Central bank cuts rates
AS DOMESTIC ECONOMY WILTS AND EXPORTS BOOM
There are two very different sides to the Brazilian economy. The much larger part of the economy geared to the domestic market has been tipped into a range of problems by the central bank's determination to knock out inflation. The bank has been doing this by raising and keeping interest rates high.
On the other hand, the primary sector of the economy, notably agribusinesses, and the export sector have been doing extremely well. The only cloud on their horizon is the strength of the Real. Exporters are already beginning to fret about their competitiveness if the Real goes much above R$2.9 to the dollar.
Paradox. Although the Brazilian central bank cut interest rates by half a percentage point, to 26%, at its June meeting, real interest rates probably rose. Ricardo Carneiro, from the Universidade de Campinas in São Paulo state, pointed out that, as inflation was expected to fall substantially over the next 12 months (to around 7.5%), real interest rates have probably increased since the May meeting of the interest-rate setting committee of the central bank, Copom. At the previous Copom meeting, in May, the forecast for inflation over the next 12 months was 8.3%; at the June one the forecast was 7.76%, so real interest rates have actually ticked up from 16.8% to 16.9%. Other people calculate real interest rates by using lagging, rather than prospective, data: on this formula the real interest rate is now 4.79%.
Carneiro carries weight with the ruling Partido dos Trabalhadores because he helped draw up the party's economic policies for last year's manifesto. Carneiro claimed that the central bank's fixation with inflation was unhinging the economy. He pointed out that it was controlled prices (such as electricity and telephones) that were driving inflation, rather than market-cleared ones. He argued that the bank's inflation fixation had sent the real economy reeling. In April, manufacturing output was 5% down on April 2002 and some key industries look to be in deep trouble: shoes and clothing were down by 27%; textiles were down by 15%, plastics products were down by 20% and pharmaceuticals down by 25%. All these industries are geared to the domestic market, which has been poleaxed.
The central bank did say that its (unanimous) decision to cut was affected by the state of the real economy. Members of the Copom committee said that the fact that inflation seemed to be falling meant that they could now give more weight to promoting growth and employment. The finance minister, Antônio Palocci, emphasised, after the central bank announced the decision, that the key point should be that rates should continue to fall. The futures markets are still forecasting a Selic rate of 23.5% by the end of the year.
Significantly, the Copom did not give any indication of whether it would cut rates at its next meeting. Its bias remains neutral, which means that rates cannot be cut until next month's meeting on 22 and 23 July. The general expectation is that although there may be some dodgy inflation data around the time of the Copom meeting, which will reflect the increase in controlled prices, nevertheless the Copom will cut rates by a couple of percentage points.
Deflation. Traders and economists, as well as businessmen and trade unionists, assume that Copom will start looking more at inflation prospects for 2004 from now on. Forecasts for inflation in 2004 are much lower than for 2003: MCM Consultores, for example, assuming current exchange rates and a 26.5% Selic, is forecasting 9.3% inflation for this year and 3.2% for 2004. The official targets are for inflation of 8.5% this year (which will, probably, not be met) and 3.75% (with a margin of error of 2.5 percentage points) in 2004.
In early July, two of the key economic analysis and forecasting organisations in Brazil, Fipe and Dieese, reported that retail prices fell in São Paulo in June. This prompted both organisations to chop their inflation forecasts for the year. The Fundação Instituto de Pesquisas Económicas (Fipe) cut its forecast from 9% to 8.5% (which brings it into line with the government's target) while the Departamento Intersindical de Estatística e Estudos Socios Econômicos (Dieese) dropped its forecast from 13% to 10%. The third big independent economic forecaster, the Fundação Getúlio Vargas, reckons that prices will have fallen by 1% in June.
Fipe's inflation-watcher, Heron do Carmo, said that the inflation outlook had completely changed over the past six months. Fipe reckoned that consumer prices fell by 0.16% in June and Dieese reported a fall of 0.26%. The fall in prices has been driven by the strength of the dollar, the fall in fuel prices and the availability of more fresh food. Plus there has been a significant drop in domestic demand.
Controlled prices. The big problem for policymakers is that controlled prices are starting to rise. Both Dieese and Fipe argue that inflation is likely to rise in July, (by as much as 0.66%) as the government jacks up the price of electricity, and probably telephone charges (although this increase is being challenged in the courts).
The peculiar point about Brazilian inflation is that unregulated prices are falling while government-controlled prices, such as telephone charges, fuel and electricity, have been rising. The official inflation index, the IPCA, which is compiled by the official statistical agency, the Instituto Brasileiro de Geografia e Estatística, may also show deflation in June, though nobody is certain. What is clear is that inflation has screeched to halt in the first half of this year, falling from almost 7% over the first quarter to, probably, below 1% in the second.
Regulated prices, however, have increased more infrequently than unregulated ones, so the fall in the inflation rate may have been flattered. Copom's only wiggle room is on fuel prices: it recently completed comparison of international fuel prices and those charged in Brazil: it found that Brazilian petrol prices were 8.5% higher than international ones and diesel prices were 24.5% higher. It argued that reducing these spreads should put a lid on the increase in regulated prices over the rest of the year: Copom reckons that regulated prices should increase by 14.1% this year; without the reduction in fuel prices, the increase would be 14.9%.
This also assumes that the Real remains strong.
Telephones. The Agência Nacional de Telecomunicaçíµes (Anatel) agreed to the telephone companies' application for an average increase in telephone rates to 28.75%, despite strong opposition from the government, which wanted a maximum increase of 17.24%. Anatel itself had come under heavy pressure from the telecom operators, notably Telefônica, the dominant fixed link and mobile telecoms company in the biggest market, São Paulo, to sanction a decent rise in prices.
The government, resisted the temptation to get involved in the detail of the price increase. It seems that the communications minister, Miro Teixeira, would have liked to have issued orders to Anatel, but he was outmanoeuvred by the finance minister, Antônio Palocci. Teixeira subsequently said that the government would back legal challenges to the increases. The telecoms companies, principally Telefônica, were cock-a-hoop that they had managed, for the first time, to persuade Anatel to allow some charges to rise by more than the average 28.75%. This would allow, Telefônica said, retail charges to rise by less: a mere 24.5%. Business users will see some of their charges increased by 41.75%.
The upside. The best performing bits of the economy are the agricultural sector and exporters. The agricultural sector is likely to grow by 5.3% this year, according to the Confederação da Agricultura e Pecuária do Brasil. The central bank is now reckoning that the overall growth of the economy this year will be just 1.5%, though the government is still hoping for a growth rate of between 1.8% and 2%. In the first quarter it was only exports and agriculture that stopped the economy from sliding into a recession.
Arable farming is by far the most successful bit of the agricultural sector: stockraising is still taking its time to recover from the foot-and-mouth crises and other problems: it is likely to grow by less than 1% this year. Arable output is likely to be up by over 9%.