Brazil's recession deepens, worst annual drop on record

By Silvio Cascione and Brad Haynes

BRASILIA/SAO PAULO (Reuters) - Brazil's economy shrank 1.7 percent in the third quarter, deepening its worst recession in 25 years and starving President Dilma Rousseff's government of taxes as she struggles with a growing fiscal deficit and a vast corruption scandal.

The quarterly contraction, reported by government statistics agency IBGE on Tuesday, was bigger than a median forecast of 1.2 percent in a Reuters poll of 33 analysts.

On an annual basis, Brazil's gross domestic product dropped 4.5 percent in the third quarter, the steepest decline since the beginning of the current data series in 1996.

"There is still no light at the end of the tunnel," said Luciano Rostagno, chief strategist at Banco Mizuho in Sao Paulo. "In the best case scenario, there will be some turnaround in the second quarter of 2016, if fiscal issues are addressed. But the risk is that we'll keep this recessionary outlook for longer."

Rousseff's unpopular austerity efforts have foundered as the recession shrinks tax revenue faster than she can trim spending, eroding the credibility of her finance minister and leading Standard & Poor's to cut Brazil's credit rating to junk.

Investment fell 15.0 percent from a year earlier, declining on a sequential basis for the ninth straight quarter. Output from the services and industrial sectors also fell sequentially for the fourth- and sixth-straight quarters, the longest slumps on record.

Household consumption fell 4.5 percent from a year earlier as unemployment hit a six-year high and consumer prices jumped nearly 10 percent in 12 months.

Financial markets expected the poor growth data after months of grim indicators. Brazil's currency, the real, edged slightly lower and the benchmark Bovespa stock index recovered less than 1 percent from a two-month low.

Other emerging economies in Latin America and Africa have struggled this year with slumping Chinese demand for their commodities, but none is suffering as dramatically as Brazil, whose political and economic crises have inflamed each other.

Rousseff struggled to pass key fiscal measures this year as her approval rating fell to single digits and the mood in the capital turned toxic as probes revealed a political kickback scheme funneling billions of dollars out of state-run firms.

The country's biggest corruption investigation ever is still rattling the heights of Brazilian politics and business, slowing public works by companies under investigation and paralyzing budget negotiations in the capital Brasilia.

Last week the Supreme Court ordered the arrest of the country's most famous dealmaker, banker Andre Esteves, and the president's coalition leader, Senator Delcídio do Amaral, bringing Congress screeching to a halt.

Lawmakers have already revolted against Rousseff and Finance Minister Joaquim Levy's proposals for new taxes and spending cuts, forcing them to slash fiscal targets repeatedly and cancel a trip to Japan to stay within federal budget rules.

A growing chorus in the opposition say Rousseff's disregard for those rules in recent years is grounds for impeachment, a motion that the speaker of the lower house, who is also the target of a graft probe, said he would decide on this week.

(Reporting by Silvio Cascione and Brad Haynes; Additional reporting by Camila Moreira in Sao Paulo; Editing by Catherine Evans and Chizu Nomiyama)