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Wednesday, September 24, 2008

Brazil's Mid-month Inflation Lowest Since March

Brazil's inflation continues to fall back steadily. Brazil's mid-month inflation rate fell in September to its lowest level since last March, increasing speculation the central bank will take its time before deciding on future interest-rate increases. Consumer price inflation as measured by the benchmark IPCA- 15 index slowed for a third consecutive month to 0.26 percent, from 0.35 percent by mid-August, according to the latest data from the national statistics agency.

The annual inflation rate fell back to 6.2 percent from 6.23 percent at the end of August. The annual rate has now been reducing slowly but steadily since the July peak.

Inflation on non-food items accelerated to 0.41 percent in September, from 0.38 percent last month, the IPCA report said. The pressure on prices from strong demand was offset by a 0.25 percent drop in food prices, which compared with an equivalent increase last month.

Central Bank Reduces Reserve Requirements

An initial indication of the policy change which may be in the works came yesterday with a decision by the central bank to ease requirements for reserves that banks must keep at the central bank. In prinviple the decision is a response to the volatility in global financial markets following the uncertainty produced by the deepening of the financial turmoil in the United States.

Banco Central do Brasil have decided to delay the introduction of higher rates for mandatory deposits from leasing companies by two months and raised the threshold on exemptions for cash, time and savings deposits, according to a statement released yesterday. The measures will add 13.2 billion reais ($7.16 billion) to the financial system, the central bank said.

This move quite possibly represents an initial reversal of the central bank's policy of slowing domestic lending growth. Central bank policy makers began to tighten reserve requirements on cash deposits from lease underwriters last May, a move that was intended to remove as much as 40 billion reais from credit markets. Bank lending had climbed by a 33 percent annual rate in the 12 months ended July, following a 27 percent rise in 2007. The central bank will release August figures on Sept. 29.

Under the new rules, a reserve requirement of 20 percent of cash deposits from lease underwriters will now take effect on January 16, two months later than originally scheduled. The reserve requirement will then increase to 25 percent in March, according to the present central bank policy. Leasing is a common practice in Brazil, and effectively constitutes an alternative form of bank lending. Also under the new rules Brazilian banks will only have to keep part of their cash, time and savings deposits at the central bank if the reserve requirement exceeds 300 million reais, the central bank said. Previously, this threshold was 100 million reais.

Bank Lending Slows

The easing of reserve requirements is obviously an attempt to offset the impact of the credit and liquidity crunch on the real economy. Brazilian bank lending growth is already slowing, and lending growth this year is expected to fall to a 24 percent year on year rate, according to a recent survey of 26 banks by the Brazilian Banks Federation. This is down from the 27.8 percent growth rate registered in 2007, which was the fastest rate in the last 12 years. This drop is, in itelf, not such a bad thing, as one of the points we should be learning from the financial meltdown is that lending rates should not be allowed to increase dramatically, but the fall may indicate that there is more to come, and year on year lending growth rates of much below 20% would be a significant negative for the domestic Brazilian economy I think.

Lending in Brazil has now expanded more than 20 percent annually since 2004. The sharp increase in lending was driven by a decline in the benchmark lending rate to 13.75 percent from 25 percent. Job creation and higher wages have also contributed to credit expansion. On the other hand the price larger Brazilian companies are paying to raise money has risen to about 2 percent a year above the local interbank rate, up from 0.4 percent six months ago. This spike in risk premium is really a direct consequence of the financial turmoil which has followed the collapse of the U.S. subprime-mortgage market last year.

Car loans have been one of the main drivers of bank lending, and there are clear signs that these loans are now slowing, with evident negative consequences for the Brazilian automotive sector. According to Banco Itau Holding Financeira data - the bank is Brazil's second-biggest non-government bank by assets - their car loans were up by 62 percent in the second quarter, while Banco Bradesco posted a 49 percent car loan expansion.

This is the type of credit which may slow as the credit tightening bites. Domestic vehicle sales - which expanded an annual 33 percent in July - only grew by 4 percent in August, the slowest pace in almost two years.

The Real Continues To Wobble In The Wake Of Uncertainty

Brazil's real yesterday reversed earlier gains, falling on concerns the $700 billion U.S. financial system rescue may be delayed. The currency declined 0.5 percent to 1.8567 per dollar at 3:50 p.m. New York time, following the effective end to the day's trading in Brazil. The currency had earlier risen by as much as 1.4 percent following the announcement that Warren Buffett's Berkshire Hathaway was going to invest $5 billion in Goldman Sachs Group.

Brazil's real has been the biggest loser against the dollar among the 16 most-active currencies this month, declining by 12 percent. My view is that this volatility in the real will continue until the US financial markets stabilise, then, when the dust settles, we will really be able to see what the new global financial landscape looks like, but I am far from being pessimistic about the consequences for sound emerging markets like Brazil, au contraire, this is a developed markets crisis, not an emerging markets one. At the end of the day it is not unreasonable to imagine that some of the key emerging markets will be the net beneficiary of the turmoil, after all the uncertainty dies down.

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