Brazil's Economy: Growth May Have a Downside

Cia de Bebidas das Américas (ABV) (AmBev), Latin America's largest brewer, recently had to import beer cans into Brazil for the first time in its 125-year history after local supplies were exhausted. One of Brazil's top sugar producers, Açúcar Guarani, left 10 percent of its crop sitting in the fields an extra 40 days because it couldn't acquire enough tires for its harvesters. "We tried to buy directly from China, but they didn't have tires for delivery either," says Jaime Stupiello, agricultural director for Açúcar Guarani. Elsewhere, a truck shortage is pushing up the costs of shipping goods from Brazil's industrial heartland to the rest of the country.

Brazil is experiencing its fastest economic growth in almost two decades, which is what's setting off those nationwide shortages. The country's government statistics office announced on June 8 that gross domestic product expansion hit 9percent in the first quarter. That's well above the potential growth rate of 4.5percent most economists have calculated for Brazil. Inflation, now at 5.2percent, is increasing faster than the government's target of 4.5percent. Central bank President Henrique Meirelles has jacked interest rates up twice this year, to 10.25 percent. The latest hike was on June 9. He won't stop there, says Elson Teles, chief economist at Maxima Asset Management in Rio de Janeiro. "Demand is growing at a Chinese pace," says Teles. "That's why the central bank will keep raising the Selic [the overnight lending rate]." Meirelles won't explicitly state his policy on interest rates for the rest of the year. He did, however, tell Bloomberg Television on June4 that the country's economy is "overheating" and policymakers are in a "tightening mood."

It sounds as if the Brazilians are about to wage a pitched battle against rampant inflation. Yet here's the puzzle—inflation is higher than the government's target, but it hardly seems out of control. Economists as prominent as New York University professor Nouriel Roubini still think the Brazilian outlook is "very positive," as he told an audience in São Paulo on May 31.

Several issues are at play here. One concerns the economic ghosts that haunt the Brazilians, who endured debilitating bouts of hyperinflation in the recent past. No one wants to see inflation reach gale force. Brazilians are also aware that they can do better at managing the economy. Nearby Peru has lower inflation and still enoys rapid growth.

Meirelles also wants to reassure international bond and stock investors. The former Bank Boston executive did a good job cutting inflation in half from 17 percent in 2003. But many investors feel the central bank kept monetary policy too loose earlier this year after it lowered rates rapidly in 2009 to combat the global recession. Brazilian bond and stock prices suffered, and the currency, which is up 4.4 percent against the dollar overall in the past 12 months, has taken a dive in recent weeks.

Meirelles' tough act is already having an impact. "The market is calmer," says Saddi Castro, chief investment officer at money managers Sul-America Investimentos in São Paulo. Investors are also fully aware that there is a critical national election in October. They want to see the government of President Luiz Inácio Lula da Silva maintain a steady course and avoid the temptation to juice the economy even further to secure votes for the ruling party. Lula is behaving responsibly thus far, and the government is trying to cool things down by cutting government spending.

Finally, Brazil faces an uncertain global economy. There's a risk that double-dip recession in Europe and a slowdown in the U.S. will shrink global demand for Brazil's soybeans, coffee, and iron ore. No one knows for sure. It may be better for Brazil to have its economic house in order in case things get turbulent.

The bottom line: Brazil wants to slow inflation and at the same time keep growing. It's a tough challenge for policymakers.

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