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Thursday, September 11, 2008

Brazil Central Bank Raises Interest Rates Another 0.75%

Brazil's central bank raised its benchmark interest rate three-quarters of a percentage point yesterday. Three of the eight directors expressed the view thatthe raise was excessive, which seems to indicate that the monetary tightening process may be nearing its close in this cycle. Policy makers voted 5-3 to raised the so-called Selic rate a fourth time since April to 13.75 percent from 13 percent in an attempt to keep a tight grip on inflation, and to confirm the Banks growing reputation as the "Bundesbank of Latin America". The decision raised Brazil's real interest rate - which is the nominal rate adjusted for the 6.17% CPI inflation -  to 7.58, the highest among emerging and developed economies alike. The dissenters on the board voted for a half-point increase.






Real Decline

Despite the interest rate rise the real fell below the 1.80-per-dollar level today for the first time since January an indication more of deteriorating global sentiment - today's drop was triggered by speculation Lehman Brothers is about to collapse. The real dropped 1.8 percent to 1.8202 per dollar at 11:03 a.m. New York time, from 1.7878 yesterday. Earlier it touched 1.8374, the weakest since Jan. 22. Lehman's 38 percent fall today pushed the Standard & Poor's 500 Index to its lowest since November 2005. As wer can see in the chart below, the real had been rising steadily in 2008 until the start of August. Then the wind clearly changed, and the dollar had been rising and the real falling.


If we look at the three month chart things are even clearer, and we can see that sentiment had been deteriorating since mid July, and then really to a hard jolt downwards in late August. Most of this evidently has no direct relation with the strength of the Brazilian economy, or with any deterioration in the inflation outlook (quite the contrary, see below) but rather with global factors, like, of course, commodity prices, since the movement conforms reasonably well wilh the downward shift in the price of oil.




Brazil's stock market, the Bovespa index (about half of which consists of raw material companies), is also vulnerable to concerns about global growth, and the has dropped around  23 percent so far this year, hurt by both inflation concerns and a decline in commodity prices.


But we need to ask ourselves some basic questions about the current USD rally and the extent to which a continuing US slowdown would will lower growth in key global movers like Brazil and India. It is also worth asking the question whether there is any real danger of capital flight from either of these two economies to the dollar perceived as a safe heaven currency. This whole argument seems to be very overstretched at this point. Indeed it seems to be a real paradox that the USD continues to be considered a safe heaven despite US credit markets being the epicenter of the current global economic turmoil, and especially at a time when returns on USD assets continue to be negative, while any continuing upward movement in the dollar can only help the trade deficit deteriorate again, Thus it is my view that the current USD rally unsustainable as seen against a select group of emerging economy currencies (and in particular the rupee and the real, is not justified, and basically not sustainable with increasing all those imbalances people had been working so hard to try and correct.


And Is Inflation Already On The Wane?


At the same time Brazil's consumer prices rose at their slowest pace in 11 months in August after food and beverage costs fell for the first time in more than two years. The August price increase as measured by the benchmark IPCA index was just 0.28 percent, compared with 0.53 percent in July, as a result annual inflation slowed to 6.17 percent from a three-year high of 6.37 percent.

Food and beverage costs dropped 0.18 percent last month, the first decline since June 2006, after rising 1.05 percent in July. On the other hand, non-food inflation actually accelerated, indicating the central bank is quite right to try to squeeze out second round effects at this point. Service prices rose by 0.73 percent in August, up from 0.51 in July. Prices for non-food goods not subject to government regulation also rose 0.5 percent in August, up from 0.3 percent in July.

The Impact Of Energy Prices

Energy prices also seem to be easing, and rapidly.


Oil prices fell to their lowest level in five months today as investors worried that the ongoing economic slowdown would continue to chip away at the demand for energy. Light, sweet crude for October delivery fell $1.88 to $100.70 a barrel on the Nymex, after dropping as low as $100.10 a barrel at one point. The contract settled yesterday at $102.58 — the lowest close since April 1. The last time crude traded below the $100 mark was April 2 Oil prices have now fallen more than $40 from the record high of $147.27 a barrel on July 11, two months ago, as a struggling global economy has cut into demand for energy. The US is leading the way in the decline in demand for oil, and the US Energy Information Administration reported last week that imports of crude in August were 200,000 barrels a day below the same four-week period last year. This pattern is repeated to some degree or another in economy after economy across the globe.

Now this decline in oil will evidently have a floor, but where exactly does that floor lie? My own view is that the decline will continue, but that it may hit bottom around $80, since at some point inflation will ease back as a major problem in a number of significant economies, and growth will rebound in some key movers (deciding which those are going to be is the tricky issue at this point), and then of course the oil price will start to head up again.

My feeling is also that we could then see quite a quick turnaround in inflation in some emerging economies like India (from the current 13% to say 7%) or Brazil (back down to the 4.5% range?) and this will then mean the negative "lose-lose" dynamic we have been seeing across a number of emerging economies of rising inflation, rising trade deficits, rising interest rates, falling currencies and falling growth can transform itself once more into the "win-win" dynamic of falling inflation, falling trade deficits, slightly lower (but still very yield differential attractive) interest rates, rising currencies and rising growth.

The interesting question is when will we hit the inflection point? Well, if we look at the NYMEX chart below, we will see that oil prices really started to take off in October 2007, and that at current rates of decline in oil prices the two curves should cross (ie 2008 prices should be below 2007 ones) sometime between October and November. Now this will be quite an important event in the emerging market economies, since given the weight which has been attached to energy and food rises in the total inflation picture, once these (for so called base effect reasons) start to clock negative readings, headline inflation should start to sink back.




GDP Growth Remains Strong

The key question then is, of course, how much will Brazil's economic growth be negatively affected by falling commodity prices, and how much will it benefit from the easing back in inflation? In the short run this is a hard one to call (although I think in the longer run commodity prices are likely to remain relatively high, and this will be more to Brazil's advantage than anything, especially if the central bank can manage to squeeze second round inflation effects out of the system.

Brazil's economic growth actually accelerated in the second quarter, so at this point there is no great sign of any formidible slowdown.  Gross domestic product in fact was up 6.1 percent from a year earlier, beating all the main forecasts. Growth was fueled by a mixture of investments and exports, and was up from a revised 5.9 percent rate in the first quarter. The economy was also up 1.6% quarter on quarter, from the first quarter of 2008.

Capital investment in Q2 was up an annual 6.2 percent, the fastest pace since the second quarter of 1995. Household spending grew 6.7 percent after a 6.6 percent expansion in the first quarter. The volume of exports rose 5.1 percent, reversing a 21 percent decline in the first quarter.

Finance Minister Guido Mantega argued today that he expected Brazil's economic growth this year to be above the current government's 5 percent forecast. Mantega, who has to some extent been a critic of central bank rate increases, said economic growth wasn't stoking inflation because supply was keeping up with demand.

The Iara Field

Basically it is hard to see why some people are so pessimistic for the outlook on the Brazilian economy. The favourable demographic moment Brazil is facing in terms of the share of the population in the working age groups means there is plenty of available capacity, and the continuing development of Brazil's oil industry means that there should be a constant and adequate inward flow of capital.  As if to ram this point home, Petroleo Brasileiro, Brazil's state-controlled oil company (otherwise know as Petrobras), said yesterday that its Iara offshore field contains 3 billion to 4 billion barrels of oil, making it the second giant find in a year and offering enough oil on its own to keep Brazil supplied for up to five years.

The assessment  is the first estimate of recoverable oil since the discovery of the field was announced on Aug. 11. Petrobras  said in January its Jupiter field in the same region contained gas quantities similar to its Tupi area, the largest oil find in the Americas since 1976. Iara is in the Santos Basin to the north of Tupi, a 5 billion- to 8 billion-barrel field announced in November. If confirmed, Iara and Tupi, which sit in non-adjacent parts of the same exploration block, could almost double Brazil's 12.6 billion barrels of proven oil reserves. 

The Iara estimate is based on a well drilled in 2,230 meters (7,315 feet) of water. The final well depth is 6,080 meters. Petrobras has not said whether Iara is an extension of Tupi. Unleased and unexplored areas sit between the two fields. The block, named BM-S-11, is in two, non-contiguous parts. The Iara portion is less than a quarter the size of the Tupi portion, according to a map supplied by Petrobras.

The Outlook Is Solid

So my feeling is that within six months or so of the oil "cross-over" we should see the Brazilian economy really start to pick up speed again, and in particular we should see a strong rebound in industrial output. Brazil, remember, is still growing at a 6.4% annual rate, and while this may well drop back in Q3 and Q4, this velocity will quite possibly be attained again as the key emerging economies start to "break sweat" and head upwards towards their earlier strong upward paths. Brazil will be there amonst the leaders, as will India. But when the role call is taken, just who will be present and who will be absent is going to make interesting reading. 



8 comments:

Anonymous said...

A question to start the discussion:

Why are interest rates so high in Brazil in the first place?

Presumably, it's to stave off inflation. Why would inflation be high? Because of loose monetary policy elsewhere? From where?

I'm just trying to imagine what would happen if rates were suddenly cut.. Say, to 6%. I suppose the Real would drop. Is this in Brazil's interest, or not?

Whatever stimulation a cut like this caused internally should be somewhat offset by the money outflows from those seeking yield.

All I know is that this tightening monetary policy is certainly propping up the Real, and may just be exacerbating the typical boom/bust cycle that these countries are prone to. How can a domestic economy grow with such restrictions on borrowing? Imagine 15% rates in the US?

KB said...

When the wind is strong even the turkeys fly. This is the case of Brazil (I am Brazilian).

Dont be foolish. Interest rate is almost the highest in the world and productivity is the lowest.

Whenever the economy grows it brings back inflation. The highly corrupt leftwing government is spending as if there is no tomorrow.

Brazil is the perfect case of boom/bust cicle. Foreigners dont know Brazilian reality and loves fairy tale.

Edward Hugh said...

Hello KB,

"When the wind is strong even the turkeys fly. This is the case of Brazil (I am Brazilian)"

I appreciate your point of view, but I am starting to wonder whether you hold it precisely because you are Brazilian, and not despite being Brazilian. What I mean here is that I am following quite a large block of middle range emerging economies (look at the top of the sidebar for the list) and I am noting a similar STRUCTURAL process in country after country in the group: namely that growth is being sustained at levels which are significantly above the trend as being forecast by analysts using traditional models (and especially ones which make no allowance for the impact of demographic changes).

And what is even more interesting is that it is precisely people in India, Brazil, Turkey, etc who tell me that what is happening can't possibly be happening, and hence what we must have is fiscal overspending, populism, and boom bust etc.

This seems to reflect a view - which I personally can't accept - that the world can never change, and that the poor and backward countries will always be poor and backward.

I don't have much to add to the argumentation I already have presented in the post, of which Claus has presented across several detailed posts here and elsewhere (see the latest one on the Chile blog if you are interested), other than to say that this is to some extent an empirical question, since economics is, after all, primarily an empirically driven science.

So I would ask you, if over the next two or three years we find that Brazil's trend growth is in the 5 to 7% range (which almost no conventional analyst is suggesting at the present time), will you be prepared to change your view?

If Marcelo Carvallo is right, and growth is rather in the 3% range in the years to come, I will certainly be prepared to adapt mine.

"Interest rate is almost the highest in the world and productivity is the lowest."

The world is a very big place (Wittgenstein famously started off his Tractatus by saying it is "all that is the case") so I feel perhaps that you may be exaggerating somewhat. What is impressive about the Brazilian central bank recently isn't so much the way it has been able to bring interest rates down from the previously very high levels, but the way it has been prepared to raise them again sharply in the face of growing inflation. I am not so cynical about Brazil's institutions as you seem to be.


"The highly corrupt leftwing government is spending as if there is no tomorrow."

I'm sure you love your country, but can you really see no difference between the evolution of Brazil's institutional structure and what has been happening in Argentina. C'mon.

And in terms of popular perceptions I see a huge difference between the mentality of CDD and Tropa de Elite.

Good luck to you anyway.

Edward

Edward Hugh said...

Hi anonymous;

"A question to start the discussion"

Well you certainly succeeded in your objective.

"Why are interest rates so high in Brazil in the first place?"

Well, I think KB is right on this, this is the way Brazil used to be. There was a very high tendency for inflation to get strongly out of hand, as governments accumulated debt, and then tried to monetise it. But I am arguing that that has to some extent become a thing of the past, Inflation in Brazil hasn't been allowed to rise to the levels we are seeing in Eastern Europe, or Russia. And there is now a very strong determination to get it under control. I don't see any boom bust risk at all here.

As I say, if the price of commodities comes down, then inflation will weaken internally, and then the bank can relax interest rates, while if commodities zoom back up again in the second half of 2009 as the emerging economies continue emerging, then they will have to battle inflation and keep rates comparatively high, but there will be lots of revenue coming in and investment in the commodity sector, so I don't really see where people expect the bust to come from. This all seems reasonably balanced to me.

"I'm just trying to imagine what would happen if rates were suddenly cut.. Say, to 6%. I suppose the Real would drop. Is this in Brazil's interest, or not? "

I think you need to take a look at what has been happening in India over the last three months or so - since the similarities are important here - and you will see that July exports are up aroun 30% y-o-y, as the rupee has fallen back.

So a falling currency is good for the domestic manufacturing sector if the currency gets overvalued, although it is clearly negative for domestic inflation, as the cost of imports rises. But 6% is still really quite high, and then we have to think what is the outlook for future movement in the real, and how long will the US fed be around 2%. I mean if the log term outlook on the real dollar was that the real would continue to climb vis a vis the USD, and the interest rate differential remained in the range of 3 to 4 percentage points, then sending money into Brazil from the US would look to me to be a very attractive proposition. The hard part for the Brazilian authorities is then to keep all this money from simply fuelling a consumer lending driven housing boom like the ones we have just seen in the US and Spain.

"should be somewhat offset by the money outflows from those seeking yield."

Well, as I say, with rates at your postulated 6% and a rising currency in the longer run, where exactly do you think the money could go to find that yield? There is a limit to how much things like the kiwi dollar or the Iceland krona can hold.

"Imagine 15% rates in the US?"

Well the thing is, the US is a developed economy, while Brazil is an emerging one. The Brazilian economy has lots more growth potential as it bridges the gap with the US. The nearer the technology frontier you get the harder it is to get that extra mile of growth. I think the reality is actually pretty much the opposite of what the average man or woman in the street thinks.

KB said...

Mr Edward Hugh, with all respects

I like my country. What I dont like is how it is has been run. Why productivity is so low in Brazil? Do you know the answer? I know, the public saving does not exists even with the highest tax burden! Do you know what percentage to GDP tax revenue represents?

Another point. Did you know that the especulative position of foreigners in Brazilian assets (stocks and bonds) equates the international reserves? You could imagine the consequence of the global deleverage. It will cause a lot of pain and despite that unavoidable process you dare to mention significant Brazilian GDP growth rate?

But there is light at the end of the tunnel. You did not mention that pre-salt area that will need investments of about U$ 1 trillion or more. This represents roughly 10% of GDP annually. The ratio investments to GPD could climb from mere 18% to 28% per year. Is so Brazil would not be a turkey anymore. But this is a story for next 2 years due to inevitable endless discussions about the exploration model.

Edward Hugh said...

Hi there again,

"with all respects,I like my country".

Oh, I never doubted that for a minute. Indeed I think it is because you love your country so much that you are so critical of it. You only expect the best, and you feel continually disappointed. I can understand that, the same as I can understand the way an Indian or a Turk can't believe that their country is growing so quickly despite all those horrible politicians that they simply cannot stand.

I found the latest example of this last night in a conversation with an economist friend - here in Barcelona - from Peru. She simply couldn't accept that under Garcia Peru can develop anything like as quickly as I think it can.

Going back to the "with respect" point, I would ask you to bear in mind that I am not making some simplistic speculative, gung-ho bet here. My assessment is made after many years of careful theoretical study about the impact of demography on economic processes both in the emerging economies and in the developed ones (like Japan, germany and Italy).

Of course, you are quite entitled to doisagree with me, and hold that demographic factors are less important that I think, and political ones are more important than I think they are. But we are empiricists aren't we so now lets go and see.

God willing, I will still be here this time next year to take a look.

"Why productivity is so low in Brazil?"
My feeling is that this is to do with levels of education and sectorial distribitutions. ie we have relatively more people in low value activities and relatively more people in high value activities than, say, a country like Germany. This is the kind of comparison you are making, isn't it.

But give Brazil time, and invest resources in those (now smaller) generations of young people you have. This is a very precious gift. Italy would simply love to have some of these people - born in Italy, and called Italian, of course.

"Did you know that the especulative position of foreigners in Brazilian assets (stocks and bonds) equates the international reserves?"

Possibly. I havenm't checked the data. But are you saying that all the foreign holdings in Brazilian equities are speculative? Are there no foreign holdings that are going to represent good value for money investments?

So maybe you are not comparing like with like here. Speculative positions evidently exist, but they are likely now way down on what they were in May. My guess is that the betting is now going to move the other way.

"You could imagine the consequence of the global deleverage."

Well isn't this precisely why Paulson and Bennanke are sticking $1.1 trillion in the US banking and insurance system, so that this deleveraging doesn't happen. And guess what, my feeling is that their plan will probably work. ie that the US will continue to struggle to sort out all the debt and the new tigers - Brazil, India and Turkey - will go full steam ahead.

Incidentally isn't this going to be the first major example of the US taxpayer shelving out so much money to support economic development in emerging markets. This must be the greatest contribution to global income equality ever.

And why do people always imagine that the deleveraging will be out of the emreging markets, and not out of, say, the US, the UK, and Spain, who seem to be the economies who are struggling most with the residential mortgage backed securities issues?

"Is so Brazil would not be a turkey anymore."

Incidentally, I am precidely saying that Turkey isn't going to be a "turkey" any more. Nor are a significant number of emerging market economies.

I wouldn't say the same about Argentina, Ecuador, Venezuela, Bolivia, Bulgaria, Romania, Vietnam and even Russia, however.

Can you see the difference? Despite all those things you don't like, institutional quality is a lot higher in Brazil than it is in these countries.

Edward Hugh said...

Oh, and incidentally KB, if you want to see what deleveraging really looks like, take a look over on my Russian blog, and see what's going on there. I just wrote a piece about the Russian crisis which contains the following extract (I simply can't resist the comparison with Brazil):

"But if demographic difficulties and excessive resource dependence are producing growing problems on one front, poor institutional quality is clearly playing its part in ballooning Russia’s difficulties on the other. Here a comparison with another oil rich emerging economy - Brazil - is instructive, for while Banco Central do Brasil is currently earning a justified reputation for being the new Bundesbank of Latin America (with an inflation rate of 6.2% and interest rates at 13.75%), no one would dream of saying anything of the kind about Bank Rosii, where - despite Russia's roaring 15% inflation rate - the benchmark lending rate is currently set at 11%. This means that far from constraining inflation Russia's domestic interest rates are actually boosting an already overheating economy with an extremely accommodative inflation-adjusted base rate of minus 4 percent."

Thiago said...

There's a new English-language website about Brazilian economic issues: http://brazil.melhores.com.br/.

Thiago