The stagflation conundrum
Brazil finds itself in a phenomenon known as stagflation, characterized by slowing economic growth, rising inflation, and high unemployment. Any two of these instances can cause the third.
These indicators must be in their respective states for a considerable amount of time for a situation to be called stagflation. One quarter of slow economic growth and high inflation would not be deemed stagflation.
Stagflation is a tough adversary, as policies that intend to lower inflation, known as contractionary monetary policies, also lead to slower growth. On the other hand, if a central bank follows an expansionary monetary policy to resuscitate growth, it fuels inflation further.
Inflation in Brazil
Brazil’s 12-month IPCA (Broad National Consumer Price Index) slowed to 10.4% in February 2016, the first fall since September 2015. Since then, inflation has continued to slow and stands at 9.3% as of April.
A slowdown in inflation is a good sign for Brazil. However, there’s still a difficult battle ahead, as inflation remains much higher than its target of 4.5% and even its upper limit of 6.5%.
The Copom—the rate-setting group of the Central Bank of Brazil—has kept the benchmark Selic interest rate at an elevated level, presently at 14.3%, in order to rein in inflation. Its contractionary monetary policy has meant that household spending in Brazil has slowed as wages have fallen. This also shows that controlling inflation has been prioritized over stoking economic growth.
In its Quarterly Inflation Report, the Central Bank of Brazil projected that inflation measured by the IPCA would be 6.6% in 2016. In December’s report, the central bank expected inflation to be 6.2% in 2016.
The bank’s baseline projection assumes the constant exchange rate over the forecast horizon to be 3.70 real per dollar and the target for the Selic interest rate to be 14.3% per year. It expects inflation to be 4.9% in 2017, marginally higher than the 4.8% that was projected in December.
Even with the rise in Brazilian equities (SID) (ABEV) (CBD), investing in actively managed funds focused on Brazil (UBPIX) (ALEAX) may not serve investors well in the short term. We’ll explore this in depth later in the series. First, let’s take a brief look at Brazil’s exports and the role commodities play.