Brazil Central Bank Fights Inflation

About Brazil’s Interest Rate Policy

Brazil’s central bank is set to raise the benchmark interest rate for the sixth time since September as economic growth and higher government spending fuel concerns about inflation.

The central bank’s nine-member board headed by President Henrique Meirelles will lift the overnight rate today by half a percentage point to a 14-month high of 18.75%, according to all 30 analysts surveyed by Bloomberg.

An increase would indicate that central bankers are concerned about the perception the inflation rate isn’t falling to its 5.1% goal for this year. President Luiz Inacio Lula da Silva’s decision to raise the minimum wage 15% this year and boost salaries for judges, attorneys and prosecutors is adding to that perception among investors.

“What you have is a basic mismatch between fiscal and monetary policy,” Sergio Werlang, a former central bank chief economist who now is a managing director at Banco Itau Holding Financeira SA, Brazil’s biggest bank by market value, said in Sao Paulo. “Government expenditures went up quite dramatically.”

The outlook for higher interest rates pushed up Brazil’s currency to a 32-month high on February 14. The annual inflation rate fell to 7.4% in January from 7.6% in December, the government said that day. The annual rate is down from a seven- year high of 17.2% in May 2003.

The government’s 13% rise in spending this year has contributed to inflation concerns. Brazil’s congress approved a budget of 357.8 billion reais ($137.6 billion) for 2005, up from the 320 billion reais allocated for 2004 and 4% more than the amount sought by Lula.

Lawmakers are setting aside 901 million reais more for hiring this year in the central government and for pay raises for judges, attorneys and prosecutors. The government plans to hire as many as 17,000 new civil servants by the end of 2005.

Lula last year cut the budget deficit to 47.1 billion reais, or 2.7% of gross domestic product, from 79 billion reais, or 5.1% of GDP in 2003. The primary budget surplus, which excludes debt payments, was 4.61%, above the government’s target of 4.5% and the 4.25% recommended by the International Monetary Fund.

Source: (story by Charles Penty)

About the Economic Crisis

Brazil Map
Brazil Map

Between 2001-03 real wages fell and Brazil’s economy grew, on average, only 1.1% per year, as the country absorbed a series of domestic and international economic shocks.

That Brazil absorbed these shocks without financial collapse is a tribute to the resiliency of the Brazilian economy and the economic program put in place by former President Cardoso and strengthened by President Lula Da Silva.

The three pillars of the economic program are a floating exchange rate, an inflation-targeting regime, and tight fiscal policy, which have been reinforced by a series of IMF programs. The currency depreciated sharply in 2001 and 2002, which contributed to a dramatic current account adjustment: in 2003, Brazil ran a record trade surplus and recorded the first current account surplus since 1992.

While economic management has been good, there remain important economic vulnerabilities. The most significant are debt-related: the government’s largely domestic debt increased steadily from 1994 to 2003, straining government finances, while Brazil’s foreign debt (a mix of private and public debt) is large in relation to Brazil’s modest (but growing) export base. Another challenge is maintaining economic growth over a period of time to generate employment and make the government debt burden more manageable.


About Brazil Economy

Brazil has vast agricultural resources, with two distinct agricultural environments. The first, comprised of the southern one-half to two-thirds of the country, has a semi-temperate climate and higher rainfall, better soils, higher technology and input use, adequate infrastructure, and more experienced farmers. It produces most of Brazil’s grains and oilseeds and export crops. The other, located in the drought-ridden northeast region and in the Amazon basin, lacks well-distributed rainfall, good soil, adequate infrastructure, and sufficient development capital. Although producing mostly for self-sufficiency, the latter regions are increasingly important to exporters of forest products, cocoa, and tropical fruits. The Central-West contains substantial areas of savannah grassland with only scattered trees, and the area is experiencing rapid and extensive agricultural expansion.

Brazilian agriculture is well diversified, and the country is largely self-sufficient in food. Agriculture accounts for 9% of the country’s GDP and employs about 20% of the labor force. Agribusiness, taken as a whole, accounts for about one-third of Brazil’s GDP. Brazil is the world’s largest producer of sugarcane, coffee, frozen concentrated orange juice, tropical fruits, and has the world’s largest commercial cattle inventory. It is a major producer and exporter of cocoa, soybeans, tobacco, wood products, poultry, pork, corn, cotton, and tobacco. Livestock production is important in many sections of the country, with rapid growth in the poultry, pork, and milk industries reflecting changes in consumers’ tastes. Agriculture accounts for about 41% of the country’s exports, and Brazil enjoyed a positive balance of trade of more than U.S. $20 billion in agriculture in 2002.

Forests cover half of Brazil, with the largest rain forest in the world located in the Amazon Basin. Recent migrations into the Amazon and largescale burning of forest areas have brought international attention. The government has reduced incentives for such activity and is implementing an ambitious environmental plan that includes an Environmental Crimes Law with serious penalties for infractions.

Brazil has one of the most advanced industrial sectors in Latin America. Accounting for nearly one-third of GDP, Brazil’s diverse industries range from automobiles and parts, other machinery and equipment, steel, textiles, shoes, cement, lumber, iron ore, tin, and petrochemicals, to computers, aircraft, and consumer durables. General Motors, Ford, and Fiat have established small-car production facilities in Brazil. Automakers look to test new production methods in Brazil, since the industry is more flexible than the more mature industries in Europe.

Brazil Central Bank Fights Inflation (AP/Alexandre Meneghini)
A man holding fake dollars and dressed as a ‘banker’ takes part in a protest in front of the Central Bank building against the government’s policy to maintain high rates to combat inflation, in Sao Paulo, Brazil, February 16, 2005.

Brazil has a diverse and sophisticated services industry as well. Mail and telecommunications are the largest, followed by banking, energy, commerce, and computing. During the 1990s, Brazil’s financial services industry underwent a major overhaul and is relatively sound. The financial sector provides local firms a wide range of financial products. The largest financial firms are Brazilian (and the two largest banks are government-owned), but U.S. and other foreign firms have an important share of the market.

Privatization triggered a flood of investors after 1996. The yearly investment average in the telecom sector the 4 years prior to the start of privatization was R$5.8 billion, and the annual average for the 4 years post privatization was R$16.3 billion, nearly tripling. Investment in the electrical power sector increased from R$5.3 billion annually in the pre-privatization era to R$7.2. U.S. companies provided a great deal of this influx of cash. After 2000, many of these investors suffered huge losses in the face of adverse regulatory decisions, the plunge of the real. The energy sector was especially hard hit.

In 2001, Brazil experienced an electricity crisis due to inadequate rainfall for its hydroelectric system and insufficient new investment in the sector. Mandatory rationing and price hikes were sufficient to prevent blackouts. The rationing system officially ended on March 1, 2002. The Energy Minister will unveil an energy plan in July 2003, which will be critical in determining future investor interest.

The Government of Brazil has undertaken an ambitious program to reduce dependence on imported oil. In the mid-1980s, imports accounted for more than 70% of Brazil’s oil and derivatives needs; the figure is now 19%. Brazil is one of the world’s leading producers of hydroelectric power. Of its total installed electricity-generation capacity of 90,000 megawatts, hydropower accounts for 66,000, i.e., 74%.

Proven mineral resources are extensive. Large iron and manganese reserves are important sources of industrial raw materials and export earnings. Deposits of nickel, tin, chromite, bauxite, beryllium, copper, lead, tungsten, zinc, gold, and other minerals are exploited. High-quality coking-grade coal required in the steel industry is in short supply.