Brazil's Government Is Betting That Inflation Is Going To Decrease

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TrendRecent policy choices indicate that political considerations are being placed ahead of sound economic management.

The central bank’s decision to cut interest rates, despite high inflation and employment, and subsequent intervention to arrest the depreciation of the real has created a tremendous amount of volatility.

Industrial policy has become paramount as protectionism leaps into the fore, jeopardizing long-term competitiveness.

Import taxes and foreign ownership laws are worsening regulatory uncertainty, leading some companies to rethink investment decisions.

By choosing to shelter local producers rather than cut red tape and invest in infrastructure and human capital, the government is further distorting market incentives.

Drivers
The government is betting that inflation will decrease as the global economy cools, making growth a higher priority.

Financial markets are pricing in an additional 100 basis points worth of cuts to the SELIC rate by the end of the year.

Political pressure to address the currency has been building ever since the Dilma administration took office.

Dilma is hemmed in by a governing coalition and constitution that makes it difficult to enact long-term reforms to boost competitiveness.

Frontier Strategy Group’s View
The recent spate of pro-inflationary policies poses serious risks to the Brazilian economy, especially given recent demands by workers to raise wages in 2012. If the global economy fails to deteriorate as much as Brazilian officials are expecting, a scenario that is not currently Frontier Strategy Group‘s base case, inflation could become a major problem.

B2C companies selling to low and lower-middle income consumer segments should be wary as inflation reduces the purchasing power of these demographics the most.

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