KEEPING IT REAL IN BRAZIL

Conclusion: Recent policy developments out of Brazil are bullish for interest rates and the real. 

We’ve noted recently that the Brazilian Central Bank’s hike in the Selic rate to 10.25% last week showed a much needed bout of sobriety in monetary policy amid white-hot GDP growth (9% Y/Y in Q1) and 5.22% Y/Y inflation. As is the case with most emerging market economies, one step forward is followed by two steps back.

The latest developments out of Brazil show that the government is still not yet ready to leave the party. This week, Brazilian President Lula approved an increase of 7.72% in pension rates – even more than the 6.14% originally proposed. He defended his decision in the media by saying that his economic team “guaranteed” him that they could find budget cuts sufficient to offset the increase, and also that added consumption from the pension increases would mean increased tax revenues. Shortly after he approved a hike in pension fund rates, President Lula approved pay rises of between 15% - 38% for members of the Chamber of Deputies. On a side note, in the wake of Lula’s approval of legislative pay raises, the Chamber of Deputies approved new proposals – including social security and pension reforms – which, if confirmed by the Senate and signed into law, would cost R$90 billion to implement – the equivalent of eight years’ worth of the entire Bolsa Familia program’s budget. Lastly, Brazil’s Senate approved an 18% pay increase for over 32 million government employees whose representatives have lobbied the government hard during the past several months, including Agriculture Ministry workers, federal prison worker, armed forces medical personnel and intelligence agency employees. 

Conclusion: if you want to get paid, move to Brazil.

All joking aside, the latest wage increases will be positive for domestic consumption. Furthermore, a recently announced export subsidy for exporters who derive at least 30% of their revenue from exports, and who are current with their tax payments will help offset any potential revenue lost from slowing growth internationally.  The measure went into effect in April and is expected to cost R$ 1 billion this year.

All told, the recent policy developments out of Brazil are bullish on the margin for Brazilian growth and inflation – which will put additional pressure on the Central Bank to raise rates again. Speaking of inflation, The general market price index increased 1.06% in the second June sampling.  This was more than the 0.95% increase in the comparable period for May, but less than the 1.55% average projection of economists surveyed.  Producer prices for the second June reading grew 1.37%, versus 1.19% in May.  Agricultural prices were down (0.24% increase, versus 0.80% in May) while industrial prices grew 1.88%, greater than May’s 1.32%. 

In a June 8-9 meeting, policy makers forecast that 2010 inflation will remain “markedly” above their 4.5% target. The minutes of that meeting, published today on the central bank’s website, spurred Brazilian interest rate futures to jump to the highest level since February 2009 (up 6bps to 11.26% as of 9:30am EST). Economists are forecasting that Brazilian policy makers will raise the Selic rate by an additional 75bps in July. The Brazilian real gained 3.4% vs. the U.S. dollar last week, which coincided with a 75bps hike in the Selic rate.

While the Bovespa continues to be broken from an intermediate-term trend perspective, we are starting to warm to the real on the long side as a currency play as a result of the aforementioned hawkish setup and our bearish view on the dollar. Stay tuned.

Moshe Siver

Chief Compliance Officer and Managing Director

Darius Dale

Analyst

 

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