Brazil faces 1970s stagflation as resource boom wilts

According to Lars Christensen of Danske Bank, "Brazil is stuck in a 1970s 'stagflation' trap." The country has rising inflation and falling long-term growth. They clearly have a structural problem that is getting worse. Brazil is attempting to manage their problems by fiddling with wage and price controls in order to treat their symptoms.

By Ambrose Evans-Pritchard
7:34PM BST 30 May 2013
The Telegraph

The central bank raised interest rates a half point to 8pc, bucking the worldwide trend towards looser money. The surprise move came hours after the release of data showing growth remained stuck at 1.9pc in the first quarter.

This was far short of expectations for the fifth quarter in a row and dashes hopes of a quick return to pre-crisis growth rates. The country grew just 0.9pc last year, a recession in emerging market terms.

“Brazil is stuck in a 1970s 'stagflation’ trap,” said Lars Christensen from Danske Bank. “It has rising inflation and falling long-term growth. There is obviously a structural problem and it is getting worse.

“The country is a very good illustration of why emerging markets have been doing so badly lately. They are trying to manage their problems by fiddling around with wage and price controls and other half-baked measures to treat the symptoms. There is a whiff of Argentina to this."

The Bovespa index of stocks in Sao Paulo is down by more than a third in dollar terms since early 2010, and has entirely missed the roaring global equity rally over the past year. The real has fallen 8pc since March and has broken out of its trading band.

manufacturing growth

Finance minister Guido Mantega gave a green light on Thursday to a further slide in the currency, saying the authorities were no longer relying on the exchange rate to check inflation, now almost 7pc.

“The sell-off in the real has been particularly violent,” said Benoit Anne from Societe Generale, calling it a symptom of a broader flight from the developing world as the US Federal Reserve prepares to tighten policy. “We think that there is a powerful shift in the thematic drivers of global emerging markets. This is the end of the bull market. It is an absolute bloodbath for rates [fixed income],” he said.

Aloisio Teles from Nomura said Brazil’s apparent abandonment of the strong real policy risks spinning out of control. “The real is having a very bad hair day,” he said.

Brazil has a war chest of €379bn (£325bn) in foreign reserves, and its public debt is no longer in dollars. It is at little risk of an old-fashioned currency crisis, but faces other deep problems.

The economic boom for much of the past decade was driven by exports of iron ore, grains and other raw materials, mostly to China. The commodity bonanza caused a surge in the real and an erosion of the country’s industrial base, a textbook case of the “resource curse”. Brazil’s car exports have been in freefall. Overall manufacturing output is still 3pc below the pre-Lehman peak, a pattern closer to southern Europe than Asia’s tigers.

A 30pc crash in iron prices this year and the broader commodity slide have choked recovery and left the country with a current account deficit of 3pc of GDP. “This should raise a red flag,” said Marcio Garcia from EconoMonitor, predicting a “melancholic ending” to Brazil’s flagging catch-up drive.

“They enjoyed the party while it lasted but they didn’t do their homework on clearing infrastructure bottlenecks,” said David Rees from Capital Economics.

Brazil languishes at 130 in the World Bank’s rankings for ease of doing business, below Bangladesh and Ethiopia. It is at 116 for enforcing contracts, 121 for starting a business and 156 for paying taxes.

The World Economic Forum ranks Brazil 107 for infrastructure, falling to 123 for roads and 135 for ports. It is 118 for wage flexibility, 123 for tariffs, 129 for customs red-tape and 132 for maths and science education. The overall picture falls far short of what is needed for a country hoping to break out of the “middle income trap”.

The Left-leaning government of Dilma Rousseff has resorted to industrial subsidies and trade barriers to protect jobs, a return to practices that have blighted Latin America for decades. The contrast with Mexico is becoming stark.

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