Brazil’s New President – Coming Down to Earth
For a variety of reasons outlined by The Economist, liquidity looks set to continue to flow towards Brazil.
“She has said she wants real interest rates, currently higher than those in any other big economy, to fall from 5% to 2% by 2014. But inflation crept up to 5.6% in November. The finance minister, Guido Mantega, who is keeping his job under Ms Rousseff, raised bank-reserve and capital requirements in a bid to cool the economy while forestalling rate hikes. Though the Central Bank duly stayed its hand, its quarterly inflation report, released on December 22nd, made it clear that the reprieve is temporary. Many economists expect a half-point rise in the benchmark Selic rate (now 10.75%) in January, and a further two or three such rises during the year.
That will put more upward pressure on a currency that more than doubled in value against the dollar during Lula’s eight years as president. Tony Volpon of Nomura Securities, a stockbroker, reckons Brazil’s treasury is losing around 40 billion reais ($24 billion) a year as it sells Brazilian bonds to foreigners while investing the proceeds in dollar instruments yielding ten percentage points less. In October Mr Mantega tripled a tax on foreign investment in fixed-income securities to try to hold back the flood. But the real has finished the year no lower.
If interest rates, and the currency they undergird, are to fall as Ms Rousseff wants, she will have to slow the hectic increase in federal spending. The bill for payroll and pensions has risen far faster than inflation in recent years, with the task of keeping inflation under control left entirely to monetary policy. In the past three years the government has ramped up the resources of the national development bank, BNDES, by at least 210 billion reais, allowing it to expand lending for infrastructure projects and a host of other ventures less obviously deserving of state support. According to IPEA, a government-linked research outfit, the BNDES’s subsidised interest rates cost taxpayers up to 21 billion reais a year.
Ms Rousseff has spoken of the need to end such fiscal incontinence: she wants to cut net government debt, now 42%, to 30% of GDP over her term. She is resisting pressure from her Workers’ Party and its allies for a big rise in the minimum wage. At the end of November Mr Mantega said that he would provide the BNDES with only half as much extra funding in 2011 as it has had this year. To encourage the private sector to take up the slack he will slash taxes on bonds to pay for new, government-approved infrastructure projects. But as long as such high returns are available on short-term government paper, even a tax break may not make longer-term, riskier investments look sufficiently appetising.”