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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.

Wednesday, September 17, 2008

Brazil Retail Sales Accelerated in July

The rate of increase in Brazil's retail sales accelerated again in July, indicating t that sustained domestic demand may well allow Latin America's largest economy to weather the fall in commodity prices rather better than expected. Retail sales were up an inflation corrected 11 percent in July, following a revised 8.2 percent increase in June. Sales rose in June at the slowest pace in 14 months, according to data from the national statistics agency.

Evidently domestic demand is still robust and four central bank interest rate increases since April have far from throttled Brazilian domestic demand, which had been contributing to the upward movement in annual inflation - to around 6.5% - well above the mid-point of the central bank's target range (4.5 percent plus or minus 2 percentage points), but still significantly below the levels seen in some emerging market economies (especially in Eastern Europe).

At the same time we need to exercise a certain amount of caution in interpreting this data. Month on month retail sales fell 0.2 percent in July from June, and this was the first drop in five months. Thus in part the acceleration in July is due to base effects from 2007. On the other hand, when cars and construction materials are added-in, retail sales were up 1 percent from June.

Vehicle sales rose 4 percent in August from August 2007, and this was the slowest pace in almost two years. The slowdown in car sales is being widely attributed to the impact of interest rate rises on car loan rates.

The prospect of sustained consumer spending against the backdrop of slower growth overseas and lower commodity prices suggests that the economy is far from the oft predicted growth slump, and that the central bank may well use the dramatic fall in oil and other commodity prices as a pretext for moving forward prudently on the borrowing costs front.

The central bank last week raised the Selic rate to 13.75 percent (up from 13 percent), in an attempt to cool demand and slow inflation. Most economists expect policy makers to raise rates further - to 14.75 percent perhaps - by year-end, but looking at the financial turmoil of recent weeks (which has its origin in developed and not emerging economy issues) I can't help feeling prudence (and a more watch and wait approach) may now be called for.

Brazil's Finance Minister Guido Mantega yesterday said that the turmoil in U.S. credit markets would slow Brazil's economic growth to about 4.5 percent in 2009 from 5-to-5.5 percent this year. This is all hard to quantify at this point. But the central argument he was making - that the Wall Street crisis won't stop Brazil from expanding - seems extremely valid to me. He is quoted as saying that under "other circumstances, Brazil would be on its knees right now", and again I cannot help agreeing, and I also don't understand why so many analysts seem to have so much difficulty getting hold of what is happening. We still seem to be in the world of knee-jerk reactions.

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.