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Brazil - Economic Briefing July 2003

Inflation Moderation Prompts Monetary Easing

The downturn in economic activity, a strengthening currency and successive hikes in interest rates are beginning to lower inflation. The prospects for lower economic growth and continued currency stability, in combination with the government’s commitment to sound economic policy, makes monetary officials confident that inflationary expectations will drop.

Inflation moderating amid slowdown in economic activity and strengthening currency
The mid-June consumer price index (IBGE-IPCA 15), which covers monthly price increases up to the 15th of every month, rose 0.22%. The June figure came in well below the 0.85% monthly increase observed in May and confirmed the emerging trend to lower inflation observed since March this year. As a result of the modest June increase, annual inflation dropped for the first time since August of last year from 16.9% in May to 16.7% in June. The inflationary pressures resulting from last year’s currency weakening and higher oil prices earlier this year are finally abating. In its quarterly inflation report, published on 30 June, the Central Bank says that the combination of a strengthening exchange rate and a slowdown in economic activity is likely to lower inflation in the coming months. According to the report, monetary authorities now see gross domestic product (GDP) to grow just 1.5%, which is down from the previous Central Bank projection of 2.2% growth. The Central Bank also adjusted its inflation estimate downward from the earlier 10.8% to 10.2%%. Even though the estimate remains well above the current 8.5% central inflation target for this year, monetary officials remain optimistic about containing inflation within the +/-2.5% band. Nevertheless, participants do not share the Central Bank’s optimism, seeing inflation much higher this year. Furthermore, inflation next year is also expected to exceed monetary authorities’ stated target of 5.5%.

Central Bank lowers interest rate amid inflation optimism
Despite the fact that inflation remains well above the current target, authorities believe that the recent currency stability and more moderate economic growth, if persistent, may give the Central Bank leeway to lower interest rates. In June, the currency appreciated again – by 3.3% in nominal terms versus the US$ - over the prior month, which represented the fourth monthly strengthening this year and brought the currency appreciation for the first six months of the year to 23.0%. In its 18 June meeting, the Central Bank decided to lower the benchmark SELIC rate from 26.5% to 26.0% - the first cut since September last year. Monetary authorities justified the monetary loosening with optimism about an easing of inflationary pressures this year amid the more stable exchange rate and lower economic growth. Consensus Forecast participants have revised their interest rate forecast again this month, anticipating the SELIC rate to drop moderately by the end of this year. In fact, panellists anticipate the Central Bank to be able to lower rates again in the third quarter. Furthermore, the easing of inflationary pressures will lower interest rate further next year.

Government maintains fiscal discipline
The public sector incurred a primary surplus of 4.3 billion reais (US$ 1.5 billion), which was down from the robust 9.9 billion reais (US$ 3.2 billion) surplus in April. As a result, the public sector’s accumulated primary surplus from January to May reached 37.0 billion reais (US$ 12.8 billion) in the first five months of this year. Consequently, Brazil already exceeded the 34.5 billion reais (US$ 11.5 billion) deficit target for the first semester agreed to with the International Monetary Fund (IMF) under the terms of the US$ 30.7 billion stand-by agreement signed on 6 September last year. The government is now well on target to meet its 4.25% primary surplus target set for 2003. However, despite the positive development in the primary fiscal balances, the overall fiscal balance, which adds debt servicing costs, registered a 5.1% of GDP deficit in the twelve months through May, up from the 4.9% of GDP shortfall observed in April for the same period. Participants confide in the government to follow a course of fiscal discipline and expect the fiscal deficit to drop to 4.0% of GDP this year, which is unchanged from last month. The decision of lawmakers to work through the July recess in order to progress on needed pension and tax reform legislation, along with the IMF’s stated interest to renew the current stand-by agreement that expires in September, are likely to reinforce confidence in the current government.


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Note:  The above text is an abridged version of the LatinFocus Consensus Forecast country briefing.  For more details please click here.


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