The Downside of Brazil's Boom: Rising Inflation and a Surging Real

As the European Central Bank’s rate hike and Federal Reserve’s policy skirmishes made headlines in the past week , in Brazil, the impact of easy money policies in the developed world is felt every day.

This past week, the Brazilian Finance Ministry took another shot at cooling capital flows and restricting credit, a campaign economists expect will have little impact in curbing inflation or reigning in the rising Real

“This liquidity is going to continue from one to two years, so we have to be inventive and control external flows of capital and inflation. Exchange rates cripple the country, but inflation kills,” said one government official in an interview this past week.

Brazil’s very success has been hurting it. Inflation is running at the high end of the Brazilian Central Bank’s inflation range and threatens to rise above it. Brazil Finance Minister Guido Mantega said Thursday that inflation should slow in the coming months, just as the 12 month rate of inflation was reported to have jumped to 6.3 percent, just below the top end of the government’s target, which is 4.5 percent, plus or minus 2 percent.

Mantega announced an increase of 1.5 percentage points on a consumer credit tax, in an effort to drive annual credit growth to 12 percent from a current 20 percent. The government last week also extended taxes for short term foreign loans of up to two years. The tax had been charged on loans of 360 days or less.

Brazil’s inflation rate is well below the hyperinflation the country experienced in the 1990s, but the concern is that the country's strong internal growth, pushed by a rising middle class, competes with external demands and the pricing pressure.

The IMF, in an about face last week, said developing countries under certain circumstances may need to curb the flow of capital, a policy previously frowned on. South Korea and Turkey have also initiated programs to cool the flow of money in a bid to battle inflation.

For average Brazilians, the price of success has meant a rapid rise in housing and food prices. Food costs have jumped an estimated 10 percent in the past year, and apartments in Sao Paulo’s nicest neighborhoods have risen 40 to 50 percent.

An estimated 35.7 million people entered the middle class and 20.5 million people moved above the poverty line between 2003 and 2009, according to Banco do Brasil. The amount of Brazilians living in absolute poverty has fallen to 15.3 percent from 28.1 percent in 2003.

“It’s hard not to be bullish on Brazil,” said Marcelo Carvalho, chief Latin American economist at BNP Paribas in Sao Paulo. Carvalho was speaking to the Financial Women’s Association of New York, during a stop in Sao Paulo on a three-city trip to Brazil.

But Carvalho and other economists point out that Brazil’s development is at a critical phase. Internal growth is strong, driving consumption, at the same time external demand for Brazilian resources is growing, fueling price rises. China, for instance, has become the fastest growing consumer of Brazilian exports, from little more than 5 percent in 2003 to more than 15 percent, in 2009 and its appetite continues to grow. At the same time, the share of exports to the U.S, has dropped from above 20 percent to the low teens.

The new Brazilian consumer has put more demands on Brazil’s infrastructure, just as the two major events — 2014 World Cup Soccer and 2016 Olympics — require hundreds of billions in upgrades to handle the visitors and much needed improvements for every day life in Brazil.

Economists forecast upwards of 700 billion Reals will be spent to build arenas, upgrade roads and airports and other projects. Some of those projections top 1 trillion Reals. The government anticipates stadium costs of 80 billion Reals and has budgeted 40 billion Reals infrastructure costs for calendar year 2011.

The concern is that these projects will compete for the same labor, raw materials and land that the private sector needs for expansion. At least one major company said it was holding off on expansion in the next several years because of rising real estate and raw material costs.