Economic Outlook Macroeconomic Research – Itaú Unibanco June 2014

Overview International The period of global recovery and low inflation will last longer. Activity is recovering in the U.S (despite the first quarter) without pressuring inflation, allowing interest rates to remain low for a longer time. Despite a disappointing first quarter in the euro zone, we expect the modest economic recovery to continue. The ECB is carrying out a round of monetary easing. Chinese economy is likely to stabilize after the government stimulus package. Positive external environment for emerging markets continues. Brazil Activity is still weak and there are downside risks. BRL is likely to depreciate because of the current-account balance, electoral uncertainty and the U.S. interest rates. Inflation is still close to the target ceiling. Amid the slow growth, a more challenging fiscal scenario. Central bank ended the hiking cycle, expressing heightened concerns about the drop in economic growth.

Global Economy Is Recovering   2004-2007 2012 2013 2014 2015 World 5.1 3.2 3.0 3.3 3.6 USA 2.9 2.8 1.9 2.3 3.1 Euro Zone 2.5 -0.6 -0.4 1.1 1.5 Japan 1.4 1.6 1.7 1.3 China 12.1 7.8 7.7 7.2 7.0 Source: Haver Analytics, CEIC, Bloomberg, Itaú Unibanco

U.S.: Activity Is Likely to Keep Recovering After a Weak 1Q14… The first-quarter GDP growth was revised to -1.0% annualized. Due to the surprise, we reduced our 2014 GDP forecast, to 2.3% from 2.5%. We expect a rebound in the second quarter (3.8% growth saar) following the winter payback, the inventories effect and a better housing investment. The good performance of the economic indicators in May underpins this positive outlook. GDP – Real Growth Seasonally adjusted, annualized change, % ISM Higher than 50 indicates expansion Source: Itaú Unibanco, Institute for Supply Management, Bureau of Economic Analysis

... With Inflation at Moderate Levels Inflation has been firmer in the last two months, but remains at comfortable levels. Due to the weaker GDP growth and modest inflation, we lowered our long-run interest rate forecast to 2.9% (from 3.45%) in December 2014. Average Hourly Earnings & Core CPI YoY change, % 10-Year Treasury Yield % Source: Itaú Unibanco, Bloomberg, BLS, Haver Analytics

Europe: The Modest Recovery Is Likely to Continue The first-quarter GDP disappointed, increasing 0.2% qoq. We lowered our GDP growth projection, from 1.3% to 1.1% this year. Our forecast for 2015 remains unchanged at 1.5%. Second-quarter activity indicators underpin this moderate recovery. GDP – Real Growth Seasonally adjusted, annualized change, % Industrial Production and Retail Sales YoY growth, % Source: Itaú Unibanco, Haver Analytics

The ECB Eased Its Policies to Counterbalance the Risks of Deflation The measures are off to a good start in terms of the impact on inflation expectations, but additional measures are possible. The economic recovery should contribute to a reduction in disinflationary pressures. Inflation Annual change, by group of countries, % Monetary Measures Lower overnight bank deposits interest rate (from 0% to -0.10%) Reduction of the main bank-lending rate by 0.10%, to 0.15%. Central bank will lend funds to banks for up to four years at a fixed cost of 0.25%. The ECB ended the weekly sterilization of its periphery sovereign-bond portfolio. Central Bank reinforced its forward guidance of low interest rates. Source: Itaú Unibanco, Eurostat, Haver Analytics

China: Signs of Improvement in the Second Quarter With the recent gains in the PMIs, we are confident that activity is stabilizing. We maintain our GDP forecast at 7.2% for 2014 and 7.0% for 2015. The risks, however, remain tilted toward the downside, specially in the property sector. GDP – Real Growth Seasonally adjusted, annualized change, % PMI Seasonally adjusted, higher than 50 indicates expansion Source: Itaú Unibanco, CEIC, Haver Analytics

Emerging Markets: Positive External Environment Continues Volatility remains low following the stable interest rates in the U.S.. Despite some recent adjustment, most emerging stock exchanges strengthened and some currencies even appreciated. The weak growth performance could limit the gains from the global environment. Stock Exchange PMI – Emerging Countries Higher than 50 indicates expansion **Emerging Asia: China, India, Korea, Indonesia, Vietnam, Singapore and Taiwan ***Latam: Brazil and Mexico. *EM Stock: Geometrical average of Stock Exchange Index from Mexico, Chile, China, Indonesia, South Korea and Turkey. Source: Itaú Unibanco, Bloomberg

Commodities: Our Projections for the Short Term Itaú Commodities Index Source: Itaú Unibanco

Latin America: Growth Continues to Disappoint Peru Mexico   2013 2014 2015 GDP - % 5.6 5.0 5.9 1.1 2.4 3.8 PEN / USD (Dec) 2.80 2.85 2.95 MXN / USD (Dec) 13.1 13.2 Interest Rate- (Dec) - % 4.00 Interest Rate - (Dec) - % 3.50 3.00 CPI 2.9 3.0 2.5 4.0 3.7 3.2 Colombia Chile 4.3 4.5 4.1 2.8 COP / USD (Dec) 1930 1950 2000 CLP / USD (Dec) 526 575 600 3.25 4.25 5.00 4.50 1.9 3.1 3.6 Argentina -2.0 0.0 ARS / USD (Dec) 6.5 10 13 BADLAR - (YE) - % 21.6 35.0 30.0 CPI - % (Private Estimatives) 28.4 37.0 27.0 Source: Itaú Unibanco

Brazil: What Do We Expect in the Short Term?   2012 2013 2014 2015 Economic Activity GDP (%) 1.0 2.5 1.7 Unemployment (%) - December 5.4 5.1 5.3 5.6 Inflation IPCA (%) 5.8 5.9 6.5 Monetary Policy Selic Rate (%) 7.25 10.00 11.00 12.00 Fiscal Primary Surplus (% GDP) 2.4 1.9 1.3 Balance of Payments Exchange Rate (eop) 2.08 2.36 2.45 2.55 Current Account (% GDP) -2.4 -3.6 -3.7 -2.9

Activity: Outlining a Lower-Growth Scenario We revised our GDP forecast for 2014 to 1.0% and 1.7% in 2015. The 1Q14 GDP report showed a deceleration in domestic demand, with the deceleration reaching gross fixed-capital formation (-2.10%) and household expenditures (-0.1%). The third straight fall in the gross fixed-capital formation. According to the available 2Q14 data, there was a retreat in industrial activity and a moderation in retail sales. 2014 – First-Quarter GDP GDP Growth Scenario Seasonally adjusted change   QoQ change (SA) GDP 0.2% Demand Household expenditure -0.1% Government expenditure 0.7% Gross fixed-capital formation -2.1% Exports -3.3% Imports 1.4% Supply Agriculture 3.6% Industry -0.8% Services 0.4% Source: Itaú Unibanco, IBGE

Recent Data Suggests an Economic Deceleration While industrial production retreats, retail sales stagnated. Confidence levels are low, and they are falling at the margin. Industrial Production and Retail Sales Seasonally adjusted Confidence Indexes Seasonally adjusted, July 2010=100 ** Source: Itaú Unibanco, IBGE, FGV

We Forecast a Moderate Rise in Unemployment Due to the slowing economy, we expect the unemployment rate to be at 5.3% by year-end and 5.6% by the end of 2015. Formal Job Creation (CAGED) Thousands, seasonally adjusted Unemployment Rate Seasonally adjusted Source: Itaú Unibanco, IBGE, Caged

Electricity Balance: Rationing Risks in 2015 Persist Reservoir levels started to fall in May, following the seasonal pattern, and should continue to drop slowly until November. Basic scenario: Rainfalls slightly above the average for the rest of the year (El Niño). Intense thermal-power-plant usage. The costs of distribution companies are likely to be BRL 6 billion in addition to the amount already paid in 2014 (BRL 17.4 billion). High rationing risks in 2015. Aggregate Reservoir Levels % of total capacity Source: Itaú Unibanco, ONS

Trade Balance: Exports Are Weakening The falling prices for exported commodities and resilient imports (which continue to advance despite the weak economic activity) are likely to have negative impact on the trade balance this year. We revised our trade-balance estimate for 2014 to USD 1.5 billion, from USD 3 billion. For 2015, we maintain our expectation of a USD 16 billion trade surplus. Terms of Trade Price of exports / price of imports, seasonally adjusted Trade Balance 12-month accumulated, USD in billions Source: Itaú Unibanco, BCB

BRL: Appreciation Is Likely Temporary The exchange rate has been fluctuating within the 2.20-2.30 range. The FX intervention program via swap contracts will be extended beyond June. BRL is set to weaken again due to: the recent worsening of external accounts, the moderate increase in the U.S. Treasury yields and election-related uncertainties. Exchange Rate Monthly average Current-Account Balance 12-month accumulated, USD billions Source: Itaú Unibanco, BCB

Inflation: We Expect a 6.5% IPCA in 2014 and 2015 Our regulated-price estimate was reduced (to 5.4% from 5.6%) after incorporating tariff reductions for landline phones and water and sewage. Our estimate for market-set prices is still at 6.8%. We expect increases of 7.3% for regulated prices and 6.3% for market-set prices. IPCA Breakdown YoY change, % IPCA 3 months 12 months 1Q13 1.94% 6.6% 2Q13 1.18% 6.7% 3Q13 0.62% 5.9% 4Q13 2.04% 1Q14 2.18% 6.2% 2Q14 1.44% 6.4% 3Q14 0.83% 4Q14 6.5% 1Q15 2Q15 1.37% 6.3% 3Q15 1.24% 4Q15 1.74% Source: Itaú Unibanco, IBGE

Fiscal Policy: Difficulties in Achieving the Target Non-tax revenue (especially dividends) remains high, while tax revenue is growing in line with GDP. By year-end, we expect a drop in the 12-month cumulative primary surplus to 1.3% of GDP. Collection of Dividends BRL in billions, January-April Public-Sector Primary Surplus % GDP Source: Itaú Unibanco, BCB

Monetary Policy: End of the Rate Hikes, at the Moment The COPOM expressed heightened concerns about the drop in economic growth and greater ease with the stability of the exchange rate. Selic Rate % p.a Source: Itaú Unibanco, Bloomberg

Conclusion The period of global recovery and low inflation will last longer. Positive external environment for emerging markets continues, but activity in these countries is at moderate pace. Brazilian economy’s growth is still weak and is likely to increase 1.0% this year. Unemployment should start rising, reversing the recent trend. Domestic and international factors are likely to pressure the BRL this year. Inflation is expected to end up close to 6.5% in 2014 and 2015. It will be difficult to achieve the fiscal target. We expect the Selic rate to remain at 11.00% this year and reach 12.00% in 2015.

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