Published by Minyanville

After last week’s interest rate rise to 12%, Brazil’s central bank this week confirmed that its adjustment of interest rates will continue in order to effectively moderate inflation—a persistent worry for Latin America’s largest economy.

Many felt the rise to 12%, from 11.75%, was too little. Goldman Sachs expects the rate to hit 13.25% later this year.

The central bank also expressed concern this week that above-inflation wage deals, being pushed by labor unions, as another risk to inflation. “Brazil’s biggest economic book in more than two decades has created a labor shortage that is driving up wages and stoking inflation amid threats of strikes,” says Reuters.

Inflation has caused major problems for Brazilian authorities, and has been the primary concern of Dilma Roussef’s first few months as president. Brazil is keen to maintain huge growth, exemplified by its 7.5% last year. However, it must slow inflation without bringing growth down with it. Inflation hit 6.44% in the 12 months to mid-April, higher than the central bank’s 2011 target of 4.5%.

Part of the problem is the strength of the real. The currency has gained 49% since 2008. This has fueled a huge increase in cheap imports, notably manufactured goods from China. It has also made Brazilian exports—primarily soy, iron ore and ethanol—more expensive to foreign nations. The central bank, therefore, is reluctant to raise interest rates too aggressively as the real would be strengthened further.

“The Brazilian real is the most overvalued major currency in the world,” says John Paul Rathbone of the Financial Times, in a major article examining the bigger picture for Brazil. “Cheaper imports have made Brazilians feel richer, feeding a consumer boom. But domestic manufacturers have appealed for help – and the same kind of tariff protections that characterized the doomed economic model of bygone years.”

The central bank is relying on so-called “macroprudential tools”. These, according to Reuters, include reserve requirements, which limit how much banks lend. The strategy is not wholly supported by economists, however.

Brazil’s economy has the appearance of strength, says Rathbone, but is stretched thin. Brazilians currently spend around 25% of disposable income on debt repayments. This, says Rathbone, should be compared to the height of the US credit boom when the figure was about 15%. “Brazil’s boom could turn to a sudden bust.”

JP Morgan (JPM) and Morgan Stanley (MS) both downgraded Brazilian stocks this week following the interest rate hike. According to Morgan Stanley, the stocks are “equal-weight” while JPMorgan has put them in the “under-weight” category.

While delicate, Brazil’s economy is booming by any standard. More than 35.7 million people have entered the middle classes with 20.5% rising above the poverty line between 2003 and 2009. The number of Brazilians living in absolute poverty has fallen to 15.3% from 28.1% in 2003.

Citigroup (C) has hiked up hiring in the country, like many companies looking to secure a greater foothold there. April along saw the hiring of 380 staff on top of the 400 hired in the first quarter, and 500 hired in 2010, taking the company’s headcount to 7,000—double the figure for 2006.

Foreign Relations Expand

Brazil’s friendship with Iran is warming, with the Middle East pariah about to open a trade center in Brasilia. Back to China, as always, Tele Norte Les Participacoes, Brazil’s largest fixed-line company, is looking to China’s Huawei for network equipment. A $30 billion credit line from the China Development Bank—with its two-year grace on payments—to Huawei persuaded chief financial officer at Tele Norte Les Participacoes Alex Zornig to the company.

“The Chinese are filling the space left empty by Americans and Europeans,” Zornig said. “They are very aggressive and they have a lot of money.” It's initiatives like this that have propelled China into Latin America, pushing out investment opportunities for the United States.

 

Banco do Brasil is still looking towards the United States as it targets new acquisitions. On Monday, the bank announced the $6 million purchase of Florida-based EuroBank and is looking to have 400,000 new American customers within five years.

Up to 10 additional flights between the United States and Brazil could be in the air later this year. American Airlines has applied for the relevant licenses in order to begin a new service from Miami to Manaus, and increase the frequency of its Miami to Brasilia and Miami to Belo Horizonte routes. This forms part of the phasing in of the Open Skies agreement between the two nations, signed during Barack Obama’s recent visit to Brazil. Under the agreement, airlines from the United States will be allowed to freely add flights is slots are available in Brazilian airports.

With this perhaps in mind, as well as the World Cup in 2014, Copa America in 2015 and the Olympics in 2016, Brazil is handing over five of the country’s largest airports to the private sector through concession agreements.