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Why the Brazilian real could depreciate further (Part 3)

Continued from Part 2

The foreign exchange depreciation has caused big losses for investors in Brazilian equities (EWZ) through 2013Q2—and the FX slide may continue

Let’s take a closer look at government intervention and food inflation in Brazil.

Brazil Inflation_ICPA Index 2013-07-30Enlarge Graph

Government intervention

The government’s inaction and slow response with respect to the protests seem to have spread to its monetary policy as well. The persistently high inflation in Brazil (EWZ) has prevented the government from taking a dovish (less aggressive) stance on interest rates.

Lowering the SELIC rate (Brazil’s Special Clearance and Escrow System) would only exacerbate the inflation problem, which had reached such high levels that growth was hindered due to lower investment driven by investors’ concerns. Instead, the government has increased the SELIC rate. This increase may have stopped inflation from skyrocketing, but it failed to bring inflation down. As a result of higher rates, growth has suffered.

Food inflation

Much of the inflation in Brazil was due to food inflation, which is an indicator that directly affects the poorest people in the country. Naturally, the higher cost of food was another reason to take to the streets and join the protests, which continued to gather strength.

The dry season will continue until November, so food inflation isn’t likely to subside significantly until then. With elections coming up next year, food pressures won’t bode well with the general crowd.

The negative macroeconomic backdrop makes the current administration look bad and increases the chances of a government change. The rise of populist governments in South America is certainly a concern for investors in the region.

Continue reading for more arguments in favor of further depreciation

Continue to Part 4