Central Banks

'No solution' to Brazil's crisis: Economist

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Brazil's central bank won't be able to save the country with monetary policy, economists warned, after downgrading their 2015 growth outlook to zero as stagflation drags the once vibrant economy.

"There is no near-term solution to deepening stagflation," said Dev Ashish, Latin America economist at Societe Generale in a note on Wednesday. "Fiscal and monetary orthodoxy is not expected to yield any fruit in the near to medium term."

Annual inflation shot up to a twelve-year high of 7.1 percent in January, according to official data on Friday, well above the central bank's 4.5 percent target range. With inflation widely expected to remain elevated, analysts in Brazil revised their 2015 gross domestic product (GDP) growth forecast to zero, according to a central bank survey this week.

South America's largest nation is estimated to have grown less than 1 percent last year.

Brazil's central bank - the Banco Central do Brasil (BCP) - engaged in an aggressive tightening cycle last year to combat inflation. It pushed the benchmark short-term interest rate, the Selic, to its current multi-year high of 12.25 percent. Markets widely expect more rate hikes in the coming months.


Analysts don't have faith in the central bank's toolbox. Rate hikes dampen economic growth, so the success of additional monetary tightening depends on how effectively the government manages its finances, but that depends on economic growth, SocGen said. The bank expects public debt to rise nearly 70 percent over the next two years on the back of weak GDP.

"Monetary tightening could prove counterproductive to both growth and the , leaving its impact on inflation ambiguous….Clearly, there is more pain in store for Brazil on growth, inflation and interest rates," Ashish said.

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Wells Fargo economists echoed those concerns in a note on Tuesday, saying it's uncertain what higher interest rates can do to minimize the impact of a weaker currency on inflation. The real has dropped over 20 percent against the U.S. dollar in the past six months.

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Furthermore, rate hikes are hurting consumer spending, they said:

"The biggest problem for growth today in Brazil is not investment or net exports; it is the Brazilian consumer, who has basically disappeared from the economic landscape in the past several quarters. The prospects for consumer spending to strengthen in the short term are not very good as the central bank continues to push interest rates."

Counterproductive fiscal measures

Recent fiscal measures by Brazilian finance minister Joaquim Levy are worsening the central bank's dilemma, Wells Fargo said. The measures, aimed at shoring up the government's balance sheet, include tax hikes, entitlement cuts and increases in administered prices such as gasoline and electricity.

"The increase in consumer prices in January is related to the policy changes made by the government in terms of administered prices and new taxes," the bank said. "The recent decision in terms of policies is threatening to up-end inflationary expectations…This means that the Brazilian central bank will have to tread lightly as it continues to tighten monetary policy going forward."

BBVA's Latin America team agreed: "As this set of prices should continue to weigh on inflation in the coming months, we expect annual inflation to continue to trend upwards in the short-term."