Brazil Faces Inflation Challenges, Seeks Balance Between Slower Growth and Overheated Economy

The slow-down in Europe and the US has sent hot money scrambling for traction all over the rest of the world. This trade-off has been most prominently on display in China but Brazil, another of the global economy's glamor triplets (India being the third)faces similar challenges. Once again, the intangibles of policy making, political accomodation, strong management, credible communication, strategic planning and deft tactical maneuvering will play an important role in how this works out for newly elected President Roussef and her countrymen.

By Erin McCarthy of DowJones Newswires via Nasdaq

Brazil's economy will likely slow this year compared with 2010's robust growth, but doubts remain whether the new administration's fiscal and monetary policies will slow it growth enough to keep inflation under control, said a panel of emerging-markets strategists Tuesday.

"The economy in Brazil is clearly blowing the doors off," said Geoffrey Dennis, an emerging-markets strategist with Citigroup Investment Research and Analysis, during a panel discussion sponsored by the Brazilian-American Chamber of Commerce in New York.

Brazil's economy is expected to have grown more than 7.5% on the year in 2010, on the back of strong domestic demand and high commodity prices. That growth has, in turn, stoked inflation, which has prompted the Brazilian Central Bank to raise rates. That has attracted big foreign inflows into the local currency, the real, which has gained 30% against the dollar since 2009.

This, as well as the fact that Brazil's inflation-adjusted interest rates are among the highest in the world, is making the Brazilian Central Bank hesitant to push the tightening trend too far. What it needs, strategists say, is for the government to take on some of the inflation-fighting burden with fiscal tightening measures of its own.

The central bank will continue to raise interest rates, likely bringing the benchmark Selic rate to a towering 13.25% by the year's end, from 11.25% currently, said Paulo Leme, emerging-markets research head at Goldman Sachs. Yet, with GDP likely to grow 5.2% and domestic demand seen expanding by 6.0%, this monetary policy tightening alone won't be enough hold back inflation, he said.

If the bank is resisting currency appreciation and if fiscal policy is not stringent enough, then "what will give will be inflation," Leme said. His " conservative" projection for 2011 is for inflation to reach 6.5%, a significant jump from 5.9% last year.

The Brazilian government can come to the central bank's aid to fight this trend by cutting back on spending, limiting future raises to the national minimum wage and making various other fiscal reforms, panelists said.

Few of these measures are likely to happen, however, said Christopher Garman, the Eurasia Group's director of Latin America.

Under former president Luiz Inacio Lula da Silva, government expenditures rose 10.8% in 2010 while the national minimum wage, when adjusted for inflation, has risen 11.9% since 2008, said Tony Volpon, head of emerging-markets research with Nomura Securities International. He added that another minimum-wage increase is likely in 2012.

Some spending reductions could occur in 2011, but panelists were pessimistic about whether the new administration will keep to the 2011 fiscal target, a budget surplus equivalent to 3.1% of GDP.

One issue, panelists said, is the new administration does not have the political willpower to fight for major fiscal cutbacks, as the emerging middle class seeks out improved infrastructure and education and health services.

"The [fiscal] policy adjustment may fall short of the slamming on the brakes that is required to do," Leme said.