It was Brazil’s annual pre-Lent carnival season last week. But investors in Brazilian stocks aren’t in the mood to party. The benchmark Bovespa index trod water last year and has slid by almost 5% in 2011.
There has been a shift in sentiment away from emerging markets. Developed world data appear to have improved and emerging markets have been getting to grips with inflation by raising interest rates. The worry is that “emerging-market central bankers are behind the curve”, says John Paul Rathbone in the FT.
It’s far from clear when the rate hikes might end. Brazil is no exception. It is “proving to be one of the most pro-active in combating inflation”, having raised rates from 8.75% to 11.75%. The government has also “taken unpopular action” to curb overheating, says Steve Rubens on Seekingalpha.com. But all this “may not be enough”.
Growth, powered largely by a consumption boom, rose by 7.6% last year. That’s the fastest pace in 25 years, as Brazil bounced back from recession. Inflation has risen to just over 6% and won’t stop there. It’s gone beyond commodities, as Alejandro Cuadrado of Société Générale points out. Core inflation has reached a five-year high above 5.5% with the price of services up by 7.9%. Rates may need to rise by another 1%, says Cuadrado.
On the plus side, the government has started to unwind the fiscal stimulus that helped Brazil through the recession by announcing plans to cut state spending by 1.5% of GDP. It is also raising reserve requirements for banks, and lowering funding to the state development bank in order to temper credit growth. It’s too early to be sure, but credit growth appears to be easing, says Capital Economics.
High relative interest rates have boosted the currency. A stronger currency implies lower inflation, but also attracts money into Brazil as rates rise. That’s adding to the money supply and threatening to fuel inflation, says Rubens. It is also squeezing exporters. So given the task facing policy-makers, “predicting the path for interest rates is unusually difficult”, says Capital Economics. Until it is clearer whether the economy is slowing and when rates might stop rising, investors are likely to stay away, says Shayo Cherman of JPMorgan. Investors, says Kenneth Rapoza in Barron’s, should “wait before testing Brazil’s waters again”.