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Will Brazil Central Bank Tame Inflation?
There are already warnings of potential stagflation in the year ahead.
BY LATIN AMERICA ADVISOR
Inter-American Dialogue
Brazil’s central bank on Oct. 27 raised its benchmark Selic interest rate by an aggressive 150 basis points to 7.75 percent, its biggest rate hike in nearly 20 years and its sixth consecutive hike this year. The increase came a day after the country’s statistics institute reported that annual inflation had surpassed 10 percent, with a 1.2 percent monthly rise in consumer prices, the quickest pace since 1995 for mid-October. The previous week, Brazil’s real weakened to a seven-month low against the U.S. dollar, trading at about 5.7 reais to the greenback. What is the outlook for economic growth and inflation in Brazil with less than a year to go before the country’s presidential election? How much is President Jair Bolsonaro’s government expected to ramp up spending before the vote, and how would that affect the economy? Which business sectors are expected to do best in the coming year in Brazil, and which will struggle the most?
Joel Korn, president of WKI Brasil and senior international partner at UPITE Consulting Services: The central bank’s steep increase in the Selic rate was expected, and the upward trend should continue in the coming months in pace with rising inflation, which is now at a double-digit level and significantly above this year’s target of 3.75 percent. September inflation was the highest since 1994, driven primarily by price hikes in food, fuel oil and energy tariffs. Moreover, the absence of a clear commitment for fiscal discipline, combined with the uncertainties of congressional approvals for new sources of revenue, is manifested by the likelihood of noncompliance with the mandatory ceiling for public expenditures. Political motivations for further spending, particularly in social programs, as the country approaches the 2022 elections reinforce negative market expectations and project escalating interest rates and continued currency devaluation. President Bolsonaro will be increasingly focused on populist measures to boost his chances for re-election. Also, vested interests in the leaders of the Senate (a potential opposition candidate for president) and the Chamber of Deputies (who is aligned with Bolsonaro) will heavily influence Congress’ inaction on sensitive legislation. This scenario reinforces the heavy reliance on the central bank’s tight monetary policy to mitigate inflationary pressures and signals a continued weak economy in the coming year. Social programs should induce a surge in consumer demand, although their effectiveness will be short-lived, given the inflation-related impact on purchasing power of the targeted low-income population. The informal economy should expand further as the current stubborn 14 percent unemployment rate subsists. Exports, particularly in the agribusiness sector, will evidently continue to benefit from exchange devaluation pressures, while new direct investments will be largely restricted to specific opportunities in infrastructure, productivity enhancements and transactions focused on strategic consolidations. The winner of next year’s presidential election will face a huge challenge to reposition the country’s economy and restore the confidence of consumers and investors.
Allison Fedirka, director of analysis at Geopolitical Futures: Unfortunately for Brazil, there’s little reason to believe 2022 will be much better than 2021. Prospects for growth remain limited, and abating inflation poses a real challenge such that there are already warnings of potential stagflation in the year ahead. Brazil entered the pandemic with a fragile economy that was midway through executing its recovery strategy. This strategy relied on structural reforms (including limits on government spending), efforts to increase the economy’s attractiveness to investors and dependence on global trade to spur economic growth. When the pandemic hit, the subsequent slowdown of trade, massive drop in foreign investment and need for emergency government spending all worked against the very strategy Brazil had employed. Now, the government has limited means to address the crisis. It will focus on fighting inflation, reducing import vulnerabilities and enacting social welfare programs. The last measure could endanger the country’s fiscal stability and discourage investors, but it will be done because it’s one of the few tools available to the government. The country has relied heavily on exports of agriculture and raw materials over the past 18 months. These are vulnerable to current supply-chain complications and facing difficulties: namely, the cost of input materials (such as fertilizer), container shortages for export and volatility in trade with China. The price of energy, shortage of key inputs and potential electricity shortages have also created operational headaches for Brazil’s industry.
Gary Clyde Hufbauer, senior fellow at the Peterson Institute for International Economics: Something unusual happened (…). The Brazilian central bank sharply raised its policy interest rate by 150 basis points—a jolt not seen in a quarter-century—and the Brazilian stock market continued to sell off, not because the rate increase was too much, but because it was too little. The stock market dreads a return to the inflationary spirals of yesteryear, once common in Brazil, and it clamors for the central bank to decisively arrest the current 10 percent inflation rate. The central bank will likely heed this call from an unusual quarter and soon lift the policy rate from 7.75 percent to above 10 percent. The price of correct but aggressive monetary policy will be no growth, or even negative growth, in 2022—shades of Paul Volcker’s Fed in the 1970s. If central bankers elsewhere are paying attention, they too will raise policy rates before their own inflationary spurts get entrenched. Meanwhile, the best Brazil can hope for in 2022 is a strong global economy (growth of more than 3 percent) that lifts demand and prices for primary commodities—such as iron ore, coffee, soybeans and petroleum. Brazil’s huge service economy and manufacturing sectors face a difficult year. Ultimately, these misfortunes can be attributed to irresponsible fiscal initiatives and a poor response to Covid-19, putting the entire burden on the central bank to arrest inflation.
Welber Barral, senior consultant at BMJ Consultores Associados and former Brazilian foreign trade secretary: Brazil’s economic prospects for 2022 are not very promising. GDP growth will not reach 1.5 percent, after a recovery of 5 percent in 2021. If the central bank’s tightening hand is apt to curb inflation, it should reach less than 5.5 percent. Higher interest rates are the central bank’s main measure to reduce inflation by cooling domestic demand. This is not a good prospect for the Bolsonaro administration, which expected the economic recovery to increase its popularity in 2022. Traditionally, election years induce more spending in Brazil at the federal and state levels. Due to compliance with laws determining a ceiling for annual expenditures, the administration is attempting to approve a constitutional amendment to postpone the payment of judicial decisions (precatórios) against the Treasury. If this amendment is approved, the administration would have financial space to increase its social program of minimum income. However, the obvious consequence is a growing federal public debt for the next administrations. This fiscal uncertainty is directly affecting market expectations in Brazil, provoking an exceptional volatility in the exchange rate and contributing to higher inflation. The current level of devaluation of the real is attracting investment for long-term projects in Brazil. Renewable energy and infrastructure are benefiting from these investments. Exporting industries (mostly in the agricultural and mineral sectors) are doing very well with the high international demand. On the other side, retail and services are still struggling to return to 2019 levels, while inflation and unemployment work against their immediate expectations.
Republished with permission from the Inter-American Dialogue's daily Latin America Advisor
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