Brazil: Election-Year Politics Could Slow Progress

On Jan. 15, 2002, Brazil began its fourth year with a free-floating currency. The move, coupled with the government's inflation targeting system, has been a clear success. Indeed, the economy's flexibility helped it to weather a barrage of challenges in 2001. Still, the country faces significant risks.

Even amid global weakness, the September 11 terrorist attacks on the U.S., Argentina's meltdown, and an energy crisis that caused power rationing, Brazil's economy appears to have grown about 2% in 2001 with 7.7% inflation. Moreover, Brazil posted a trade surplus, the first since 1994, and toward the end of the year, the currency rallied strongly, although it has relinquished some of those gains in recent weeks.

The economy begins 2002 with two key--but possibly opposing--goals: continued trade improvement, which will require restraint in domestic spending, and political stability in a presidential election year. Trade gains will have to continue in order for Brazil to cut its dependency on scarcer foreign capital. And the government must avoid easing fiscal policy ahead of the elections, while promoting a smooth transition of power.

Given recent signs that the U.S. economy is set to lead a global pickup, Brazil's growth outlook is improving. But gains may be halting in the first half. The central bank will not be quick to lower interest rates, currently at 19%, because of badly missing its 4% inflation target for 2001. The goal for 2002 is 3.5%.

As a result, consumer and business demand is soft. Consumer confidence rebounded in January, but employment is not improving, and inflation is cutting into purchasing power. December retail sales and industrial production looked tepid, and capacity utilization is the lowest in two years, suggesting little incentive to lift capital spending.

Economists expect inflation to decline, allowing the central bank to trim rates and bolster growth. But the October elections will be crucial. Lower rates and a stable currency could lie in the balance.

By James C. Cooper & Kathleen Madigan

    Before it's here, it's on the Bloomberg Terminal.