Thomas White Global Investing
Brazil Stamp
May 28, 2010
A Postcard from the Americas
Brazil: Plans Afoot to Cool Overheating Economy

Brazil Real bills

Brazil has attracted significant foreign investment flows since last year, causing the real to appreciate during this period.

Just last month, Brazilian President Lula da Silva announced a colossal $346.4 billion investment plan as part of his Growth Acceleration Program. In the aftermath of the global recession, it was considered to be just the shot in the arm that Brazil’s economy needed. Now, the government’s primary concern is to slow down a fast-heating economy with the Finance Ministry seeking to cut $17.7 billion from its 2010 budget. It’s a topsy-turvy world.

Finance Minister Guido Mantega’s $5.5 billion cut followed an earlier budget freeze of Real 21.8 billion ($ 11.82 billion) that was announced in March. Mantega’s plan? To not ‘allow’ the super-hot Brazilian economy to expand by more than 7% this year. It is the sort of luxury that developed economies like the U.S. or the U.K would give up an arm and leg for. But it is indicative of the sort of confidence that Brazil, the B in the BRIC Group of Countries, has in its own path to economic superstardom.

In April, for the first time in almost two years, Brazil’s central bank raised interest rates by 75 basis points to 9.5% in order to cool inflationary pressures. That decision was prompted by Brazil’s Consumer Price Index, which rose 0.63% in the month through mid-May from 0.48% the previous month. The South American country’s gross domestic product grew at a scorching 8% in the first quarter, although Mantega does not expect that same level of growth in the second quarter. This is in sharp contrast to last year when the GDP contracted 0.2%. Brazil, it seems, has relatively little to worry about on the economic front these days. Or does it?

Retail sales rose the most since 2001, shooting up by 15.7% in March over a year earlier, an improvement also from a 12.2% gain in February. Such a rapid rise has prompted fears of an economic bubble building up; fears which Mantega says are quite unfounded. Mantega insists that with $250 billion in foreign reserves, the country is relatively well insulated against crises, even one arising from the current Greek drama in Europe. As Mantega told Business Week, slashing public spending is a ‘quick tool to reduce the government’s demand,’ one that takes effect immediately, unlike interest rates which take around four or five months before the benefits filter down to the economy. The central bank too welcomed the government’s spending cut, but more rate cuts are expected in June, especially if the bank has to meet its inflation target of 4.5% for the year.

Brazil’s fastest expansion in two decades may be giving the central bank a headache, but this heated pace of growth is indicative of just how far this B in the BRIC has come. As Mantega told Reuters, throwing a bucket of cold water is the best way to cool heat. Going by that, he will be hoping that this one bucket will be enough.

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