Inflation not letting go

Inflation is not letting go of its vice grip on Brazil. This has made matters worse for the Banco Central do Brasil, Brazil’s central bank. Unlike its peers in Japan, China, and Europe, which have been easing to stimulate their respective economies, the Banco Central do Brasil can’t adopt an easing approach, the primary reason being its high levels of inflation.

Inflation, as measured by the IPCA index, rose to 9.9% in the 12 months ended October 2015. This is the fastest rise in nearly 12 years. Housing prices rose 18.3% in the period, while prices of food and beverages rose 10.4%. Transportation and personal expenses also contributed to the surge in inflation.

Inflation Isn’t Giving Breathing Room to Banco Central do Brasil

Monetary policy response

Brazil’s economy is experiencing what is known as stagflation: low levels of economic growth coupled with high levels of inflation and unemployment.

If the Banco Central do Brasil were to reduce the SELIC rate, its key interest rate, at this point in time, it would fuel inflation further. This is something it cannot afford to do. In fact, in the bank’s November meeting, a few of its members were of the opinion that the SELIC should be raised to 14.8% from its present level of 14.3% in order to rein in inflation. The graph above shows that a rise in the SELIC rate has been unable to control inflation.

A rise in the interest rate cools off economic growth, while a rate cut stimulates the economy but fuels inflation as well. As you can see, this is a double-edged sword for Brazil’s central bank.

What should investors do?

The situation is quite messy in Brazil. Investors, especially retail investors, may wish to avoid investing in the country. Mutual funds such as the JPMorgan Latin America A Fund (JLTAX), which have a majority of their assets invested in Brazilian companies, may seem cheap right now, but the macroeconomic picture is just too distorted to take risks.

Though the JLTAX is also invested in companies such as Credicorp (BAP), Copa Holdings (CPA), Gruma (GMK), and Grupo Aeroportuario del Sureste (ASR), its major exposure remains to Brazilian companies.

Let’s look in detail at what investors can do in the last article of this series.

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