Brazil: Possible Impacts of the Floods
Unprecedented floods in Rio Grande do Sul, a state that contributes 6.4% to Brazil's GDP and 13.3% to its agricultural production, have submerged several cities. The immediate halt in economic activity may reduce Brazil's Q2 GDP by up to 0.4%. The federal government is increasing aid, potentially raising the fiscal deficit to 1.5% of GDP. Inflation may rise by 0.3 percentage points due to disrupted logistics and reduced food supply. Soybean exports could drop by $5 billion.
Brazil's southern state, Rio Grande do Sul, is being affected by unprecedented floods. Several cities are mostly underwater, with human and economic impacts still difficult to predict. Rio Grande do Sul accounts for over 6.4% of Brazil's GDP and approximately 13.3% of the country's agricultural production, including significant production of soybeans, rice, poultry, and cattle. The state is also an important exporter of soybeans and tobacco, contributing over 6% of Brazil's exports.
The impacts of the floods can be compared to those of Hurricane Katrina in the U.S. Initially, a sudden stop in economic activity will occur, followed by the reconstruction of affected infrastructure. Only after this reconstruction will the economy return to its usual behavior. Assuming a 50% reduction in economic activity in May and June, the impact on Brazil's GDP would be around 0.3% in Q2. Considering spillover effects, this impact could increase to -0.4% in Q2. A possible U-shaped recovery might compensate in subsequent quarters, but the timeline for the reconstruction of the affected cities remains unclear.
The federal government announced aid packages for the state, with several credit lines from multilateral development banks also making funds available. Currently, around 0.2% of the GDP is being directed to the state, but it is likely that the federal government will provide more resources, potentially reaching over 1% of the GDP. This will increase the projected fiscal deficit for 2024, prompting a revision of the deficit forecast from 0.5% to 1.5% of the GDP. The catastrophic situation permits increased spending under the new fiscal framework, but there is a risk of general flexibilization that could jeopardize the long-term impact of the framework.
Due to the agricultural significance of the state, some food items such as soybean oil, rice, and meat may see price increases. This would be due to affected logistics in the region and reduced supply from enterprises. The price impact is expected to occur mainly in May and June and will likely be restricted to the Food and Beverages category. We foresee a 0.3 percentage point increase in inflation in May and an additional 0.2 percentage point in June. However, it is possible that some of this increase will be reversed in the second half of the year once the situation normalizes.
The focus of the Central Bank of Brazil (BCB) will remain on achieving inflation convergence. Despite a temporary rise in inflation, we do not expect the floods to significantly affect inflation convergence. Therefore, it is likely that the BCB will maintain its current views on inflation, with the policy rate expected to end the year at 10.25%.
Soybean production in Rio Grande do Sul is likely to be severely affected by the floods. However, since most soybean production occurs in the central areas of the country, we estimate the impact to be around USD 5 billion in lost soybean production, corresponding to 1.4% of Brazil's total exports.