Here's Why Brazil's Inflation Won't Hit Target Anytime Soon

Price Indexation Keeps Inflation Stubborn

BRAZIL CONSUMER CONFIDENCE
Photographer: Paulo Fridman/Bloomberg

Why does Brazil's inflation stay so stubbornly high despite even more interest-rate hikes in the horizon? The one-word answer is indexation.

 

A vestige of the country's hyperinflation period in the 1990's, when annual price gains reached heights above 6,000 percent, indexation was meant to protect Brazilian companies and citizens from depreciating purchasing power by linking costs such as wages to inflation.

Today, inflation is down to 10.67 percent, but indexation means the price of everything from electricity to health care is still going up based on an array of formulas taking into account industry costs and one of Brazil's many inflation indexes. It also means a temporary shock could be factored in for years to come. As a result, Barclays says Brazil has the highest inflation persistence of all emerging markets.

For example, minimum wage is increased based on gross domestic product from two years prior, plus inflation of the previous year. That means that it rose by more than inflation this year, putting upward pressure on all salaries. It's more difficult for the central bank to disinflate the economy when consumers are getting real wage gains.

Rent is adjusted by an index made up not just of consumer prices, but also wholesale prices; that means the largest single determinant of one's rent adjustment is the fluctuation of soy in commodity markets. That can also create a feedback loop. Higher wholesale prices raise rent, which then factors into the index's consumer side, and so boosts rent again. It's worse than Kafkaesque, says Paulo Picchetti, a researcher in IBRE's public statistics division,``because Kafka is fiction and this is the real world.'' IBRE is the economics institute at the Getulio Vargas Foundation.

There are also price increases that aren't formally established, and without clear rationale. Maids tell employers how much their prices are rising as though each received a memo at home. Aline Passos, 38, was shocked to learn her daughter's daycare in Rio de Janeiro upped the monthly fees by more than inflation -- 18 percent.

``At the start of every year there’s an increase, because of the increase in the indexes, so I imagined it was going to go up some, but I think it went up too much,'' Passos said by phone.

 

Exorbitant increases can be due to how widespread inflation has become. Diffusion has been on the rise and, according to Bloomberg Intelligence Economics, in December the 12-month moving average reached its highest level in at least nine years. That adds to inertia by spurring some to raise prices even when unwarranted.

``When all the prices are going up, when there is a lot of price dispersion, it’s easier for you to sneak in a hike,'' Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., said by phone.  

Price-setters also use inflation forecasts to make their adjustments, and lately expectations have spiked. Traders' 10-year outlook, for example, has shot up to nearly 9 percent.

 All this leaves inflation inertia at its highest level in more than a decade, according to Goldman's Ramos. As recently as 2013, it took four to five months for an inflation shock to fade substantially. Now it takes about a year and a half.

 Were it not for inflation inertia, consumer price increases in 2016 would be 1.5 percentage points less -- closer to the 4.5 percent center of the government target, according to Flavio Serrano, senior economist at investment bank Haitong in Sao Paulo. As it stands, economists surveyed by the central bank anticipate inflation won't slow to the target's midpoint until 2019 -- two years later than the monetary authority intends.  

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