The threat of stagflation is posed by accelerating price rises as growth prospects falter.
In the shadows: The Statue of Justice outside Brazil's Supreme Court – an institution constantly under attack from president Jair Bolsonaro. Photo: Reuters
In April, the annual rate of consumer price inflation in Brazil increased to 12.1%, from 11.3% in March, marking an eighth consecutive month in double-digits – and the highest in almost a decade. The month-on-month increase has not been higher in April since 1996.
The country’s monetary policymakers have embarked on one of the most aggressive tightening cycles in Latin America, raising the Selic policy interest rate from 3.75% to 12.75% in a year, with the central bank poised to tighten further at its next meeting in June.
Although inflation is being driven by soaring international energy and food prices, there is evidence it is becoming a more broad-based phenomenon, fuelling price expectations alongside anxiety among the poorest.
This increases the risk of protests and instability, given what is also a high unemployment rate of 11.1%, and not withstanding the fact that reopening the economy has helped to bolster formal employment.
The Executive is permanently working against the Supreme Court, the press and the election structure- Felix Larranaga
This is building amid election fever as the country heads to the polls in October for a competitive presidential contest pitting the populist-right incumbent Jair Bolsonaro against the Workers’ Party leader Luiz Inácio Lula da Silva, the 76-year-old leftist former president, who is leading the polls.
Bolsonaro has failed to improve Brazil’s investor rankings. Under his watch, Euromoney’s country risk score has deteriorated, although the decline began before he came to power.
Once considered one of the world’s most appealing emerging markets (EMs), Brazil’s total risk score has fallen sharply during the past decade.
With the downwards trend continuing this year, Brazil is now languishing at 116th out of 174 countries in the global risk rankings, down three places since the end of 2021 and by 55 in total during the past five years:
Euromoney risk panel expert Felix Larranaga, a professor at the São Paulo-based Sumaré University Centre, points a finger at Brazil’s deteriorating GDP and GDP per capita trend since 2010 underpinning its poor economic performance. This is highlighted in a set of low-scoring economic risk indicators in the survey.
All of these score less than five out of 10, and almost all worsened in the first quarterly survey of the year. This year, GDP growth is expected to be just 0.8% in real terms, according to the IMF, and 1.4% in 2023. The IMF’s inflation and unemployment rate forecasts are high.
Brazil is also under the worst government in years, says Larranaga, and for this reason the level of risk for investments is high.
This is demonstrated by deteriorating governance indicators from the World Bank, particularly the worsening of political stability, highlighted by the falling score – to an extremely low level – for government stability in the survey.
“The Executive is permanently working against the Supreme Court, the press and the election structure,” he says.
Bruno Vasconcelos, an economist at ISI Emerging Markets, saysthe coming months promise to be turbulent due to the elections. He reiterates the fact that Bolsonaro is constantly attacking the institutions in Brazil, especially the Supreme Court.
“He adopted this strategy to regularly create a tumultuous political environment to avoid discussing the problems in his government or the campaign proposals,” he says.
Bolsonaro knows the chance of losing his re-election is very high, so he is seeking for an excuse, in a similar way to Trump- Bruno Vasconcelos
Bolsonaro is constantly questioning the electoral process, despite the fact electronic voting in Brazil is secure, and so far he has failed to present any evidence or proof of any inconsistency in the system.
“Bolsonaro knows the chance of losing his re-election is very high, so he is seeking for an excuse, in a similar way to Trump,” says Vasconcelos.
The risk of institutional rupture, even though it is small, is hovering around the country due to his close relationship with the armed forces, Vasconcelos adds, and the uncertainty is making investors fearful and uncomfortable.
Gustavo Pessoa, chief economist at Macroeconomics Associated, adds that Bolsonaro was elected promising to be liberal and an advocate for the “minimum state”, with less interference from government in the market, but he has been acting the opposite.
Pessoa cites the example of Bolsonaro’s interference in state-owned oil and gas firm Petrobras to reduce gas prices “exactly as the same Bolsonaro had criticized former presidents Lula and Dilma Rousseff, plus Venezuelan presidents Hugo Chávez and Nicolás Maduro.”
Pessoa goes on to state that the Brazilian economy is not performing well because of several old structural problems – corruption, lack of infrastructure, low education, low productivity, for example – and problems such as Covid and inflation.
Inflation is a centuries-old problem, he says, and a resilient one.
“We’ve been dealing with it for at least 200 years,” adds Pessoa. “Brazilian independence from Portugal was promulgated on September 7, 1822, and in order to develop it, the state started its inception with a very large debt. We created a very particular kind of inflation called inertial inflation – that is a rise in price today because there was a rise in price yesterday.
“Brazil tried to stop the inertial inflation in the 80s and 90s using shock monetary politics, including money freezing – or hijacking – from bank accounts to reduce money circulation. It was a very traumatic period for the population, especially for the poorest.”
At this point, inflation was not produced by fiscal problems, supply or demand, it was basically a “financial disease”, says Pessoa, given that Brazil is used to two-digit inflation. Plus, it is a cultural problem.
Therefore, the inflation risk is not new, but it is scary for a population that is learning how to live without it.
The rise in the Selic interest rate and the deterioration in household income will be determining factors for the supply and demand of credit in the financial system- Raime Díaz
Brazil-based economist Raime Díaz, pricing analyst at Total Express and contributor to Euromoney’s global risk survey, notes that among the 20 largest economies in the world, Brazil is the only one with interest rates, inflation and an unemployment rate in double-digits.
He sees inflation subsiding next year and says there do not seem to be any signs that the average real income of workers will increase, but warns that millions of Brazilians will continue to suffer the effects: those without a job or in debt will pay dearly.
This macroeconomic scenario is also a considerable challenge for the banking sector.
“The rise in the Selic interest rate and the deterioration in household income will be determining factors for the supply and demand of credit in the financial system,” says Díaz.
Positively for Brazil, the war in Ukraine and the consequent increase in the price of commodities has generated an improvement in the collection of taxes through the export of oil.
“The more favourable results for the public accounts this year should make the general government's primary balance remain in surplus in 2022, but the government's gross debt will end the year above 81% of GDP,” says Díaz.
He adds that Bolsonaro is looking for ways to regain support and an advantage in the election by adopting a series of measures to increase the purchasing power of families to reduce the impact of high inflation.
“Although these two objectives are to some extent contradictory, and the measures adopted are very questionable, they can undoubtedly help Bolsonaro,” says Díaz.
“Perhaps the most important so far are the tax exemptions on industrialized products and diesel, and the new income-transfer programme for poor families [Auxílio Brasil].”
Still, these are seen as temporary election measures. The fact that the central bank is continuing to increase borrowing rates will undoubtedly have a strong effect on domestic demand, says ISI’s Vasconcelos.
“This will impact on the low and middle classes, as access to credit is more expensive, discouraging household consumption and investments,” he says.
“Additionally, the increase in commodity prices due to the war in Ukraine – especially oil, natural gas, wheat, corn and soybeans – is very concerning. It can be good for some sectors, such as agrobusiness, but the worsening inflation is very negative for the overall economy.”