Brazil Inflation Really at 8% Without Rouseff Fiddling

Brazilian President Dilma Rousseff has been fighting inflation by holding down government-regulated prices. The bill will come due next year.

The winner of this October’s presidential election will suffer the consequences of policies that have repressed electricity prices by 30 percent, urban bus fares by 20 percent and gasoline prices by 15 percent since 2011, according to data from Rio de Janeiro-based firm Modal Asset Management. Lifting controls will unleash pressures that will keep inflation above the mid-point of the target for a sixth straight year.

Consumer prices as measured by the benchmark IPCA index rose 0.4 percent in June, pushing annual inflation to 6.52 percent, the national statistics agency said today. Prices would be rising by almost 8 percent if it weren’t for controls, according to estimates by Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., who spoke by phone from New York.

Lifting regulated prices becomes an even more delicate job given the context of weak growth, according to Flavio Serrano, senior economist at Banco Espirito Santo de Investimento.

“It’s a huge challenge,” Serrano said by phone from Sao Paulo. “You have to find a way to adjust the prices in such a way that the economy doesn’t suffer too much, inflation improves and social discontent is avoided.”

Brazil’s first-quarter growth was half the pace of the previous three months as industry contracted and investment shrank the most in two years. Economists surveyed by the central bank expect the economy to expand by 1.07 percent this year and 1.50 percent in 2015, compared with 2.5 percent in 2013.

Slower Growth

Slower growth hasn’t helped tame inflation, which has remained above the official 4.5 percent goal during Rousseff’s entire tenure and will exceed the 6.5 percent ceiling of the target range in September, according to a central bank forecast.

The cap in regulated prices also failed to make a dent in annual inflation as tax cuts and low unemployment fuel demand for goods and services. The real has weakened 25.6 percent since January, 2011, further driving up prices of imports.

Yields on inflation-linked notes due in 2015 have dropped 20 basis points to 4.44 percent since the central bank halted benchmark rate increases on May 28, according to data compiled by Bloomberg.

While raising regulated prices may be unpopular, there’s no way for the government to avoid it, said Andre Cesar, director at public policy and business strategy consulting firm Prospectiva.

Main Contenders

“Consumers will feel the impact in their pockets, without a doubt,” Cesar said by phone from Brasilia. “The effect will be spread out among common people, businesses and taxpayers. Price adjustments are more than necessary. They are almost urgent.”

Items subject to price controls accounted for 22.7 percent of the June inflation index, according to the statistics agency.

Rousseff’s two main contenders in the Oct. 5 first round of presidential elections, former state governor Eduardo Campos and opposition Senator Aecio Neves, have pledged changes to regulated price policies.

Clear Rules

Campos criticized government price intervention in an April interview, and said the country must create clear rules for regulated price adjustments. While increasing fuel, energy and transportation prices will boost short-term inflation, the move will help Brazil recover credibility, Campos’ economic adviser Eduardo Giannetti said in an interview in May.

Aecio Neves in a June 2 television interview echoed the need for clear rules on regulated prices, and said increases would not be made all at once. He promised to study the effects of price changes on companies including state oil company Petroleo Brasileiro SA.

Eduardo Campos’s and Aecio Neves’s campaigns weren’t available for comment when contacted by phone and e-mail.

An opposition victory may lead to a sharper adjustment, while Rousseff would be more inclined to boost regulated costs in a piecemeal fashion, according to Joao Castro Neves, an analyst at Eurasia Group in Washington.

Price Caps

Brazil is not the only country employing price controls. Since January the Argentine government has put price caps on a basket of 320 products from detergent to chicken to bottled water in an attempt to contain quickening inflation. Supermarkets including Carrefour and Wal-Mart have been fined for noncompliance with proper stocking of price-controlled goods. Electricity spot prices in the Philippines have been affected by a price cap.

Regulated prices have been increasing since the end of last year, the finance ministry’s secretary for economic policy, Marcio Holland, said in a telephone interview today. Brazil’s inflation is under control and government policies have been helping control consumer price increases, he said.

The gap between annual regulated price inflation and market prices has declined to 3.36 percent last month from 6.5 percent the year prior, according to data compiled by Bloomberg.

Brazil’s central bank and presidential palace declined to comment on future adjustments in regulated prices. The Finance Ministry wasn’t available to comment when contacted by phone and e-mail.

Fuel Prices

The restrictions on fuel price increases have saddled Petrobras with a $42 billion operating loss from the beginning of 2011 through the first quarter of this year, according to data compiled by Bloomberg. Petrobras is selling gasoline and diesel at a 6 percent and 14 percent discount, respectively, to international prices, UBS AG said in a July 4 note to clients.

Those measures contrast with policies in countries such as Colombia, where state-controlled Ecopetrol SA regularly adjusts prices in line with international rates.

Investors have reacted to the price controls. The Sao Paulo Stock Exchange Electrical Energy Index, which includes Brazil’s 16 main utilities, dropped 8.8 percent last year after plunging 12 percent in 2012, when Rousseff announced that license renewals would only be given to companies that cut prices. The index has rallied in 2014, as polls earlier this year showed a decline in Rousseff’s re-election support.

Her backing rose to 38 percent in July from 34 percent in June, the first gain this year, according to a July 1-2 survey by Sao Paulo -based pollster Datafolha. Neves had 20 percent, up from 19 percent a month earlier, the survey of 2,857 people with a margin of error of two percentage points showed. Her support was 44 percent in February.

Shares Fall

Petrobras’s market value has fallen 37 percent since it started subsidizing fuel imports in 2011 and growth in production has missed expectations.

Last year, Rousseff forced utility companies to cut electricity prices about 20 percent in exchange for early renewal of concessions. Cities including Sao Paulo and Porto Alegre delayed bus fare increases, bowing to pressure from the biggest street protests in decades.

Power failures affecting swaths of Brazil’s territory this year and last, together with the worst drought in at least four decades, have sparked concerns of energy rationing. Reduced investments in areas such as electricity could drag down overall growth, John Welch, macro strategist at Canadian Imperial Bank of Commerce, said by phone from Toronto.

‘Lose Money’

“The biggest problem in the electricity sector is the lack of investment,” Welch said. “The suppression of prices before was bad, and it’s even larger now. Why would anyone invest in a sector if they’re going to lose money?”

Holding regulated prices down also renders the world’s longest monetary tightening cycle less effective as it fuels inflation expectations, according to Tony Volpon, head of Americas research for Nomura Holdings Inc.

Central bankers on May 28 held the benchmark Selic unchanged at 11 percent after increasing borrowing costs by 375 basis points during the previous nine gatherings.

Analysts have increased their 2014 inflation expectations to 6.46 percent on June 27 from 5.70 percent when policy makers started raising the key rate in April 2013 , according to a central bank survey.

“The biggest culprit of the apparent inefficiency in monetary policy is the policy around regulated prices,” Volpon said by phone from New York. “Everyone expects them to go higher in the future, which means the government has guaranteed a future inflation shock.”

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