Postponing Decisions and Increasing the Costs of the Adjustment
Executive Summary
By all indications, GDP growth in 2014 will fall shy of that in 2013, with a further decline in 2015. Inflation will close the year near 6.5%, which together with the effects of the correction of gasoline and electricity prices will require a further increase in the interest rate. This is a picture that discourages gross fixed capital formation. At the same time, the weak growth of employment and deceleration of real payroll levels added to the slower growth of credit due to the risk of non-preforming loans will contain growth of household consumption.
To what point can the Central Bank use interventions through exchange rate swaps to strengthen the real, helping to fight inflation? The high yields paid by bonds with longer maturities attract foreigners to the fixed-income market, and these inflows are responsible for the current behavior of the exchange rate. Without the recent surge of capital, the sum of all inflows would be below US$ 80 billion on an annualized basis, which is the same size as the current account deficit. In this case, the real would have to depreciate more. With the interventions, the Central Bank has reduced the exchange rate risk and opening room for more flows to the bond market. But it cannot force appreciation due to the current account deficit. There are no prospects for significant change in the current accounts because of the negative effects on Brazil’s exports of: the weak global trade growth; the fall of commodity prices; and the subdued imports by important trading partners, such as Europe and Argentina.
The risk of a downgrade of Brazil’s credit rating has been eliminated for the meantime, causing the quotations of Brazil’s CDS to fall and reducing the spread with that of Mexico’s CDS. The government has been reiterating its intention of meeting the primary surplus target, but the market is not convinced this will come to pass based on the consensus projections in the most recent Focus survey. As recalled by a competent former finance minister, in election years governments tend to do crazy things. Postponing payments is one of these: while it allows presenting a higher primary surplus, even without the benefits of effective control over the macroeconomic equilibrium, the bill will come due in 2015…
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