How the Rio Grande do Sul floods are likely to impact Brazil's economy

Brazilian government officials and economists have been assessing the impact of the unprecedented floods in southern state of Rio Grande do Sul.

Heavy rains in the country’s fourth largest state caused rivers to overflow and dikes to collapse, which left a large portion of Rio Grande do Sul under water and over 150 people dead.

The federal government monitors the impacts on a daily basis and has announced multiple measures to help the state recover. 

Luis Octavio Leal, chief economist at local asset management firm G5 Partners, spoke to BNamericas about the impact of the natural disaster on Brazil’s economy.

BNamericas: What is your current expectation for Brazil's GDP in 2024?

Leal: I'm currently noticing some economic indicators that are worse than expected. We monitor several indicators daily and since February we've noticed a deterioration in the scenario. In view of this, we recently reduced our GDP projection for the first quarter from growth of 0.7% to 0.5%. Meanwhile, our projection for the full year continues to be an expansion of 2.1%.

BNamericas: Does your current GDP projection already take into account the effects of the floods in Rio Grande do Sul state?

Leal: A difficulty in calculating all the effects of the floods in Rio Grande do Sul is that the water in many places has not yet receded.

However, we've made two projections to try to measure the economic impact of the situation.

One of the projections we made was to calculate the weighting of the entire agricultural, industrial and services sectors in that state, projecting the impact of days of stoppage of these activities due to the floods. This model gave us the figure of a negative impact of 0.4% on the country's GDP this year.

At the same time, we adopted another projection model that sought parallels with similar disasters and chose to study what happened with Hurricane Katrina in economic terms. 

[Editor's note: Hurricane Katrina passed through southern US states in 2005, causing hundreds of deaths and major destruction.]

By carrying out simulations of what happened in the US at that time, making current considerations and taking into account the particularities of Brazil and the state of Rio Grande do Sul, we arrived at a potential negative impact of 0.3% for the Brazilian economy this year.

Therefore, we can say that according to our models the negative economic impact for this year of the events that occurred in Rio Grande do Sul is around 0.3% or 0.4% of the country's GDP.

But, for now, I'm not going to change my GDP projection for the entire year because I want to wait for the GDP information for the first quarter. If the number for the first quarter is better than expected, it's possible that the GDP revision due to the effects of Rio Grande do Sul will be smaller or not even exist, because the economic performance of the first quarter has an important statistical impact on the performance of the economy in the whole year.

BNamericas: Can state infrastructure reconstruction projects have a positive effect on GDP?

Leal: Yes, they will have a positive effect on GDP, but the trend is that this will only have an impact on the economy in 2025.

So, it's possible to say that the floods in Rio Grande do Sul will have a downward effect on Brazil's GDP this year and an upward effect next year, due to these reconstruction projects in the state.

BNamericas: What effects do these events in Rio Grande do Sul have on interest rates and inflation?

Leal: On interest rates, there is a fiscal effect related to the measures that the government is announcing in support for Rio Grande do Sul.

As for prices, in June we should see an inflationary impact because of the price of rice, which is likely to rise because of the floods in rice production areas in that state.

But I believe that the central bank shouldn't make any monetary policy decisions based on what's happening in Rio Grande do Sul.

BNamericas: Why not?

Leal: Because on the inflation side, the effects should be short term. Soon the price of rice should fall, with the government increasing imports to contain the effects on local production.

On the fiscal side, the effect on monetary policy will tend to be null.

Generally, when there's fiscal expansion, an increase in government spending, this generates an inflationary effect because there is more money circulating in the economy, with people using this money to consume more.

What happened in Rio Grande do Sul is different.

We expect the cost for reconstruction to be up to 85bn reais [US$16.5bn] but in practice this value doesn't mean money that people will take and use to consume. These resources will be used to invest in the recovery of infrastructure, so it has a different effect, which won't generate inflation and due to that I don't think the central bank should consider these effects in its interest rate decision.

BNamericas: And what is your forecast for the Selic policy rate at the end of this year?

Leal: My Selic rate projection for the end of the year is 9.25% but I should revise this to 9.75%.

This revision isn't associated with the effects of Rio Grande do Sul, but rather the previous statement that the central bank has already expressed concern about inflation and also due to not so clear signals from the Fed in the US that perhaps the interest rate won't fall as quickly as expected. 

The Fed's decisions have an effect on the decisions of central banks around the world.

My inflation projection for this year has not changed, I expect inflation of 4%.