Currency poses risk to Brazilian economic growth

Brazil has posted annual growth numbers that most developed markets would be overjoyed with but the country’s appreciating currency remains a significant risk.

Last week the Instituto Brasileiro de Geografia e Estatística (IBGE), a statistics office, reported that GDP grew by 2.7% in 2011 – down from 7.5% in 2010 and trailing the growth seen in emerging market peers such as China and India.

The numbers show the country narrowly avoided recession in the fourth quarter, as a pick-up in consumer spending reversed the slight contraction seen during the previous three months and took quarter-on-quarter growth to 0.3%.

Daniel Isidori, who holds 66.9% of his £1 billion Threadneedle Latin American fund in Brazil, says: “With unemployment low and infrastructure investment high across the country, domestic consumption should protect Brazil to some extent from the economic turbulence of the western world,” he says.

However, the Brazilian real touched a 12-year high in 2011 and the effect of its continued strength on export competitiveness remains a key challenge.

The currency’s appreciation has been driven by strong capital inflows stemming from risk aversion in the developed world and liquidity injections into financial markets by central banks in America, Europe and Japan.

Figures from the IBGE last week showed the impact this is having on the Brazilian manufacturing sector. Industrial production dropped by 2.1% month-on-month in January, driven largely by the overvalued real.

In response, the Brazilian Central Bank surprised the market last week by cutting the Selic base interest rate 75 basis points to 9.75%.

Neil Shearing, the chief emerging markets economist at Capital Economics, sees the Selic falling to 8.75% by the middle of the year, equalling the record low seen in 2009, as the central bank attempts to curb the appreciation of the real and stimulate growth.

However, Shearing argues that monetary policy loosening could only have a limited effect on the economy.

“Much depends on whether the recent recovery in global risk appetite and rebound in commodity prices is sustained,” the economist says.

“If so, then capital inflows to Brazil are likely to remain strong, bringing an increased risk of economic overheating and asset price bubbles.”