Brazil Real’s Gains Mask Stagflation Qualms: Currencies

The Brazilian real’s world-beating advance is masking the problems of an economy that Goldman Sachs Group Inc. says is in the grips of “stagflation.”

The real has strengthened 7.5 percent against the dollar in 2014, the most among 31 major currencies and reversing three straight years of losses. Economists say the gains highlight the shortcomings of a central bank that’s focusing on raising interest rates to curb inflation at the risk of making the nation uncompetitive.

“The strength of the exchange rate is actually a sign of weakness,” Alberto Ramos, the chief Latin American economist at Goldman Sachs in New York, said yesterday by phone. “Hoping for the best isn’t a strategy. The central bank should’ve dealt with inflation three years ago and instead it got entrenched in the economy.”

These concerns were borne out by the central bank’s quarterly inflation report yesterday, which lowered the outlook for economic expansion in 2014 while warning that consumer-price increases will remain above-target for at least two years. Central bank President Alexandre Tombini has raised borrowing costs three times since December, enticing international investors seeking higher-yielding assets.

While Ramos predicts the real will tumble 8.5 percent by year-end to 2.4 per dollar, from 2.1968 yesterday in New York, he said a level of 2.7 to 2.8 would be more consistent with Brazil’s “minuscule” growth. The currency will slide to 2.5 to 2.55 by the end of 2015 as “stagflation,” or a mix of low growth and high inflation, takes hold, he forecast.

Swap Auctions

Goldman Sachs’s year-end prediction is in line with the median estimate of 29 strategists surveyed by Bloomberg, which shows the real weakening more than any other major currency after Argentina’s peso, which was devalued in January.

Rather than falling, the real has been buoyed since August by Tombini’s sale of dollars through currency-swap auctions. The central bank announced this week that it will keep offering $200 million a day through at least Dec. 31.

Brazil’s high inflation is due to government intervention in the economy and a low level of foreign trade, according to Lars Christensen, the chief emerging-market analyst at Danske Bank A/S. Barriers to investment and trade curb competition from abroad as an “unholy alliance” of old industries, unions and agriculture fends off attempts to open the economy, he said.

‘Kill’ Economy

“It’s really hard to find reasons to be optimistic on Brazil,” Christensen said by phone from Copenhagen on June 24. “The structural problems continue to get worse. You’d need to kill the economy to get inflation back on track and that would threaten what independence the central bank still has.”

Policy makers predicted in yesterday’s report that Brazil’s economy will expand 1.6 percent this year, down from a previous forecast of 2 percent. Data from the official statistics office on May 30 showed gross domestic product grew 0.17 percent from January through March.

Yesterday’s inflation report forecast consumer prices will rise 6.4 percent this year, assuming the benchmark Selic rate remains at 11 percent. The central bank targets an upper inflation limit of 6.5 percent. The report predicted Brazil will enter a “disinflationary” period where prices increase more slowly.

To Standard Chartered Plc, which gets more than half its revenue from emerging markets, Brazil’s economic shortcomings are underlined by the contrast between the real’s strength and the weakness of Chile’s peso, this year’s fourth-worst performer among major currencies.

Chile’s Peso

While both economies are slowing, Brazil has been unable to follow Chile’s path of cutting rates to stimulate a rebound.

“Chile is a clear case of cyclical pressure hitting the currency,” Mike Moran, a senior currency strategist at Standard Chartered in New York, said June 23 by phone. “Brazil has some fundamentally deep-seated issues that are keeping growth below trend: in Brazil’s case it’s not a cycle.”

Banco Bilbao Vizcaya Argentaria SA, Spain’s second-largest bank, expects the real to weaken to 2.4 per dollar by year-end.

“Brazil is facing a much more acute issue of a structural inflation problem,” Alejandro Cuadrado, a New York-based strategist at BBVA, said by phone on June 23. “In Chile it’s more temporary so they have flexibility to use monetary policy to kick-start the recovery cycle.”

Elections Loom

Industrial output in Brazil fell 5.8 percent in the 12 months through April, matching a five-year low, as investment fell. Consumers are reining in spending as inflation erodes purchasing power, undermining President Dilma Rousseff ahead of elections in October.

The central bank doesn’t have “absolute” autonomy and should take the government’s employment and income goals into account as it fights inflation, Ricardo Berzoini, a member of Rousseff’s cabinet said yesterday. The Brazilian central bank’s press office declined to comment on market views on its autonomy.

“Inflation is going to go above the threshold of the target range,” Neil Shearing, the chief emerging-markets economist in London at Capital Economics Ltd., said by phone on June 25. “So the question becomes, does the central bank hike rates before the elections and risk the wrath of the government or do they wait until after the elections and risk their credibility?”

To contact the reporter on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net

To contact the editors responsible for this story: Brendan Walsh at bwalsh8@bloomberg.net Paul Armstrong, Robert Burgess

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