Brazil: Interest Rates Cut To Record Lows

British Embassy Brasilia

June 2012

Summary

Central Bank cuts interest rates by 50bps to 8.5%, the lowest level ever. Follows further fiscal stimulus as government reduces tax on cars (including imports). More tax incentives are expected as the economy remains subdued - economic activity expanded by 0.15% in the first quarter, whilst inflation fell to 5.10%. Strong capital outflows have led to a sharp depreciation in Real, leading Central Bank to intervene to reduce volatility. Depreciation and combined stimulus may provide temporary relief to struggling industry, but unlikely to be enough.

Detail

On 30 May, the Brazilian Central Bank’s Monetary Policy Committee (COPOM) voted unanimously to cut the basic interest rate (SELIC) by 50bps to 8.5%, its lowest level since introduction in 1986. This was the seventh consecutive rate cut in monetary easing which stretches back to August 2011, though was less than the 75bps in previous meetings.  The decision was widely expected, and analysts are predicting at least one further cut of 50bps at COPOM’s next meeting in mid-July. The cut was made possible by recent reforms to the popular savings scheme (known as poupança) which had restricted the government’s ability to raise finance at low rates, acting as an artificial floor for the SELIC. This was also the first time the individual votes of the committee were published owing to the recently enacted Brazilian freedom of information law, which should give markets more information to forecast the Central Bank’s actions.

This followed further fiscal stimulus as the government seeks to boost the economy. On 21 May, Finance Minister Mantega announced another package lowering Brazil’s tax for cars until 31 August and new credit measures to fuel car financing. The cuts will range between 3% and 7%, depending on the category. Final prices are expected to fall by 10%, increasing sales by 30%.  Imports will also receive the tax cut, but will still face taxes 30pp higher than domestically produced cars. As car inventory levels are high, it is likely that the government will extend the measure if sales do not increase. Further tax incentives are expected to be introduced, potentially on electronics and white goods.

Both monetary and fiscal stimulus come as the Brazilian economy remains subdued.  The Central Bank’s economic activity index (an indicator of GDP) hinted at a timid 0.15% expansion in Q1 2012, a slight reduction from the previous quarter (GDP results will be released at the beginning of June). Mantega expects a slightly larger expansion – a 0.3-0.5% increase which is in line with some analysts’ predictions. Industrial production continued to hold down growth, contracting 3% in the period. Although most analysts expect growth to pick up in the second half of 2012, average forecasts for 2012 fell below 3% for the first time, to 2.99%. Mantega has revised down his forecast from 4-5% to 3-4%. Meanwhile inflation continues to fall, dropping to 5.10% in April, where markets expect it to hold for the rest of the year.

Falling interest rates, coupled with global uncertainty, have led to a sharp depreciation in the previously high Brazilian Real, which should provide some short-term relief to struggling industry. Strong capital outflows saw the currency lose almost 10% against the US Dollar in just 12 days in May. Foreign investors withdrew more than R$3bn (£1bn) in the first three weeks of May, the most since the peak of the financial crisis. Concerned about volatility and effects of a fast depreciation, the Central Bank intervened by selling dollars to bring the Real back to around US$1=R$2. Reports suggest the government is considering reversing recent increases in the IOF financial operations tax to attract more foreign investment, though this may have the opposite effect as reducing cost of re-entry may allow more capital to leave.

Comment

Though still early days to make a judgement, there is a risk that reducing interest rates alone may not be sufficient to stimulate the economy. Many consumers are already stretched quite thinly and, with delinquency rates creeping up, are taking this opportunity to re-finance their debts rather than to finance new purchases. Brazilians’ famously high propensity to consume means that cutting taxes on cars and consumer goods may provide a temporary boost to consumption, but it appears to have come too late for some – Mercedes reportedly plan to temporarily lay off 10% of their workforce in Brazil (1,500 jobs).

It is impossible to disentangle the effects of lower returns for investors from current global uncertainty, though the government must hope recent outflows are principally being driven by the latter given Brazil’s reliance on foreign investors to fund investment (savings levels are just 17% of GDP).

The Brazilian economy still remains in a good position. It is less exposed to global risks than most, and its domestic market will continue to be a source of growth. Stimulating more-than-3% GDP growth is the kind of problem most developed countries would like to have.

Disclaimer

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