Economic growth, policies to fight inflation, and now budget cuts in an election year from Brazil? Yes, Brazil

05/14/2010 10:51 am EST


Jim Jubak

Founder and Editor,

Where can you find financial responsibility and sound fiscal policies these days?

Forget about the debt-ridden United States. Washington hasn’t even begun to address its deficit. The United Kingdom? The new Conservative/Liberal coalition government is still lying to voters about the extent of the pain to come. The Euro Zone? German taxpayers are counting up the bill they’re being asked to pay and questioning whether the euro is worth the price. 

In general, I’d say, you have to forget about the world’s developed economies and look to the developing world where China, India, Poland, and Brazil, have their financial and fiscal acts together in a way that residents of the developed world can only observe with envy.

Brazil is perhaps the brightest—and most unexpected member of this group. It’s not so long ago that the country’s mix of low growth, high inflation, and run away government made the joke “Brazil is the country of the future. It always will be” hit too close to the mark to be very funny.

 But now? Look at what the country’s president Luiz Inacio Lula da Silva announced this week.

 Budget cuts of 10 billion real ($5.6 billion). Granted that the cuts are tiny, a mere 0.3% of GDP and therefore mostly symbolic. But even symbols are important and this one signals that the government isn’t going to leave the central bank to fight inflation on its own. And the timing of the cuts is especially significant: bond buyers had been worrying that the government would increase spending as the country neared October elections.

 The bond market thinks the gesture means something. The spread between yields on two-year fixed-rate notes and two-year inflation-linked notes has narrowed this week by 0.14 percentage points to 5.6 percentage points, according to Bloomberg. That’s a sign that bond buyers believe that the government and the central bank are more likely to get inflation under control.

 Last month the Banco Central do Brasil raised its benchmark Selic interest rate 0.75 percentage points to 9.5% (not extraordinarily high by Brazilian standards) in an effort to fight inflation that had climbed to an annual rate of 5.3%. No one expects that to be the last interest rate increase with the consensus calling for increases in the benchmark rate to total 4 percentage points before the bank is dones later this year. (For more on the interest rate increase see my post )

 But the combination of an interest rate increase and a small government budget cut has already started to reduce expectations for future inflation. Yields on the fixed-rate notes due in 2012 have fallen to 12.37% since May 4. Bloomberg quoted Marco Freire, chief investment officer of Brazilian fixed income at Franklin Templeton Investimentos Brasil, saying he expects government notes due in 2017 to fall to a yield of 12% by the end of 2010 from 12.672 on May 13.

 I think it’s a little too early to by Brazilian equities. The interest rate increases still to come will keep downward pressure on stocks. And continued turmoil in the Euro Zone will hurt emerging market stocks in general.

 But keep Brazil on your radar screen for later in 2010. The economy is predicted to be growing at a 6.3% rate by the end of the year. If the Banco Central do Brasil looks like its got inflation under control by then, Brazil would be one of the few places in the world to look for sound fiscal and monetary policy and solid economic growth.
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