Brazil likely to loosen policy but growth fears persist

Brazil is expected to ease monetary policy in the coming months after the country grew by less than expected in 2011, fund managers and ratings agencies agree.

However, some economists doubt whether the country will be able to return to the rocketing growth rates of the past and are concerned by the heavy flows of foreign capital into the economy.

Yesterday, official figures showed that Brazil grew by 2.7% in 2011 – down from 7.5% in 2010 and below forecasts by some commentators. Despite the slowdown, the country overtook the UK to become the world’s sixth largest economy.

Fitch Ratings predicts the government will focus its efforts on stimulating domestic demand over 2012 to compensate for the pressure the appreciating Brazilian real is expected to place on export growth.

The agency points out that the real’s exchange rate is around the 1.75-a-dollar mark, which may prove damaging to export competitiveness at a time when trade and current account balances are being hurt by falling global demand.

“As exports, industrial output and GDP growth slows, the Brazilian Central Bank [BCB] may choose to continue easing monetary policy by cutting the benchmark interest rate further,” Fitch adds.

Furthermore, the agency says the BCB is likely to continue with its efforts to stem the appreciating real. The currency is expected to strengthen further due to flows of money from risk-averse investors in developed markets and liquidity injections from central banks in Europe, the US and Japan.

James Syme, manager of the £16.7m JOHCM Global Emerging Markets Opportunities fund, says: “Monetary policy will continue to be accommodative and the currency market will be forgiving of any uptick in inflation because Brazilian real interest rates are so high in a global context.”

“We see continued rapid growth in credit creation, particularly from the state-owned banks, while investment in the commodity sectors and in infrastructure will support job creation and wages.”

Syme notes that 20.5% of his portfolio is in Brazil, giving it a 5.1% overweight to the MSCI Emerging Markets benchmark.

Neil Shearing, chief emerging markets economist at Capital Economics, on the other hand, says the “familiar concerns” over economic imbalances in Brazil have started to resurface, despite the country avoiding technical recession at the end of 2011.

Shearing claims that the country is reverting to the “two-speed” pattern of growth seen in 2010 and early 2011, with consumer-facing sectors registering high levels of activity but lower fixed investment and exports dragging on output.

The economist is also concerned by the foreign capital flowing into Brazil.

“Even if global risk appetite holds up, Brazil is less able now than it once was to absorb rapid capital inflows, raising the risk of both economic overheating and asset price bubbles,” he says.

“Household balance sheets are looking extremely stretched and the property market appears frothy.”

Shearing expects Brazil’s economy to grow by 2.5% this year and 3.5% in 2013. However, the economist warns that expecting growth rates of above 5%, which were commonly seen in the past, could be “optimistic” given the headwinds facing Brazil.