The Commodity Prices and Brazilian Economic Growth

The Commodity Prices and Brazilian Economic Growth

The Economic Activity Index of the Central Bank of Brazil (IBC-Br), a preliminary indicator of GDP, surprised the market with 0.80% growth in September compared to the previous month. The January 2024 Focus Report had forecasted a mere 1.6% growth for 2024, yet the economy has already accumulated 3.00% growth over the last 12 months, suggesting a more optimistic scenario than initially expected.

However, how is such growth possible in a volatile environment marked by weakened fiscal and monetary policy credibility, rising dollar exchange rates, and increasing future interest rates? Many analysts had already anticipated a recession, yet it has not materialized. Why?

First, the full impact of the Selic rate hike is expected to affect the economy only by 2025 due to the gradual transmission of monetary policy effects. When the Central Bank raises the Selic rate, it sets off a chain reaction that influences borrowing costs, consumer behavior, business investment, and inflation expectations. These effects unfold over time because they depend on financial contract adjustments, market dynamics, and economic behavioral changes.

Higher interest rates directly increase borrowing costs for businesses and consumers. For companies, this typically leads to a reduction in investments, as capital becomes more expensive, making expansion projects less attractive. Households face higher monthly payments on credit cards, loans, and mortgages, reducing discretionary spending. However, many existing financial commitments are based on fixed rates or long-term agreements, meaning the impact of rate hikes is not felt immediately but rather when these contracts are renegotiated or new ones are signed.

This process is even slower as businesses and consumers adjust their expectations and spending behaviors. Decisions to cut investments or reduce expenses usually happen gradually as companies and households assess the broader economic environment. Empirical evidence suggests that the strongest effects of monetary policy changes on economic output typically take 12 to 24 months to fully materialize. In the case of recent Selic rate increases, their full influence on output, employment, and consumption is expected to become more evident by 2025.

Second, the potential for an economic downturn may be delayed due to the strong influence of international commodity prices on Brazil's short-term growth. Since 2004, the correlation between the IBC-Br and the World Bank's Commodity Price Index has been approximately 66%. Historically, economic crises—such as the 2008 financial crisis, the Dilma Rousseff presidency period, and the COVID-19 pandemic—coincided with falling commodity prices. While correlation does not imply causation, Brazil, as a small open economy, appears to experience a direct relationship between global commodity cycles and its own economic cycles.

Many still believe that commodity influence is limited to trade balance, but its impact is far broader. During high commodity prices, domestic demand strengthens, while during price declines, demand contracts. Some studies indicate that commodity price shocks impact investment and consumption more intensely than exports. As a result, Brazilian GDP is highly influenced by global commodity price movements—when prices rise, Brazil grows; when they fall, the country faces economic crises.

The unexpected economic growth figures for 2024 seem to reflect a mild recovery in commodity prices following a post-pandemic decline. This has temporarily kept Brazil away from an imminent economic crisis—a situation that appears to be more luck than strategy, especially considering ongoing fiscal and monetary policy uncertainties.

However, without strong regulatory and fiscal policies that stimulate production on the supply side—reducing current interventionist measures—the fundamental risks for a crisis remain in place. A decline in commodity prices may very well be the final trigger.

Source: Tiago Piassum, CEO of Rivool Finance, and Cristiano Oliveira, Head of Research at Rivool Finance.