Brazil Faces Inflation Threat

(BUSINESS INTELLIGENCE BRIEF) As Dilma Rousseff prepares to take office in Brazil, she is facing an issue that has not plagued Brazil in some time: economic progress being undermined by bouts of extreme inflation. This was what led to the tongue-in-cheeks assessment of the nation as the "country of the future and always will be". The threat this time, however, is far less dramatic than in the past as the rate is nowhere near the double- digit levels that blasted holes in the nation's economy in the past.

But at 6%, the inflation rate is high enough to induce heartburn in the investment and banking communities as well as real fear within consumer ranks. Part of the threat is caused lemgthy and bitter experiences by Brazilians with the ravages of high prices, and their natural inclinations inevitably make the situation worse. This is already starting to occur, as many assume that prices will rise next year and are trying to buy what they want now. That fuels the inflation scourge as does the fact that Brazil's growth is attracting a great deal of international attention.

Rousseff will face a tough challenge from the moment she takes office as she made some ill-advised promises during the campaign and will now have to break them or risk a more profound inflation spike. In the heat of the second round campaign against Jose Serra, she reverted to the tactics of past left-leaning campaigns and promised that there would be wage hikes for the unions and government workers. She also vowed to pressure the central bank to reduce the record high interest rates, expand welfare and start up various project so that more people could find work. It was a very typical message from a populist but now the candidate is the president, and these promises will be immensely hard to keep without setting the economy off in a destructive direction. This is the point where people will see whether Rousseff has the skills of her predecessor, Inazio "Lula" da Silva, who ran a similar campaign when he first won office. He made all the usual promises regarding wage hikes and expanded welfare but, upon taking office, he emerged as a pragmatist and one who had the strength to explain to his supporters why these changes in policy had to be made. He gained support from the center but lost some of his left wing supporters. This came back to haunt the Workers Party in the last election as Marina Silva from the Green Party exploited the disillusionment of the left and mounted a challenge to Rousseff that gained sufficient momentum to force the second round. Now it will be the turn of Dilma Rousseff to show that she has that same pragmatic streak and the political strength to pull off this reversal from the campaign. There are also those who assert that she is not really that excited about being the kind of pragmatist that Lula was. She considers herself closer to the left of the party.

Analysis: The steps that need to be taken include reneging on the promises of wage hikes and expanded welfare and it also involves reducing the pressure on the central bank to lower interest rates. The fact is that the bank is about to raise them again in an attempt to slow the pace of inflation. The expectation is that the 10.75% rate will be hiked at least another quarter point as early as the end of January, and that creates problems in some key areas of Brazil. It makes the real stronger and that is not welcome news for an export community that is already having some issues selling outside Brazil. It will inhibit the expansion of small and medium-sized business. There is also the fact that high interest rates are attracting a lot of "hit" money from the global investment community, which has the perverse effect of boosting inflation. The inflation surge started with the stimulus measures introduced in 2009. Unlike the effort in the United States and Europe, the Brazilian stimulus plan worked like a charm and now the economy has started to overheat. The first test of the Rousseff government will be tough - pitting her desire to address her core supporters against the needs of the business and investment community.

Chris Kuehl, founder of Armada Corporate Intelligence, is NACM's economic advisor

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