Some Thoughts On Brazil

By Win Thin

Local Brazil analysts are saying that new measures to curb currency appreciation are basically ready to go. Finance Minister Mantega has reportedly not decided yet if he is going to release details today or not, and that he is working closely with central bank chief Tombini to tailor the package. According to reports, Brazil policy-makers are going to increase the IOF tax for fixed income once again but that any other measures have not been confirmed. Rumored measures also include some sort of lockup period (like Chile’s encaje) as well as SWF intervention in FX markets. Note that USD/BRL traded below the key 1.65 level on Friday to the lowest level since August 2008, but jumped late in the day as those rumors made the rounds and has remained largely above 1.65 since. Risk off trading due to euro zone and Middle East tensions has also been a negative factor for EM currencies as a whole this week. Another IOF hike now may have a bigger impact given the generally more negative global risk backdrop for BRL, but we expect losses to be limited. USD/BRL has not traded above 1.70 since December.

Central bank minutes from the March 1/2 meeting were reported today and are worth a mention. Despite dropping reference to “macro prudential measures” when the 50 bp hike was announced, minutes show that the central bank continues to put a lot of weight on them, calling them “rapid and potent,” and suggests that it is still hoping to limit orthodox tightening via rate hikes for fear of encouraging greater foreign inflows. The bank added that any new “macro prudential measures” could lead it to reexamine its interest rate policy. Brazil bank stocks have underperformed today due to concerns that credit curbs will impact their bottom lines more than rate hikes would. Some local analysts are saying that after a 50 bp hike at the April 19/20 to 12.25%, the central bank will pause again to see how its measures taken so far are affecting the economy.

We remain a bit more bullish on the Brazilian economy, and believe that the central bank will have to continue with its orthodox rate hikes this year despite its reluctance to do so. February IPCA inflation came in slightly lower than expected but at 6% remains near the top end of the 2.5-6.5% target band, and we are skeptical that it will start in Q4 to return to the 4.5% target without more aggressive measures. The bank sees inflation “slightly” below target by end-2012. We note that loan growth remains strong, with private loans rising 20% y/y in January and are the cycle peak. Unemployment remains very low and as a result, retail sales remain strong.