Brazil: Inflation concerns and lax monetary policy dampen economic allure


Matthew Turner
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Brazil’s position in the ECR global rankings remains unchanged this quarter as analysts digest the impact of policy-rate hikes on economic growth.

Brazil’s economic assessment deteriorated by 0.5 points, as country experts become more alarmed about the sustainability of the country’s economic growth trajectory and the dangers posed to monetary tightening, along with issues of banking sector stability.

A deteriorating economic outlook and a lacklustre monetary policy had a negative bearing on the country’s economic assessment.

With inflation (IPCA) peaking at 5.8% in Brazil in April and breaching the upper bound of the central bank’s 4.5% target range, analysts have raised the spectre of an aggressive monetary tightening cycle during the coming months, despite political pressure for lower rates to nurture an economic recovery.

The country’s widening inflation gap is a concern to ECR analysts and presents downside risks to the country’s risk profile, according to the latest Q1 results. Brazil’s monetary policy and currency stability indicator declined by 0.1 last quarter, reflecting the central bank’s laagered policy response, while banking sector strength weakened by 0.1 points.

Accelerating inflation and the prospect of policy-rate hikes appear to be also feeding into negative economic growth. Brazil’s economic outlook indicator declined a further 0.1 points in Q1 and a further 0.3 points year-on-year, as ECR contributors remain concerned about the country’s growth trajectory.

The Brazilian economy slowed to 0.9% in 2012, from 2.8% in 2011, which was below the consensus forecast of 2.5% growth.
“The slowdown in Brazil spilled over to its regional trading partners, especially Argentina, Paraguay and Uruguay,” according to the IMF.

The negative impact of Brazil’s slowdown on the sovereign’s trading partners is reflected in ECR data, which shows that five countries in South America suffered from deteriorating economic outlooks in Q1 (see chart below).

Marijke Zewuster, emerging markets economist at ABN Amro and one of ECR’s expert contributors, says: “The high real interest rates were an impediment to stronger growth last year. On the other hand, there were a lot of structural issues which required these high interest rates to be put in place.

“The question is: has the country overcome these structural challenges? Lower interest rates can be beneficial, but not if the risk perspective of the country increases.”

HSBC has responded to accelerating inflation by reducing its real GDP growth forecasts for 2013 to 2.6% from 3% and for 2014 to 3.5% from 3.8%.

“Brazil’s inflation is proving stickier than expected, and the central bank adopted a more hawkish tone as a result,” states a report by HSBC. “These factors lead us to forecast rate hikes, and we now expect the central bank to raise the Selic policy rate by 150 basis points this year to 8.75%.

“The bottom line is therefore that interest rate hikes will produce lower inflation by depressing domestic demand. Accordingly, we lower our forecasts of consumption growth for 2013 to 3.3% from 3.5% and for 2014 to 3.8% from 4.4%. This reflects several factors, including slightly weaker credit growth and the impact of lower growth expectations on sentiment.”

In addition, creeping concerns of banking sector strength also had a negative impact on Brazil’s economic assessment score.

Analysts lowered Brazil’s by 0.1 point to 6.0 amid concerns about credit-fuelled growth. Secondly, rising defaults and more restrictive regulation have put pressure on smaller banks in recent months.

Pascaline della Faille, risk manager at ONDD and one of ECR’s expert contributors for Brazil, says: “The growth of credit to the private sector has expanded rapidly over the past several years. This credit boom was largely financed by domestic funding [bank deposits], which mitigates the risk of financial instability.

“Nevertheless, the importance of external funding is increasing, though it remains so far smaller than other funding sources. The recent credit boom in Brazil reflects the process of financial deepening but also an increase in private sector leverage.

“However, even if non-performing loans are on the rise, the situation in Brazil’s largest banks is under control for the moment as financial soundness indicators are robust and financial supervision is strong.”