Poor performance of machinery, equipment industry hurts investment

In the second quarter, GDP grew by 0.9% compared to the previous quarter and by 3.4% compared to the same period last year. On the expenditure side, exports and household and government consumption grew strongly. However, productive investment, especially in machinery and equipment, remained stagnant. Gross fixed capital formation (GFCF, which aggregates investment in machinery and equipment, construction, and other fixed assets) rose by 0.1% in the quarter and fell by 2.6% year-on-year, ending the first half with a decline of 3.3% compared with the previous semester and 0.9% year-on-year.

With the poor performance of GFCF, the investment rate reached 17.2% of GDP, which represents a decrease of 1.1 percentage points compared to the second quarter of 2022. A technical note from the Applied Economics Research Institute (IPEA) said that the picture is challenging when looking at the manufacturing industry in decline and warns of the weight of high interest rates on this.

According to July data from the IPEA Monthly GFCF Indicator, which aggregates investment in machinery and equipment in civil engineering and other fixed assets, there was a fall of 1.5% from June to July in the seasonally adjusted series, after a fall of 0.7% in the previous month. As a result, the indicator stands at 168.04 in seasonally adjusted terms, 17.6% below the series peak of 203.84 in April 2013.

“Investment in machinery and equipment — measured according to the concept of apparent consumption, which corresponds to national production destined for the domestic market plus imports — fell by 4% in July,” specialists Leonardo Mello de Carvalho wrote in the note, adding that domestic production of components fell by 3.6%, while imports declined 4.7%.

On a 12-month cumulative basis, apparent consumption (or domestic demand) for machinery and equipment fell by 3.2%.

A less serious picture was presented by investment in civil engineering, which reported a decline of 0.1% in July, after a decline of 3.2% in June and an expansion of 4.2% over 12 months.

“Investment has been on a decelerating path since last year. There was a positive period in 2021, given the low base of comparison, but it slowed down again last year and this year, becoming negative in the second quarter,” said Rafael Cagnin, with the Institute of Studies for Industrial Development (IEDI).

According to him, the production of capital goods in the red since 2021 and the advanced average age of the Brazilian industrial park are directly related to this scenario.

“Another point of attention is the CNI survey, according to which the average age of equipment in industry is high and more than a third is obsolete.”

The June 2023 survey “Age and Life Cycle of Machinery and Equipment in Brazil” shows that these assets are on average 14 years old, and 38% of them are close to or have already exceeded the age indicated by the manufacturer as the ideal life cycle.

The CNI said that 12% of the Brazilian industrial park is a legacy from the 1980s and 1990s, before the internet, and 20% from the period between 1998 and 2008. The peak of acquisitions of machinery and equipment took place in the period between 2008 and 2013, which concentrates 28% of the acquisitions. Only 22% are from 2016 onwards, when the concepts of Industry 4.0 began to spread more widely.

Mr. Cagnin said that today there is a greater speed of diffusion of digital technologies, but they are not in Brazil. “So, we have the double task of updating what is getting old and going beyond this technological frontier,” he said. For him, part of the problem is that the manufacturing sector has not grown since 2014.

“We see one or two years of positive performance. There was a way out of the crisis in 2017, with slightly better performance, then a slowdown in 2018, manufacturing GDP in the red in 2019, negative again in 2020, and growth in 2021 on a very low base of comparison. In 2022, despite countercyclical measures, the industry will end the year in the red and will continue to perform so this year,” he said.

Mr. Cagnin attributes the lack of dynamism in the sector to “distortions in the Brazilian economy,” such as fiscal and logistical obstacles that affect the production chain, and high interest rates, which impact investments in the short term. “There is no way to get investment going with double-digit interest rates.”

The Brazilian Association of Machinery and Equipment Manufacturers (Abimaq) predicts that Brazil will end 2023 with an investment rate of around 17% of GDP, below the average of 21% and well below the 24% that the association believes is necessary.

According to the association, from January to August, the sector experienced a cumulative decline of 13% in net sales and a 7.9% contraction in apparent consumption. In locally produced items alone, the drop reaches 13%.

“We have pent-up demand. We should be investing between 24% and 25% of GDP in industry and infrastructure, but we are investing 17%. The main reason is the restrictive monetary policy,” said José Velloso, president of Abimaq.

The statistics agency IBGE’s Monthly Industrial Survey – Physical Production (PIM-PF) shows that capital goods are the item of the major categories that show the greatest decrease.

The contraction was 7.4% in July compared to June, and 16.9% compared to July 2022. The production of capital goods accumulated a decline of 10.8% from January to July. In the 12 months to July, there were only four months of growth.

“We see many sectors that are performing well, such as agriculture, which is expected to grow by 13% in the year, with difficulties [in acquiring machinery and equipment]” due to currency problems, said Cristina Zanella, head of competitiveness, economics and statistics at Abimaq. According to her, from January to August, investment in machinery and equipment in the agricultural sector fell by 19.2% year-on-year. In the manufacturing industry, it was 10.3% and in the road machinery segment, it was 14.5%. Even in civil engineering, with a less negative scenario, the decline was 11.4%, and the outlook is for a 13% decline this year.

Data from the Brazilian Economic Institute of the Getulio Vargas Foundation (FGV Ibre) for the third quarter indicate a continuation of this scenario, with a sharp contraction in the absorption of machinery and equipment (local production plus imports, excluding exports). Calculations with data from the Center for Foreign Trade Studies Foundation (Funcex) show a drop of 13.3% in July and August this year, compared to the same period last year. Those based on FGV’s foreign trade indicator (Icomex) show a decline of around 11.1% in the same period.

In the September edition of its Macro Bulletin, FGV Ibre stated that “even with a better performance in construction, everything points to a contraction in investment in the year of 0.9%, after growing only 0.9% in 2022.”

“We see that the production of capital goods is much lower than last year. The same goes for imports of these goods,” said Silvia Matos, coordinator of FGV Ibre’s Macro Bulletin. “The very negative absorption of machinery and equipment at the beginning of the third quarter paints a rather bad picture for investment.” It highlights the current heterogeneity between economic indicators, with positive GDP and investment in the opposite direction. “That’s a red flag, especially when we think about the potential of the economy.”

In the medium and long term, said Mr. Velloso, with Abimaq, the outlook for investment is less harsh, with the fall in inflation, the fiscal framework, the tax overhaul, and the signaling of a monetary easing ahead.

“I believe that the rate of investment, as gross fixed capital formation, will begin to rise in the coming months, and at the end of the first quarter of 2024, it will grow,” said Mr. Velloso.

Ms. Zanella, also with Abimaq, sees a more positive scenario than that of 2023, but without much euphoria. “Looking at each segment individually, consumption by the agricultural sector is likely to stop falling, while that of construction may improve, through municipal elections, My Home My Life [housing program] and PAC [Growth Acceleration Program],” she said.

She also said that in the extractive industry, demand is expected to remain good, but in the manufacturing industry, it tends to be driven by the reorganization of income and household consumption.

“As interest rates fall, the outlook improves. But it will take time until it reaches the lending rates [that are crucial for the industry],” Mr. Cagnin said.