Brazil: testing the limits of investor patience

By Win Thin

Brazil Finance Minister Mantega announced macroprudential measures today, raising the IOF tax on consumer credit by 150 bp from 1.5% to 3% in order to help limit credit growth. So far, measures already taken are not working as evidenced by still-strong credit growth and rising inflation. Earlier, IPCA inflation was reported at 6.3% y/y in March, higher than expected. The central bank has warned that it may pierce the 6.5% ceiling in Q3, but it looks like it will happen sooner than that. We have long felt that macroprudential measures are not working as desired and that old-fashioned rate hikes are going to be needed, and markets seem to be coming around to that view. Looking ahead to the April 19/20 COPOM meeting, the market has gone back to expecting a 50 bp hike after tilting towards no action previously. We have remained bullish on the Brazilian economy and stuck with our view that rates will be hiked this month, and that rates are likely to end the year at 12.75% (at least) vs. 11.75% currently. Weekly central bank survey shows year-end rate of 12.25% expected by analysts, but we think that will be adjusted upwards in the coming weeks in response to the recent data. Mantega said he’d like credit growth in the 12-15% range, but we note that loans (both public and private sector) rose 21% y/y in February. He added that other measures can be taken to slow credit growth if needed, but that inflation was going to ease to an “adequate” level in two months.

Brazil policy-makers up until now have enjoyed good credibility with the markets, but Mantega is testing the limits of investor patience. Price pressures remain high, growth remains above trend, and macroprudential measures are not working as desired. The experiment must end and orthodox policy must be returned to the forefront. If Mantega and others continue to paint a rosy picture when markets clearly see otherwise, there will be trouble brewing, especially if policy-makers continue to roll out ad hoc measures every few days. With regards to the real, yesterday’s mild measures as well as Mantega’s admission that the currency is likely to continue firming was an open invitation to take USD/BRL down below 1.60, and that is where we are now. The 1.5545 low from 2008 is within reach, and we cannot rule out further gains below that. Of course, higher rates and a stronger currency are the natural policy responses needed to help limit inflation pressures, but even that is being done begrudgingly.