For the first time since 2008 the Central Bank has raised interest rates and against a back drop of the developed world frantically trying to fend off a wave of sovereign debt defaults in Europe. The real GDP growth is at its best performance since 1986, having reached 6% and forecasts are predicting it could go up by one more percentage point.
However analysts are sceptical that Brazil can keep this up. According to them multiple inefficiencies mean that the economy can only grow at 4.5% without triggering inflation. This was recognised by the Central Bank in April of this year and to avoid overheating the monetary-policy committee raised the SELIC benchmark interest rate by 75 basis points to 9.5%.
The boom is based on solid foundations. China has become the largest importer of Brazilian commodities, ahead of the US and despite a strengthening currency Brazilian manufacturers such as Embraer have remained competitive in foreign markets. Also, thanks in part to an expansion of bank credit, millions of Brazilians have left poverty behind and begun to consume more, joining an ever more expanding middle class.
The global recession hit Brazil briefly in 2008. The government response led by President Lula da Silva was to cut sales tax and increase lending by state owned banks. It looks like this was a good approach as Brazil was one of the last to enter the recession and one of the first to get out again, certainly other countries could learn from their example.
Despite this, growth in productive capacity, which determines long term economic performance, remains limited. In recent years Brazil’s investment rate has increased but at its pre-crisis peak it was just 19% of GDP and the government’s entitlement programmes leave little room in the budget for much needed infrastructure improvements. After decades of inflation long term projects are not getting the backing they need from private firms. And productivity gains are limited due to poor schools turning out poorly educated workers.
Brazil’s closely monitored inflation rate is creeping up, as consumers demand more goods and services than producers can provide, resulting in higher prices. Brazil’s inflation is a distant cry from the four-digit spirals of the past. At 5.2% over the last year it has already exceeded the Central Bank’s target of 4.5%.
In order to keep a lid on prices, Brazil has shown that it is willing to suffer sky high interest rates. Soon after Lula took office in 2003 they reached 26.5%. However, a stiff dose of monetary discipline is only a short-term solution for overheating. In the long-term the challenge will be removing the obstacles to a faster growth rate. Unfortunately this would require deeper reforms than Lula has been willing to push so far.
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