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Monday, December 24, 2007

Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.

Credit crunch, did someone use the expression credit crunch?

Friday, December 21, 2007

Brazil Inflation December 2007

Brazilian consumer prices rose in the month through mid-December at their fastest pace in two years, damping expectations that the central bank will resume interest rate reductions any time soon. Consumer prices, as measured by the government's benchmark IPCA-15 index, rose 0.7 percent in the month through mid- December, triple the 0.23 percent in the previous month, the national statistic agency said today on its Web site.

Surging domestic demand on the back of the Brazilian economy's fastest growth since 2004 has pushed up the annual inflation rate from an eight-year low of 2.96 percent to just below the central bank's annual target of 4.5 percent this year.

Brazil's central bank kept its benchmark overnight interest rate unchanged at a record low 11.25 percent at each of the last two meetings on concern rising consumer demand may threaten its inflation target for 2008. In two years through September, policy makers cut rates at 18 straight meetings

Today's inflation report cements expectations that the central bank may not begin cutting rates again until year-end 2008, compared to just a few months ago when many economists said policy makers could resume cuts by March.

The surge in monthly inflation was led by food, fuel and cigarette prices. The IPCA-15 is a mid-month preview of the central bank's benchmark IPCA inflation rate, scheduled for release on Jan. 11.

The price of beans surged 104 percent in the 12 months through Dec. 10, while milk and potato prices climbed 20.5 percent and 70.4 percent respectively.

Latin America's biggest economy expanded 5.7 percent in third quarter, compared with a revised 5.6 percent increase in the second quarter, the government said Dec. 12.

In the four quarters ended Sept. 30, the economy grew 5.2 percent from 4.9 percent in the same period ended in June, the biggest accumulated annual growth rate since the end of 2004.

In a separate report from the national statistics agency, unemployment in the six largest Brazilian cities fell to 8.2 percent, the lowest since the government began a new series for the indicator in 2001.

Average household inflation-adjusted wages, a gauge of disposable income, jumped 2.4 percent from the same month a year earlier.

About 717,000 new jobs were created in November from the year-ago month, spurred by a jump in real estate-related occupations and social work including education and health care assistance, the government said.

Two in every three workers have remained in the same job for at least two years, indicating that the economy's expansion is also helping to stabilize to the nation's workforce.

Yields on interest-rate future contracts rose. The yield on the contract maturing in January 2009, the most widely traded in Sao Paulo's Commodities and Futures Exchange, rose 9.7 basis points, or 0.097 percentage point, to 11.98 percent at 10:45 a.m. New York time.

Wednesday, December 12, 2007

Brazil's economy expanded 5.7 percent Q3 2007

Brazil's economy expanded 5.7 percent in the third quarter, the fastest year-on-year expansion since June 2004. Gross domestic product rose more than the revised 5.6 percent increase in the second quarter. Latin America's biggest economy expanded 1.7 percent from the previous quarter, faster than the revised 1.3 percent pace in the second quarter, according to the Rio de Janeiro-based statistics agency.

Sunday, December 09, 2007

Brazil to Create SWF?

From Jonathan Wheatley in the FT today.

Brazil SWF to counter rising currency

By Jonathan Wheatley in São Paulo

Published: December 9 2007 22:10 | Last updated: December 9 2007 22:10

Brazil will create a sovereign wealth fund with the primary aim of intervening in foreign exchange markets to counter the appreciation of Brazil’s currency, according to finance minister, Guido Mantega.

“It will have the function of reducing the offer of dollars in the market and helping the real to appreciate less,” he told the Financial Times.

His statement adds to controversy surrounding the fund, first announced by Mr Mantega in October. Since then, funding plans and objectives have undergone several revisions. The uncertainty has caused concern among investors and officials at the country’s central bank. The SWF appears to differ substantially from funds operated by other countries.

Under Mr Mantega’s original plan, the SWF would have drawn on Brazil’s foreign reserves, which have risen quickly this year to about $180bn. That plan sparked a behind-the-scenes row between the finance ministry and the central bank.

Darwin Dib, economist at Unibanco, a São Paulo bank, said the plan was unorthodox and that that level of firepower would have no lasting impact on exchange rates. He said the proposal raised doubts over the government’s commitment to Brazil’s floating exchange rate regime.

“The big victory for the central bank,” a central bank official said, “is that the fund will have nothing to do with Brazil’s foreign reserves and nothing to do with the central bank.”

But in an interview with the FT in Brasília last week, Mr Mantega said the fund would indeed affect the accumulation of reserves and would share the central bank’s source of funding at the national treasury.

Under current rules intervention in currency markets is the sole prerogative of Brazil’s central bank.

Friday, December 07, 2007

How Sensitive Is Brazil To A Global Slowdown?

Marcelo Carvalho is again spot on in this Tuesday's MS GEF post:

As the US economy appears to slide towards recession, and global growth forecasts are cut back, the debate intensifies about whether emerging markets like Brazil would be able to ‘decouple’ from the developed world’s agony. The ‘decoupling’ debate is misplaced, in our view, at least in its binary version. If the US goes into recession, does Brazil necessarily have to contract sharply? We think the answer is no. But then is Brazil fully immune? Our answer is again no. Decoupling should not be seen as a yes or no proposition, but rather as a spectrum of possibilities, in a continuum of outcomes. As usual with these matters, in medio stat virtus: the truth lies somewhere in the middle.

As the US economy appears to slide towards recession, and global growth forecasts are cut back, the debate intensifies about whether emerging markets like Brazil would be able to ‘decouple’ from the developed world’s agony. The ‘decoupling’ debate is misplaced, in our view, at least in its binary version. If the US goes into recession, does Brazil necessarily have to contract sharply? We think the answer is no. But then is Brazil fully immune? Our answer is again no. Decoupling should not be seen as a yes or no proposition, but rather as a spectrum of possibilities, in a continuum of outcomes. As usual with these matters, in medio stat virtus: the truth lies somewhere in the middle.

The balance of payments is the main channel of transmission from global turbulence into Brazil. We have already made the point that Brazil’s trade surplus is likely to narrow much faster than the consensus believes (see “Brazil: Waiting for Godot”, EM Economist, October 26, 2007, and “Brazil: Trade Consensus – What Is Wrong with This Picture?” EM Economist, November 16, 2007). Robust domestic demand and a strong currency should keep imports growing rapidly, while exports are set to struggle amid a less encouraging global environment. The market consensus is calling for only a modest decline in the trade surplus from roughly US$40 billion this year to around US$35 billion in 2008. By contrast, we see the trade surplus falling by half, to about US$20 billion in 2008. Correspondingly, while the consensus view still looks for a current account surplus next year, we are confident that the current account will fall into negative terrain in 2008. But the current account is just part of the picture. In this note, we take a closer look at the other side of the balance of payments: the capital account.

Das Kapital account

Swings in the capital account have been by far the main driver behind changes in Brazil’s international reserves, much more so than the relatively less volatile current account balance. Indeed, an unprecedented surge in capital inflows this year has allowed the central bank to speed up its pace of intervention in the foreign exchange market, and to more than double its stock of reserves from the US$85 billion mark seen at end-2006.

Capital account strength has been broad-based, across net foreign direct investment (FDI), equities and fixed income. Net FDI has surged to record-highs, even without the help from privatization-related inflows which boosted FDI figures at the beginning of the decade. Macroeconomic stability has expanded companies’ planning horizons. Declining real interest rates have unlocked investment opportunities. And robust domestic demand has enticed firms to expand their output capacity. Coupled with favorable global conditions, the improving domestic environment has attracted FDI into Brazil, mainly in the form of new operations (although also through inter-company loans, to a lesser degree). Interestingly, net outward direct investment has risen in recent years too, as Brazilian companies expand abroad.

Where is FDI going?

Net FDI inflows are widely spread across the economy. Services (including financials and retail) account for about half of the total, although the broadly defined agribusiness-mining complex has gained importance (especially mining). Within industry, the main recipients of FDI include sectors such as metallurgy, fuels, chemicals and food processing.

Capital inflows into the equity market have also boomed to unprecedented highs, spurred by a record-high number of IPOs. The expansion and maturing of the local capital market has brought a deluge of new companies to the local stock market. Foreign participation in IPOs has been high at about three-quarters of the total, and so it is unsurprising that capital inflows through this channel have boomed.

Registered inflows into the local fixed income market have jumped high as well, in part supported by tax and regulatory changes aimed at facilitating direct foreign participation in the local market. Brazil’s Treasury has steadily bought back its external debt, migrating its financing towards the local market. That brings hope of redemption from the so-called ‘original sin’ (or emerging markets’ historical inability to issue long-term debt in local currency). It also lures foreign investors into the local fixed income market.

The outlook for 2008

What to expect for the capital account going ahead? We look for a slowdown in capital inflows next year. As the global economy decelerates, and global risk-aversion re-emerges after being suppressed for years, recent all-time high capital inflows seem unlikely to persist. Net FDI should prove relatively resilient, as this type of flow tends to follow normally slow-moving perceptions about longer-term trends. We suspect that the peak in IPOs in the local stock market is behind us. Likewise, we fear that an environment of less global risk appetite might take its toll on capital inflows into the local fixed income market. We assume that these inflows slow towards levels seen prior to the 2007 boom.

All in all, we assume that capital inflows slow from about US$90 billion in 2007 to almost a third of this in 2008, although admittedly the capital account is harder to predict than the current account. How does that compare with expectations about global capital flows into EM overall? The latest report from the International Institute of Finance on this subject sees a modest decline (to still-high levels) in capital flows to emerging markets in 2008 after a peak in 2007. To be frank, such a projection now looks a bit sanguine in light of ongoing downgrades in the global environment for next year, in our opinion. For Brazil in particular, our assumptions are less smooth than the IIF’s: we see a higher peak in capital inflows in 2007 and a larger decline in 2008.

What are the risks around our forecast? If our numbers materialize, Brazil would still be able to accumulate foreign reserves next year, albeit at a slower pace than in 2007. That should prove to be a relatively benign backdrop. We suspect that the main downside risk to our scenario would be a sharper-than-expected turnaround in capital inflows. If the capital account really dries up, on top of what seems to us to be an inevitable deterioration in the current account, then the Brazilian real would suffer – although the central bank theoretically could lean against currency-weakening by selling reserves. In turn, currency devaluation could push inflation expectations up, eventually forcing the hand of the central bank to tighten. Monetary tightening, for its part, could take the punchbowl away from the domestic demand party. To be fair, there is potential upside risk too. If capital inflows prove more resilient than we assume, resulting currency strength would prolong Brazil’s virtuous-cycle story.

Bottom line

The current account balance is bound to fall into deficit next year, and capital inflows look set to take a hit too, in our view. We assume that the overall balance of payments will remain sufficiently robust to allow further reserve accumulation, albeit at a slower pace. The main downside risk: if capital inflows really dry up, then the currency could weaken significantly, pushing inflation expectations up, forcing interest rates higher, and entailing a downturn in the growth outlook.