company's strategy to focus on powertrain testing

and cater to the growing demand for development capacities,

owing to stricter global standards for fuel consumption and

emissions. The new centre has been built with an investment

of about BRL28mn (US$13.8mn) and has 50 staff members

mainly from the local area.

In August, Denso Do Brasil (DNBR), a subsidiary of global

automotive firm Denso Corp., opened a new plant and technical

development centre in Santa Barbara, Sao Paulo, Brazil. The

company has invested US$101.4mn in the plant, employing 800

employees. The technical centre will develop motor parts for the

South American market. DNBR's president, Hiroshige Shinbo,

says the technical centre will increase production capacity and

reduce development time for new technology.

In August, US component manufacturer Wabtec Corporation

acquired a 100% stake in Brazilian subsidiary Winco Equipa-mentos Ferroviarios. The move is in line with Wabtec's strategy

to expand its business footprint in Brazil. Wabtec's sales outside

the US grew from US$370mn in 2006 to US$916mn in 2011,

with a compounded annual growth rate of 20%. The company

expects double-digit growth in 2012.

In August, Air and ocean freight specialist DHL Global Forward-

ing opened a new Automotive Competence Centre in SãoPaulo,

Brazil. The company expects the Centre to handle some 2,000

shipments per month from original equipment manufacturers

(OEMs) and first-tier suppliers importing auto components into

the country.

In July, US-based Yaskawa America Inc's (YAI) divisions,

Motoman Robótica do Brasil and Yaskawa Eléctrico do Brasil, jointly stated their plans to expand in Brazil. Both

divisions will move together to a larger manufacturing area in

Diadema, but will stay as separate divisions. Both divisions

are scheduled to be fully functional by mid-July 2012 and will

relocate around 150 employees. The new location will enable

the divisions to bolster efficiencies and production capacity as

well as offer efficient customer service.

Industry ForecastSales: Passenger car sales in Brazil decreased 5.2% y-o-y in

September, to 214,351 units. Over the first nine months of 2012,

sales in this segment have increased 7.2% y-o-y, to 2,100,365

units. BMI has long maintained that passenger car sales in Brazil

will increase 3.8% over the course of the year. We maintain this

view for now, as we believe sales in this segment will moderate

over the remainder of the year, and drop in line with our forecast.

We believe that greater access to credit for vehicle loans will

provide some modest increase in sales over the remainder of

the year, but not a substantial increase.

Earlier in 2012, the Brazilian government implemented stimu-

lus measures aimed at boosting investment and consumption,

including cheaper credit for vehicle loans and tax breaks for

domestically produced vehicles. These were extended for two

month sin late August, along with other measures to stoke the

economy. Car sales increased massively on the back of these

moves. At the time, we maintained that car sales would dip

once these incentives finished, and our fears were borne out

when passenger car sales declined in September. Although

the measures are in place until the end of October we believe

their effects were felt the most in the June-August period, and

that their impact will be more subdued in the latter stages. As a

result, we maintain our 2012 sales forecast, with sales abating

somewhat over the remainder of the year.

BMI maintains its view that significant fiscal and monetary

stimulus will precipitate a pick-up in private consumption over

the coming quarters, although we believe that private banks'

concerns over elevated non-performing loans, high household

debt levels, reduced purchasing power, and weak consumer

45Business Monitor International Ltd www.businessmonitor.com

KEY SECTORS

confidence mean that such a development will be more modest

than we previously expected. BMI believes that this modest

increase in private consumption in the second half of the year

will boost passenger car sales. This has partly informed our

bullish forecast throughout the year.

The rate of delinquent car loans in Brazil dropped to 6.0% in

June, from 6.1% in May – the first decline since December

2010. The rate of total loan delinquency is slightly lower, com-

ing in at 5.8% in June. BMI believes that lower interest rates

in the second half of the year will lower this rate further; this

may facilitate a boost in vehicle loans as banks becomes more

willing to issue credit.

Vehicle loans to customers in the non-prime, sub-prime, and deep-

sub-prime risk tiers accounted for 25.4% of all vehicle loans in

Brazil in Q212, a 14% increase on Q211. As banks increased loan

access to a wider section of the population, the average customer

credit scores for both new and used vehicle loans decreased in

the period. BMI believes that this widening of access to credit

has helped, in part at least, to boost passenger car sales in Q212.

Despite the increase in loan volumes to riskier consumers, how-

ever, the loan-to-value (LTV) ratios (the amount of money paid

over the life of a loan versus the purchase price of the vehicle)

were lower than they were a year ago. For new vehicles, the aver-

age LTV ratio was 109.55% in Q212, compared with 115.65%

in Q211. BMI believes that, although banks have widened their

access to credit to sections of the population that were hitherto

unable to access official credit for vehicle purchases, the lower

LTV ratio suggests that this is not a considerable increase in the

riskiness of their portfolios, and therefore remains a sustainable

increase in operations.

Over the first nine months of 2012, Fiat's sales increased 11.6%

y-o-y, to 493,976 units. The company is the largest auto company

in the country by sales volume, with a market share of 23.5%.

In this period, Volkswagen's (VW) sales increased 9.6% y-o-y,

to 482,085 units. The German marque has a market share of

22.9%. General Motor Company's (GM) sales increased 1.9%

y-o-y in this period, to 396,543 units, giving the company a

market share of 18.8%. Ford's sales over this period increased

8% y-o-y, to 197,342 units, resulting in a market share of 9.4%.

Despite weak Q212 growth, BMI believes there will be a mod-

est pick-up in economic growth over the coming quarters, in

line with our 2012 real GDP growth forecast of 1.8%. Indeed,

the July industrial production reading recorded the smallest

contraction since March, at 2.9% y-o-y. We believe this will

resurge somewhat in H212.

Light commercial vehicle sales declined 0.5% y-o-y in 9M12, to

565,786 units. We have become increasingly bearish on sales in

this segment, forecasting a 2% increase in 2012, down from 4.2%

previously. We maintain this forecast for now, as we believe the

year-to-date reduction will be moderated by an upswing in the

economy and rise in industrial production in H212.

Heavy truck sales fell 22% y-o-y in 9M12, to 101,318 units. We

recently revised down our 2012 sales forecast for this segment

to a more bearish 18% decline over the year, from an 8.7% de-

crease previously. However, we also believe that falling truck

sales will be moderated by the upswing in the economy and rise

in industrial production in H212.

Production: Vehicle production in Brazil increased 8.2% y-

o-y in September, 282,540 units. Over the first nine months of

the year, production declined 5.7% y-o-y, to 2,462,873 units.

In July, we revised down our vehicle production forecast, to a

5% decrease in 2012, predicated on our belief that the Brazilian

economy, and with it industrial and vehicle production, will

pick up in the second half of the year. This view is continuing

TABLE: BRAZIL AUTOS SALES BY SEGMENT – HISTORICAL DATA AND FORECASTS, 2010 – 20172010 2011 2012e 2013f 2014f 2015f 2016f 2017f

Vehicles, units 3,524,970 3,644,151 3,764,256 3,892,227 4,131,583 4,394,399 4,686,898 5,167,621

– % chg y-o-y 12.21 3.38 3.3 3.4 6.15 6.36 6.66 10.26

Passenger cars, units 2.644.704 2,647,032 2,748,943 2,827,917 2,981,594 3,150,841 3,351,999 3,647,106

– % chg y-o-y 6.87 0.09 3.85 2.87 5.43 5.68 6.38 8.8

Commercial vehicles, units 880,266 997,119 1,015,313 1,064,310 1,149,988 1,243,558 1,334,899 1,520,516

– % chg y-o-y 32.05 13.27 1.82 4.83 8.05 8.14 7.35 13.9

Motorbikes, units 1,818,181 2,044,422 2,233,693 2,393,004 2,588,072 2,789,282 3,031,056 2,728,936

% chg y-o-y 15.13 12.44 9.26 7.13 8.15 7.77 8.67 8.1

e/f = estimate/forecast. Source: National Association of Motor Vehicle Manufacturers, Registro Nacional de Veículos Automotores, Federação Nacional da Distribuição de Veículos Automotores, BMI

46 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

to play out, and we maintain our forecast for now.

BMI believes that despite weak Q212 growth, we will see a mod-

est pick-up in economic growth in coming quarters, in line with

our 2012 real GDP growth forecast of 1.8%. The July industrial

production reading recorded the most moderate contraction since

March, at 2.9% y-o-y. We believe, however, this will resurge

somewhat in H212. This has informed our belief that vehicle

production will pick up in the remainder of the year.

Further, BMI sees little to suggest substantial further apprecia-

tion for the Brazilian real in the short term. Rather, we believe

central bank intervention, both through monetary easing, as well

as directly purchasing US dollars, will mute any upside potential

for the currency. An appreciation of the currency would provide

further downside risk to our forecast, as this would make exports

less competitive.

Over the longer term, we maintain our bullish outlook for the

autos production sector, predicated on government policy bearing

fruits, our view of resurging domestic sales, and the potential

for Brazil to become a regional production hub.

In May 2012, as part of a BRL60.4bn (US$31.6bn) stimulus

package designed to boost foreign and domestic investment, in-

novation, and GDP growth, the Brazilian government announced

a number of tax incentives and other perks for the autos industry.

BMI has long maintained that, although investments are neces-

sary to boost Brazil's productive capacity, such changes will not

happen immediately, and the domestic production sector will

take time to mature. Imposing tight restrictions on importers will

cutoff supply in the short to medium term, before the domestic

manufacturing sector is ready. The current downward trend in

vehicle production is commensurate with this view.

BMI believes that once the sector does begin to develop we

will see strong growth in domestic manufacturing. Indeed, a

number of auto manufacturers continue to invest in the country,

predicated on their longer-term faith in the sector.

Food & Drink

Executive SummaryA number of pressing challenges are facing Brazil's economy

over the next few years, informing our view that the country

is in for a period of lower-trend growth. We highlight slowing

private consumption and the end of China's investment boom as

major contributors to Brazil's medium-term growth trajectory.

Following substantial growth in the last decade, we believe

Brazil's consumer story is in for a period of more moderate

expansion over the medium term due to re duced consumer

purchasing power o n the back of currency weakness and high

household indebtedness following significant credit growth in

recent years.

Household debt levels have ballooned in recent years, a factor

we expect to co nstrain consumer borrowing despite government

pressure on commercial banks to bring down their lending rates.

As such, we have revised our medium-term growth forecasts

to reflect a more moderate consumer story in coming years. W

e forecast private consumption to contribute an aver age of 2.0

percentage points to real GDP growth between 2012 and 2017,

implying average real private consumption growth of 3.1%

between 2012 and 2017.

Headline Industry Data (local currency)

• 2013 per capita food consumption = +9.8% year-on-year

(y-o-y); forecast compound annual growth rate (CAGR)

to 2017 = +9.3%.

• 2013 alcoholic drink sales = +10.8% y-o-y; forecast CAGR

to 2017 = +10.7%.

• 2013 soft drink sales = +9.0% y-o-y; forecast CAGR to

2017= +9.3%.

• 2013 mass grocery retail sales = +8.0% y-o-y; forecast

CAGR to 2017 = +8.7%.

Key Company Trends AmBev Volume Growth Muted : In

August 2012, AmBev, the Brazilian subsidiary of beer giant

Anheuser-Busch InBev, posted muted growth for its fiscal

first half. For the six months to the end of June, total volumes

were up by 3.4%, with beer volumes up by 2.7% and soft drink

sales up by 4.9% (on an organic basis). Net sales advanced by

10.1% on an organic basis. However, growth of just 2.7% for

beer sales points to the firm's recent push for revenues over

volumes as well as the ongoing challenges within the Brazilian

beer market due to slowing economic growth – a situation set

to be compounded by upcoming duty hikes.

Brasil Foods Facing Cost Challenges :Body 1In August 2012,

47Business Monitor International Ltd www.businessmonitor.com

KEY SECTORS

Brasil Foods, Brazil's largest food producer, registered a mas-

sive drop in profitability after seeing commodity and financial

costs eat into its earnings. For the six months to the end of June,

the firm reported a 7% increase in net sales, which reached

BRL13.2bn. However, earnings before interest, taxes, deprecia-

tion and amortisation fell by 32% to BRL1,097mn, while net

profits slumped by 82% to BRL160mn.

Key Risks To Outlook: The risks to our growth forecasts for

Brazil remain substantial. We previously outlined two potential

scenarios for the country's economic imbalances to unwind over

the coming years, both of which remain on the table. First, given

policymakers' massive toolkit and demonstrated willingness to

use it, we do not rule out that the current policy mix could achieve

higher returns to growth through the 2014 general election than

we currently forecast, particularly if the authorities change their

view on a weak real. However, this would result in a sharper

adjustment thereafter, as the reduction of massive fiscal stimulus

would likely prompt a substantial drop in private consumption,

and two more years of strong credit and money supply growth

would make the ensuing deleveraging period even more painful.

Meanwhile, given the real's break through long-term trend-line

support, and analysts' and investors' increasingly bearish views

on the economy, we believe our worst-case scenario has become

increasingly likely in recent months. A significant and sustained

change in investor sentiment could precipitate an aggressive

currency sell-off, sending the unit towards BRL2.5000/US$

much faster than we currently anticipate. This would severely

dampen private consumption and likely drag headline growth

down as well. Such a scenario also implies greater potential

for a full-fledged banking sector crisis given the currency mis-

match on banks' balance sheets and potential for loan quality

to deteriorate substantially.

Industry ForecastFood Consumption:

• Headline food consumption compound annual growth, local

currency, to 2017: +10.1%

• Per capita forecast food consumption compound annual

growth, local currency, to 2017: +9.3%

Due to rapid income growth and a steady increase in the value

of the Brazilian real against the dollar, per capita food consump-

tion (food and drink, excluding alcoholic drinks) in Brazil is

now above average for the Latin America region in US dollar

terms. Despite this, food consumption is still growing at a

tremendous rate.

In the next five years, food consumption is expected to continue

growing rapidly, despite the current economic slowdown.

Between 2012 and 2017, per capita consumption is forecast to

grow by 55.7% (nominal growth rate in local currency terms),

which translates into a compound annual growth rate (CAGR)

of 9.3%. With the size of the Brazilian population forecast to

increase by 6% over the same period, total food consumption

is expected to grow by more than 60%.

This growth is expected to be driven by consumers trading up

to higher-value, branded and premium products and by lower-

income consumers simply buying more. In urban locations, there

is also an ongoing trend towards value-added convenience foods

as working lifestyles increasingly come to mirror those in the

developed world. Industry confidence in the continued growth of

domestic demand is reflected both in investments in production

facilities and in a renewed focus on popular multinational brands.

Processed Food:

• Canned food volume sales compound annual growth to

2017: +4.3%

• Canned food value sales compound annual growth, local

currency, to 2017: +9.4%

Brazilians are very fond of canned foods, especially vegetables,

meat, fish and beans, sales of which are expected to increase over

the forecast period, both in terms of values and volumes. This

is especially true among the poorer segments of the population,

where these comparatively cheap and easy-to-store products

form a substantial part of the average person's diet.

Dairy: The dairy sector in Brazil remains one of the most ar-

chaic and fragmented sectors within the country's agricultural

industry. This means that the supply of raw milk is limited and

that prices are higher than they might otherwise be. This in turn

limits scope for expanding consumption among the country's

large low-income population, with per capita consumption of

dairy products low, even in comparison with some of the world's

other emerging markets.

On the plus side, the undeveloped nature of the sector leaves

tremendous room for further growth, and dairy consumption

has been rising steadily. This strong growth is a result of ris-

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BRAZIL Q2 2013

ing disposable incomes, population growth and the increased

perception of dairy products as healthy and nutritious.

In the meantime, the Brazilian dairy sector is rapidly consolidat-

ing, with all of the leading firms keen to secure market share.

With the number of remaining opportunities diminishing, all

the big firms are now concentrating on soaking up the smaller,

regional firms that can help their expansion in less-consolidated

regions. In a move further encouraging this trend, in November

2008, Brazil joined the International Dairy Federation (IDF),

bringing IDF's global representation up to 54 countries and

increasing IDF's presence in Latin America – alongside Mexico.

With dairy produce becoming one of the fastest-growing food

sectors in Brazil, this process of consolidation is expected to

remain in place over the next five years. A recent report from

Rabobank suggests that growth in Brazil's dairy sector is ex-

pected to be driven by the yoghurt and cheese markets, which

are both relatively immature.

Confectionery:

• Confectionery volume sales compound annual growth to

2017: +6.8%

• Chocolate volume sales compound annual growth to 2017:

+10.1%

• Sugar confectionery volume sales compound annual growth

to 2017: +4.6%

• Gum volume sales compound annual growth to 2016: +1.4%

Over the 2006-2011 review period, confectionery value sales

in Brazil increased significantly. In 2011, an estimated 67.5%

of the overall market was accounted for by chocolate confec-

tionery, followed by sugar confectionery and gum, with market

shares of 25.5% and 7% respectively. Between 2012 and 2017,

overall confectionery sales in local currency terms are forecast

to nearly double, with all sub-sectors expected to continue to

grow rapidly thanks to the country's strong economic growth

and large youth population.

There is a gradual trend towards the purchase of premium

confectionery products, particularly among Brazil's growing

middle-class population. This trend explains the success of

premium chocolate manufacturer and retailer Kopenhagen,

which has retail outlets in most Brazilian malls. As a result of

this trend, value sales of confectionery are expected to increase

slightly faster than volume sales.

Discussion about obesity levels and dietary choices has been

intensifying, with busier lifestyles and consumption of conveni-

ence foods having led to an increase in related diseases. Thus,

demand for healthier food and confectionery options, which

retail at a premium, is increasing in Brazil – in line with global

trends – as consumers try to adopt healthier lifestyles. A key

challenge and opportunity for manufacturers is to serve the north

and north east of the country, where income levels are lower but

growing quicker, as distribution has so far been focused mostly

on the more affluent south east.

In 2012, Brazilian biscuit consumption was expected to be

9.9kg per capita. This compares with per capita consumption

of 6.9kg in 2002 and demonstrates the rapid advancement of

the market. This relatively high level of consumption can be

attributed to a longstanding tradition of biscuit consumption

at every socioeconomic level, with biscuits already purchased

by 98% of Brazilian households. This wide base means that

consumption can be expected to continue advancing rapidly as

affluence increases throughout the income spectrum. We are

currently forecasting that per capita consumption will reach

12.9kg in 2017, representing growth of 35% in the size of the

overall market (in volume terms) over the next five years.

Hot Drinks:

• Coffee volume sales compound annual growth to 2017:

+6.1%

• Coffee value sales compound annual growth, local currency,

to 2017: +11.3%

• Tea volume sales compound annual growth to 2017: +16.5%

• Tea value sales compound annual growth, local currency,

to 2017: +22.2%

Brazil is the largest grower of coffee in the world and the second

largest coffee market, behind the US. The increased popularity

of coffee in Brazil can be attributed to the improved quality of

locally processed coffee (ABIC – the country's coffee industry

association – introduced a coffee quality programme in 2004), as

well as rising consumer affluence. The industry is set to receive

a further boost from growing international demand for coffee

that has been processed in Brazil.

49Business Monitor International Ltd www.businessmonitor.com

KEY SECTORS

According to figures from ABIC, total domestic volume sales

of roast/ground coffee increased by more than 20% between

2004 and 2009, while sales of soluble/instant coffee increased

by 35%. Despite this strong growth, per capita consumption

remains relatively low in comparison with more mature markets

such as Argentina, leaving plenty of room for further increases.

Nevertheless, consumption growth has increased markedly since

2003, and in June 2008 US coffee shop chain Starbucks revealed

that its Brazilian stores were currently generating the highest

number of sales transactions per store in Latin America. As a

consequence of this success, it announced in August 2010 that

it would take full control of its operations in Brazil through the

acquisition of local firm Cafés Sereia do Brasil Participações,

which owned a 51% stake in the network. Starbucks also said

it plans to expand aggressively in the country. The success of

Starbucks highlights the growing demand for higher-value

gourmet coffee varieties and this trend should mean value sales

increase at a faster rate than volume sales over the next five years.

The company's US origins and high prices have made it some-

thing of a status symbol for affluent young Latin Americans.

In addition, Starbucks has brought a consistency of quality to

the market place, which is currently lacking in the region's

independent coffee houses, which use lower quality beans to

keep prices affordable. The firm has been to some extent limited

by the number of consumers willing to pay up to US$5 for a

cup of coffee. However, the ongoing explosion in the number

of middle class consumers in emerging markets such as Brazil

means this problem is gradually diminishing.

Growing international demand for coffee that has been processed

in Brazil is set to give a further boost to the coffee industry. The

emergence of a sophisticated local market has facilitated the

development of higher-quality domestic processing and ABIC

figures reveal that, during 2008, Brazilian exports of roasted

and ground coffee more than doubled.

While this sub-sector still represents only a tiny percentage of

Brazil's total coffee exports, the phenomenal growth rate is an

indicator of the industry's potential and, with domestic consump-

tion also on the rise, the Brazilian coffee-processing industry

looks to have a bright future.

Meanwhile, tea value sales are expected to increase over the

forecast period, albeit from a low base, as consumers drink

more herbal and speciality varieties thanks to the perceived

health benefits. Neverthelesss, at the end of the forecast period

in 2017, tea sales are expected to represent no more than 15%

of the total value of the hot drinks market, with per capita con-

sumption still only just 0.61kg.

Alcoholic Drinks:

• Alcoholic drinks volume sales compound annual growth

to 2017: +5.7%

• Alcoholic drinks value sales compound annual growth,

local currency, to 2017: +10.7%

The economic slowdown, combined with increased duty, have

combined to slow growth in the previously very dynamic beer

sector. During 2011 sales in volume terms were virtually flat,

and in 2012 the market continued to prove tricky.

In the beer sector, BMI expects the market share of premium

beers to increase over the next five years. We are therefore

forecasting that value sales will grow at a faster rate than vol-

ume sales. In the next five years, BMI expects value sales to

increase by 69% in local currency terms, while volume sales are

expected to increase by 33% to come in at 16.6bn litres in 2017.

Meanwhile, wine is gradually becoming more popular among

middle-class Brazilians as an accompaniment to a meal, and value

consumption is thus forecast to gradually rise over the forecast

period. Despite the historic dominance of beer, BMI believes a

shift towards wine remains a long-term possibility as consumer

affluence increases. In European markets traditionally dominated

by beer, such as Germany, Ireland and the UK, the past 20 years

have witnessed a phenomenal rise in wine consumption and an

associated drop in the consumption of beer. This has been driven by

wine's well-publicised health benefits, the growing trend towards

drinking at home and the increased affordability of good-quality

wine. All of these trends may eventually be mirrored in Brazil.

BMI believes the final factor – the availability of good qual-

ity, affordable wine – is likely to be the main sticking point

currently limiting consumption growth. High import taxes and

low sales volumes mean that foreign wine is expensive and can

often be difficult to find, while the quality of Brazil's domestic

wine often leaves a lot to be desired. However, with this now

changing, with wine distribution increasing and investment in

the local industry increasingly resulting in wines of comparable

quality to its regional neighbours, the Brazilian wine sector could

potentially be one of the most dynamic in the Latin American

food and drink industry over the next five years.

50 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

Brazil already has a fairly strong spirits culture and over the

next five years we see gaining market share from the beer sec-

tor. Rising affluence will increasingly push consumers towards

premium varieties and as a result BMI is forecasting that total

spirits sales in Brazil will increased by 52.3% in value terms to

reach BRL45.95bn in 2017.

Soft Drinks:

• Soft drinks volume sales compound annual growth to

2016: +3.6%

• Soft drinks value sales compound annual growth, local

currency, to 2016: +9.3%

Brazil's climate favours the consumption of cold soft drinks,

while consumption is also boosted by the young average age of

the country's population. However, sales figures released by the

country's national soft drink association ABIR show that growth

in the sector has not been uniform across categories, with volume

sales of fruit juice/juice drinks and energy drinks greatly outper-

forming sales of carbonated soft drinks, iced tea and bottled water.

This contrasting growth is expected to be a feature of the sec-

tor for the five years to 2017 and is reflected in our five-year

forecasts, with volume sales of carbonated soft drinks expected

to grow by 15%, sales of fruit juice expected to grow by 52%

and sales of bottled water forecast to grow by 24%. We also

expect strong growth of the functional drinks market through

to 2017, of 46% in volume terms.

Mass Grocery Retail:

• Mass grocery retail value compound annual sales growth

to 2017: +8.7%

• Supermarket sector value compound annual sales growth

to 2017: +8.4%

• Hypermarket sector value compound annual sales growth

to 2017: +7.3%

• Discount sector value compound annual sales growth to

2017: +10.4%

• Convenience sector value compound annual sales growth

to 2017: +11.3%

The dynamism of the Brazilian consumer has translated into

strong growth for the mass grocery retail segment. While retail

sales moderated following the global financial crisis, the indi-

cator remained in positive territory throughout the downturn.

With the favourable economic climate adding wind to a sector

that is already powering forward thanks to changes in consumer

behaviour and sustained investment, we are anticipating dynamic

levels of growth in the mass grocery retail (MGR) sector over

the next five years.

BMI forecasts that sales in the MGR sector will grow by nearly

52% between 2012 and 2017, compared with the 62% growth in

the 2007-2012 historical period. Supermarkets will continue to

take the lion's share of sales by value, but of increasing impor-

tance are the convenience, discount and hypermarket formats,

which are all expected to register significantly more rapid

growth over the forecast period. Hypermarkets are growing in

popularity, and through their sheer size and selling power per

unit are expected to experience significantly more rapid sales

growth. Smaller outlets in the form of discount stores will also

experience considerable growth rates, albeit from a lower base.

The large number of low-income consumers in Brazil, and

the recent focus on the discount format by the country's major

retailers, means that sales from discount stores are forecast to

grow by 64% through to 2017. Sales in convenience stores are

expected to increase by 71% over the forecast period as they

become increasingly popular with Brazil's growing number of

urban middle-class consumers.

TABLE: FOOD CONSUMPTION INDICATORS – HISTORICAL DATA & FORECASTS, 2010-20172010 2011 2012f 2013f 2014f 2015f 2016f 2017f

Food consumption (BRLbn) 350.3 374.2 407.9 451.5 495.0 544.1 598.9 660.6

Food consumption (US$bn) 199.0 223.4 203.9 210.0 217.6 224.4 249.5 293.6

Per capita food consumption (BRL) 1,797 1,903 2,056 2,257 2,454 2,676 2,924 3,202

Per capita food consumption (US$) 1,021 1,136 1,028 1,050 1,079 1,104 1,218 1,423

Total food consumption growth, BRL (% y-o-y) 11.00 6.82 9.00 10.69 9.63 9.92 10.07 10.31

NB nominal growth rate; f=BMI forecast. Source: Agency for Statistical and Geographic Information, BMI

51Business Monitor International Ltd www.businessmonitor.com

KEY SECTORS

The key task to master for MGRs will be taking advantage

of Brazil's large consumer base while accounting for the fact

that large parts of the population continue to suffer from low

incomes. In terms of future market position, the degree to which

individual operators manage to attract today's low-income con-

sumers, many of which might belong to the middle classes of

tomorrow, will be decisive.

MGRs, in the medium-to-long term, are expected to benefit

from the Growth Acceleration Programme, which is aimed at

increasing infrastructure-related investment via tax incentives

and large public and private investments. The planned measures,

if successful, could ease retailers' logistical problems, which are

mainly caused by poor road networks in many parts of the country.

Trade:

• Exports value compound annual growth to 2017 (US$):

+8.8%

• Imports value compound annual growth to 2017 (US$):

+2.2%

Brazil has a highly positive food and drink trade balance thanks

to the country's highly developed agricultural sector. Brazil is

the world's largest exporter of coffee, soybean, poultry, beef,

orange juice and sugar.

Statistics from the UN Conference on Trade and Development

show that Brazil's food and drink exports continue to grow rap-

idly. The rapidly rising global demand for food caused by the

swift economic advancement of emerging markets means that

BMI forecasts Brazil's food and drink exports to grow by 53%

over 2012-2017. In 2017, exports are forecast to reach a value

of US$88.1bn, with imports amounting to just over US$5.3bn,

having grown by 12% in the five years to 2017.

53Business Monitor International Ltd www.businessmonitor.com

KEY SECTORS

Other Key Sectors

Latest Forecast DataBelow are the latest forecast tables for our other core key sectors:

TABLE: PHARMA SECTOR KEY INDICATORS 2012e 2013f 2014f 2015f 2016f 2017f

Pharmaceutical sales, US$bn [2] 25.880 25.882 26.272 26.450 28.656 32.746

Pharmaceutical sales, US$bn, % chg y-o-y [2] -9.88 0.01 1.51 0.68 8.34 14.27

Pharmaceutical sales, BRLbn [2] 51.760 55.645 59.769 64.142 68.775 73.679

Pharmaceutical sales, BRLbn, % chg y-o-y [2] 7.60 7.51 7.41 7.32 7.22 7.13

Health expenditure, US$bn [3] 208.229 212.627 218.789 222.482 242.942 281.770

Health expenditure, US$bn, % chg y-o-y [3] -7.88 2.11 2.90 1.69 9.20 15.98

Health expenditure, BRLbn [3] 416.457 457.149 497.746 539.518 583.061 633.982

Health expenditure, BRLbn, % chg y-o-y [3] 9.99 9.77 8.88 8.39 8.07 8.73

Communicable, maternal, perinatal and nutritional conditions, DALYs [1,4] 4,839,006 4,699,774 4,564,905 4,434,404 4,308,273 4,186,518

Non-communicable diseases, DALYs [1,4] 22,051,353 22,272,002 22,483,891 22,687,012 22,881,355 23,066,912

Notes: e BMI estimates. f BMI forecasts. 1 Data is DALYS, disability-adjusted life years. Sources: 2 The Brazilian Pharmaceutical Industry Federation (Febrafarma), Group of Executives of the Pharmaceutical Market (Grupemef), IMS Health, BMI; 3 World Health Organization (WHO), BMI; 4 WHO, World Bank, IMF, BMI research.

TABLE: TELECOMS SECTOR KEY INDICATORS 2011 2012e 2013f 2014f 2015f 2016f 2017f

Number of Main Telephone Lines in Service ('000) [1] 42,691 42,928 42,761 42,541 42,374 42,289 42,286

Number of Main Telephone Lines in Service, % chg y-o-y [1] 1.6 0.6 -0.4 -0.5 -0.4 -0.2 -0.0

Number of Main Telephone Lines/100 Inhabitants [1] 21.7 21.6 21.4 21.1 20.8 20.6 20.5

Number of Cellular Mobile Phone Subscribers ('000) [2] 242,232 266,455 287,771 307,570 319,442 331,261 342,988

Number of Cellular Mobile Phone Subscribers, % chg y-o-y [2] 19.4 10.0 8.0 6.9 3.9 3.7 3.5

Number of Mobile Phone Subscribers/100 Inhabitants [2] 123.2 134.3 143.8 152.5 157.1 161.7 166.3

Number of Mobile Phone Subscribers/100 Inhabitants [2] 123.2 134.3 143.8 152.5 157.1 161.7 166.3

Number of Mobile Phone Subscribers/100 Inhabitants, % chg y-o-y [2] 18.3 9.1 7.1 6.0 3.0 2.9 2.8

Number of Internet Users ('000) [3] 92,365 102,370 112,473 122,079 129,379 135,201 139,284

Number of Internet Users, % chg y-o-y [3] 12.1 10.8 9.9 8.5 6.0 4.5 3.0

Number of Internet Users/100 Inhabitants [3] 47.0 51.6 56.2 60.5 63.6 66.0 67.5

Number of Internet Users/100 Inhabitants, % chg y-o-y [3] 11.2 9.9 8.9 7.7 5.1 3.7 2.3

Number of Broadband Internet Subscribers ('000) [1] 16,497 19,548 21,550 23,440 24,910 26,355 27,760

Number of Broadband Internet Subscribers, % chg y-o-y [1] 19.6 18.5 10.2 8.8 6.3 5.8 5.3

Notes: e BMI estimates. f BMI forecasts. Sources: 1 World Bank (International Telecommunications Union – ITU), BMI research, Teleco, Operators, Anatel; 2 World Bank (International Telecommunications Union – ITU), BMI research, Operators, Anatel; 3 World Bank (International Telecommunications Union – ITU), BMI research, Teleco, Anatel, Ibope.

TABLE: INFRASTRUCTURE SECTOR KEY INDICATORS 2009 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f

Construction industry value, BRLbn [1,2] 146.78 182.48 204.07 222.86 247.95 274.98 303.11 333.73 367.38

Construction industry value, US$bn [2] 73.4 103.7 121.8 114.2 116.6 120.9 125.0 139.1 163.3

Construction industry, real growth, % y-o-y [2] -6.26 11.70 3.62 2.21 5.76 6.20 5.23 5.30 5.48

Construction industry value, % GDP [2] 4.5 4.8 4.9 5.1 5.2 5.3 5.4 5.5 5.5

Notes: e BMI estimates. f BMI forecasts. 1 http://www.sidra.ibge.gov.br/bda/cnt/default.asp. Sources: 2 IBGE.

54 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

This report is abstracted from BMI's industry report series, which covers 22 sectors across global markets. Every quarter, we will provide tables

showing the latest five-year forecasts for key industries as well as a forecast scenario for a key sector. If you would like to order a full report, or find

out about BMI's other 1,113 industry reports, please contact subs@businessmonitor.com

TABLE: DEFENCE AND SECURITY SECTOR KEY INDICATORS 2011 2012e 2013f 2014f 2015f 2016f 2017f

Defence expenditure, BRLmn [1] 65,871.9 69,279.6 78,777.0 89,349.7 101,802.8 115,665.8 131,104.1

Defence expenditure, BRL, % chg y-o-y [1] 7.7 5.2 13.7 13.4 13.9 13.6 13.3

Defence expenditure, % of GDP [2] 1.6 1.6 1.6 1.7 1.8 1.9 1.9

Defence expenditure, BRL per capita of population [2] 335.0 349.3 393.8 443.0 500.8 564.7 635.5

Defence expenditure, US$mn, constant prices [1] 36,843.9 30,500.9 30,646.0 31,470.1 32,159.2 35,279.0 41,101.4

Defence expenditure, US$, constant prices % chg y-o-y [1] 6.7 -17.2 0.5 2.7 2.2 9.7 16.5

Defence expenditure, constant US$ per capita of population [1] 187.4 153.8 153.2 156.0 158.2 172.2 199.2

Notes: e BMI estimates. f BMI forecasts. Sources: 1 SIPRI/BMI; 2 SIPRI, BMI calulation.

TABLE: FREIGHT SECTOR KEY INDICATORS2011 2012e 2013f 2014f 2015f 2016f 2017f

Port of Santos container throughput, TEU 2,985,922 3,105,359 3,291,680 3,495,568 3,707,883 3,939,106 4,191,138

Port of Santos container throughput, TEU, % y-o-y 14.8432 4.0000 6.0000 6.1940 6.0738 6.2360 6.3982

Air Freight Tonnes (000) 1,179.60 1,251.09 1,359.86 1,470.79 1,592.66 1,732.25 1,882.60

Air Freight Tonnes % chg y-o-y 3.55 6.06 8.69 8.16 8.29 8.76 8.68

Source: BMI

55Business Monitor International Ltd www.businessmonitor.com

Chapter 6: BMI Global Assumptions

TABLE: GLOBAL ASSUMPTIONS2011 2012e 2013f 2014f 2015f 2016f 2017f

Real GDP Growth (%)

US 1.7 2.2 2.1 2.5 2.5 2.4 2.4

Eurozone 1.6 -0.7 0.4 1.4 1.7 1.9 1.9

Japan -0.6 0.5 0.9 1.2 1.1 1.1 1.1

China 9.1 7.7 7.5 6.7 6.0 5.8 5.8

World 3.1 2.5 2.9 3.4 3.4 3.5 3.5

Consumer Inflation (ave)

US 3.0 2.1 2.1 2.1 2.1 2.1 2.1

Eurozone 2.6 2.1 1.7 1.8 1.9 2.1 2.2

Japan -0.2 0.0 0.3 0.8 1.3 1.8 2.3

China 5.6 3.0 2.6 2.9 2.8 2.7 2.7

World 4.1 3.5 3.3 3.2 3.2 3.3 3.3

Interest Rates (eop)

Fed Funds Rate 0.00 0.00 0.00 0.00 0.00 1.00 2.25

ECB Refinancing Rate 1.00 0.50 0.50 0.50 0.50 1.00 1.50

Japan Overnight Call Rate 0.10 0.10 0.10 0.10 0.10 0.25 0.50

Exchange Rates (ave)

US$/EUR 1.39 1.27 1.25 1.20 1.20 1.20 1.20

JPY/US$ 79.74 79.00 75.00 76.00 78.00 82.25 84.75

CNY/US$ 6.46 6.34 6.40 6.55 6.60 6.60 6.60

Oil Prices (ave)

OPEC Basket (US$/bbl) 107.52 107.05 99.10 96.15 95.20 93.25 93.30

Brent Crude (US$/bbl) 111.05 110.00 102.00 99.00 98.00 96.00 96.00

e/f = estimate/forecast. Source: BMI

Global Outlook

Growth May Be Turning The Corner Our global real GDP growth forecasts remain steady, at 2.9%

in 2013 and 3.4% in 2014 and 2015, following estimated 2.5%

growth in 2012. Nonetheless, we have upwardly revised growth

estimates and forecasts for a few key states, most notably the US

and China. Despite these amendments, our core global outlook

remains relatively unchanged. We believe that 2013 is likely to

see improved economic activity, with cyclical indicators begin-

ning to indicate that the near-recessionary conditions seen in

mid-2012 are abating. Developed states still have a long way

to go before recovering pre-crisis output levels, while emerging

market (EM) performance will be mixed.

With the global economy only likely to slowly pick up mo-

mentum, further stimulus is desirable, particularly in developed

states where economic slack remains significant. Japan and the

US are set to up the ante on this front in the new year. Given

the state of the Japanese economy, we believe that the further

enactment of expansionary monetary and fiscal policy is almost

guaranteed, and we expect budget proceedings to come to the

fore in Q113. Although we believe that the Bank of Japan (BoJ)

is likely to expand its asset purchases at its next few meetings,

we expect the newly elected Liberal Democratic Party govern-

ment to keep pressure on the central bank to increase money

supply further, and see scope for the party to exert influence

over the appointment of the next BoJ governor.

In the US, the decisions announced by the Federal Reserve (Fed)

on December 12 2012 changed the game for monetary policy

once again. The Fed will now purchase an additional US$45bn

56 Business Monitor International Ltdwww.businessmonitor.com

BRAZIL Q2 2013

TABLE: DEVELOPED STATES, REAL GDP GROWTH FORECASTS2011 2012e 2013f 2014f

Developed States Aggregate Growth 1.4 1.0 1.3 1.9

G7 1.4 1.2 1.5 2.0

Eurozone 1.6 -0.7 0.4 1.4

EU-27 1.7 -0.5 0.7 1.5

Selected Developed States

Australia 2.3 3.2 1.5 2.0

Austria 2.7 0.4 0.9 1.5

Belgium 1.8 -0.5 1.1 1.6

Canada 2.6 2.0 1.9 2.5

Denmark 1.0 -0.1 1.2 1.7

Finland 2.8 -0.4 0.6 1.9

France 1.8 -0.2 0.6 1.4

Germany 3.0 0.7 1.3 1.9

Ireland 1.4 -0.5 0.3 1.4

Italy 0.5 -2.3 -0.2 1.2

Japan -0.6 0.5 0.9 1.2

Netherlands 1.2 -1.1 0.6 0.9

Norway 1.6 3.5 2.1 2.3

Portugal -1.6 -3.4 -1.9 0.1

Spain 0.8 -2.1 -0.5 0.5

Sweden 3.9 0.6 1.2 2.6

Switzerland 2.1 0.7 1.5 1.8

UK 1.0 0.0 1.0 1.4

US 1.7 2.2 2.1 2.5

e/f = estimate/forecast. Source: BMI

TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS (%)US Eurozone Japan Brazil China Russia India

2012 Bloomberg Consensus 2.2 -0.4 1.7 1.5 7.7 3.6 n/a

BMI 2.2 -0.7 0.5 1.0 7.7 3.4 5.7

2013 Bloomberg Consensus 2.0 0.1 0.7 3.8 8.1 3.5 5.8

BMI 2.1 0.4 0.9 3.5 7.5 3.4 6.2

n/a = not available. Source: BMI, Bloomberg

per month in 'longer-term' treasury securities, meaning that, be-

ginning in January 2013, the growth of the Fed's balance sheet

will accelerate to US$85bn/month, with US$40bn accounted for

by QE3. The Fed also set out explicit quantitative targets that

must be reached before monetary policy is tightened, so will

keep rates at near-zero levels 'at least as long' as the unemploy-

ment rate remains above 6.5% and the one- to two-year inflation

outlook remains below 2.5%. Our view on US rate policy is not

substantially changed by the newly created explicit targets, and

we continue to expect the next funds rate hike in 2016; however,

we now expect to see at least US$1trn in asset purchases until

early 2014, marking a substantial expansion of the Fed's balance

sheet by around a third.

Developed StatesOur developed state aggregate growth estimate for 2012 has risen

to 1.0% from a previous forecast of 0.9%, while it has fallen to

1. 3% from 1.4% for 2013. The 2012 upgrade is due to a change

in our US real GDP growth estimate for that year, which has

been revised up to 2.2% from the 2.0% forecast we set out at the

beginning of the year. Our general outlook for a slow and erratic

growth path for the US economy therefore remains in place. Our

2013 growth forecast for the eurozone has slipped slightly to

0.4% from 0.5% previously, owing mainly to a downgrade in

the Italy projection to -0.2% from 0.0%. Meanwhile, we have

downgraded other growth forecasts for both 2012 and 2013,

including those of Austria, Sweden and the UK.

57Business Monitor International Ltd www.businessmonitor.com

BMI GLOBAL ASSUMPTIONS

TABLE: EMERGING MARKETS, REAL GDP GROWTH FORECASTS2011 2012e 2013f 2014f

Emerging Markets Aggregate Growth 5.6 4.7 5.0 5.1

Latin America 4.1 3.0 3.4 3.7

Argentina 8.9 2.8 0.9 2.7

Brazil 2.7 1.0 3.5 3.7

Mexico 3.9 4.0 3.4 3.7

Middle East 3.9 5.1 3.9 4.8

Sub-Saharan Africa 4.0 4.2 6.1 5.8

South Africa 3.1 2.3 2.8 3.4

Nigeria 7.4 6.6 7.1 7.2

Saudi Arabia 7.1 5.2 4.5 3.6

UAE 4.2 3.3 3.6 4.3

Egypt 1.4 2.2 3.0 5.2

Emerging Asia 7.2 6.1 6.2 6.0

China 9.1 7.7 7.5 6.7

Hong Kong 5.0 1.8 2.5 3.6

India* 6.5 5.7 6.2 6.6

Indonesia 6.5 6.2 5.6 6.5

Malaysia 5.1 4.2 4.5 4.3

Singapore 4.9 1.9 3.6 3.4

South Korea 3.7 1.9 3.0 4.6

Taiwan 4.0 0.9 3.0 4.0

Thailand 0.1 4.3 4.4 4.4

Emerging Europe 4.8 2.6 3.2 4.0

Russia 4.3 3.4 3.4 3.6

Turkey 8.5 3.0 4.4 5.0

Czech Republic 1.9 -1.2 0.5 1.9

Hungary 1.7 -1.2 1.2 2.3

Poland 4.3 2.3 2.3 3.7

e/f = estimate/forecast; *Fiscal years ending March 31 (2011 = 2010/11). Source: BMI

Emerging MarketsEMs are estimated to have grown by 4.7% in real terms in 2012,

and we forecast a slight acceleration in growth in 2013 to 5.0%.

While our aggregate regional forecasts are relatively steady, we

have modestly downgraded the 2013 outlook for some major

EM economies, including Turkey, the Czech Republic, Poland,

Brazil and India.

Owing to the strength in the recent rebound in economic data

and upside risks to the external economy, we have upgraded

China's real GDP growth forecast for 2013 to 7.5% (from our

previous forecast of 7.1%). We have been calling for a cycli-

cal bounce in Chinese growth for a couple of months, and a

number of leading and coincident indicators suggest that this

is now well in play. Despite this upward revision, we remain

below the consensus forecast of 8.1% for 2013 and believe

that the current growth momentum is likely to fade towards

the middle of the year.

Analyst: Katherine WeberEditor: Mark SchaltuperSub-Editor: Kerry LambethSubscriptions Manager: Shineade Nicol-SeyMarketing Manager: Joanna AshtonProduction: Neil Murphy, Reema PatelPublishers: Richard Londesborough, Jonathan Feroze

©2013 Business Monitor International. All rights reserved.

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