Brazil to tame inflation after record growth

After its counter-cyclical policies successfully steered the country through the financial crisis, Brazil must now face up to the problem of inflationary inertia


The financial crisis of 2008 pushed the Brazilian economy into recession starting in the fourth quarter of 2008, mainly by limiting the ability of small and medium banks and companies to obtain funding in the market and by causing problems with credit portfolios. This situation increased interest rates on loans and reduced liquidity in the financial system, impacting companies and the job market. The government swiftly adopted counter-cyclical policies, by injecting credit into the system through official banks, cutting taxes on certain industrial products to stimulate consumption, and increasing disbursement of infrastructure investments under the existing Growth Acceleration Plan. The Central Bank eased banks’ reserve requirement and lowered the benchmark interest rate. These measures proved effective, and the economy recovered starting in the second quarter of 2009, with continuing strong growth in 2010.

Brazil’s GDP grew 7.5 percent in 2010, and may have overtaken Italy (whose data are still preliminary) as the world’s seventh largest economy. That strong expansion happened because companies increased their investments in 2009, getting ready for 2010. The tax incentives offered by the government had a big impact on the economy, by hastening consumption and stimulating the industries and retailers. The real increase in the minimum wage was also very important in boosting demand, and the strong economy caused unemployment to fall to record low levels. The credit market was strong and consumer confidence was high. In fact, first-quarter growth was so robust that it took the market and the Central Bank by surprise.

In early 2010 the market had already projected growth above seven percent. But with such strong expansion of output, spurred by aggregate demand, capacity utilisation increased and inflation started creeping upward. This prompted the Central Bank to start a tightening cycle in April. After two increases of 75 basis points, the most recent hike was 50 basis points, bringing the benchmark SELIC rate to 10.75 percent from 8.75 percent (the lowest ever seen). The reason for not taking stronger action given by the Central Bank was that current inflation permitted more accommodating monetary policy.

In fact, the consumer price index (CPI) held steady for the first quarter (at zero percent), but the economy was just going through an adjustment, and inflation started climbing steeply in September, closing the year at 5.91 percent, 1.41 percentage points above the target of 4.5 percent.

The outlook for 2011
Inflation is a big problem now in Brazil. The loose fiscal policy since 2009, real increase in the minimum wage, record low unemployment and strong expansion of credit are all boosting consumption and pushing up the inflation. There are two particular problems on the inflation front: foodstuffs have a large weight (around 22 percent) in the CPI and many prices (such as rents) are subject to indexing. Because of the run-up in commodity prices and seasonal factors (climate conditions and harvest periods), the food group has been under pressure since September 2010, exerting pressure on the index. Another big problem is the inflationary inertia, particularly affecting the services group. In this case the causes are the low unemployment and higher payroll levels. However, the effects of the monetary tightening last year and the continuing monetary and fiscal tightening this year should reduce inflation to 5.9-6.0 percent this year and 4.7 percent next year.

Because of the expansion of demand, and to avoid future problems in the credit market, the Central Bank adopted macro prudential measures in December, by raising reserve requirements and also increased the factor of risk weighting on personal loans with maturities of more than 24 months. Additionally, the Central Bank raised the interest rate in January to 10.75 percent from 10.25 percent, and three or four more hikes are expected at the next meetings of its Monetary Policy Committee, so that the SELIC (overnight lending) rate should close out the year between 12.25 percent and 12.75 percent.

After a fast growth in 2010, GDP growth will decrease to 4.0-4.5 percent this year. The strong growth in 2010 was driven by fiscal incentives and low interest rates – Brazil is enduring high rates, no fiscal incentives, more inflation and measures to constrain credit. With the cooling growth this year, expansion should be 4.0 percent to 4.5 percent. This is very positive because it is within the range of potential GDP growth. The Central Bank also understands the need to anchor inflation expectations to allow inflation to converge back to the central target, and thus to have a sustainable growth rate.

Individual economic results
Exchange Rate: The Real has been appreciating against the US dollar, prompted by strong capital inflows attracted by Brazil’s good growth prospects, relative macroeconomic stability, high commodity prices and large interest rate differential. Last year the government adopted some measures to avoid this appreciation, such as increasing the IOF tax. This year the Central Bank created a reserve requirement for banks’ short position in foreign exchange. The Central Bank also bought US dollars almost daily in the spot market and resumed using reverse swaps as well, employing a new tool called the Term Auction. The Central Bank argues that these purchases are to accumulate reserves, but they are also an attempt to counteract the forces acting to strengthen the currency, in deference to pressures from exporters and producers of domestic goods that compete with imports. Without these interventions, the exchange rate would be stronger than it is at present.

Public Accounts: The primary surplus target was not achieved in 2009 or 2010. In the case of 2009 this was due to the counter-cyclical fiscal policies introduced in response to the international crisis of late 2008. In 2010 these looser fiscal policies were continued because it was an election year, and they were accompanied by many artificial accounting adjustments to make the public accounts look better. The new administration of Dilma Rousseff has announced spending cuts this year.

Current Account/Trade Balance: The overvalued exchange rate and strong demand growth acted to stimulate imports, which grew significantly and lowered the trade balance. The small trade balance and the higher repatriation of profits and dividends along with net international travel spending helped to expand the current account deficit. Foreign direct and portfolio investments are strong enough to cover the current account deficit.

About ICAP and ICAP Brazil
ICAP’s businesses are distributed across more than 70 locations in 32 countries worldwide, with a strong presence in all major financial centres in EMEA, the Americas and Asia Pacific. Our largest offices are in the UK, the US and Brazil. Our business is organised across three divisions: voice broking, electronic broking and post trade risk and information services.

ICAP is the largest securities broker in the world in intermediating operations with voice broker and electronic systems. To keep the average volume over $2trn traded per day, ICAP employs approximately 4,500 people worldwide including in the three largest financial markets: London, New York and Tokyo.

ICAP is a publicly held company with shares traded on the London Stock Exchange and is part of the FTSE 100 index. The London branch is globally present with 60 percent of its employees and 54 percent of its revenues derived from outside the European Union.

Despite the financial crisis of 2008, ICAP has closed its fiscal year with record revenues of £1.5bn. This fact is explained by the “fly to quality” phenomenon, which is when, in moments of crisis, investors seek bigger and stronger institutions to run their operations.

The purpose of ICAP is being a global leader in the OTC market intermediation, such as 35 percent of total market revenue. Its energy is focused on the transfer of business to higher growth markets, innovating and maximising the potential for conversion to electronic transactions.

Brazil is considered a strategic market by ICAP. Boosted by growth in recent years, the country has the potential to represent more than 80 percent of the company’s revenues in South America. Supported by these figures, in November 2008, ICAP held its first strategic acquisition in the country: the purchase of 100 percent stake of Arkhe, one of the top five brokerages in the BM&F.

In April 2009, ICAP began negotiating with Bovespa and established its Home Broker, named MyCAP (, and received the award for “Best Online Broker of the Year” in 2011 for Latin America from World Finance. Today, ICAP has also become a major broker in the Brazilian market in equities, futures, FX, bonds, commodities and energy, increasing its market share, as can be seen below:

Overall, including futures and equities, ICAP today is the biggest independent broker (non bank owned) in Brazil. With offices in São Paulo and Rio de Janeiro, ICAP currently has more than 280 direct and indirect employees. The Brazilian operation reinforces the ICAP’s presence in Latin America, already established in Argentina, Chile, Ecuador, Colombia and Mexico.

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