Everything fares well for Brazil.  Good news abounds and everyone is joyful… All is well?  No, not everything…. The inflationary specter has returned to frighten and preoccupy Lula, who up until recently had everything going well this year.

However, while everything was going well and the economy grew, so too did inflation, reaching 0.79% in May, the largest increase in the last 12 years.  So far this year retail inflation has reached 2.88% and 5.58% for the last 12 months.

And while it is true that inflation remains within the generous goal of two percentage points going either way, currently it is less than a percentage point from reaching the upper limit and is threatening to continue to rise.

Making matters worse, the inflation is making the poorest of the country its primary victim as food prices in May increased 1.95% (for an increase of 6.4% the last 12 months).

Is there a problem with an inflation level of 5.6%?  By comparison, Brazil is surely the envy of countries such as Venezuela and Ecuador.  However, the truth of the matter is that it is imperative to get levels such as these under control.  This is desirable not only because this level of inflation greatly affects the purchasing power of Brazilians (and it does), but also because it runs the risk of taking on a life of its own.  This in turn creates a vicious cycle, increasingly difficult to halt, for as food prices rise, the workers ask for higher wage increases (thus spiraling the situation out of control).

What will Brazil do to restrain the price increases?

In a similar situation, Argentina decided to limit its food exports (meats, wheat, corn, and the like) and the result was clearly different from that which was intended. Argentina now has an inflation problem far more serious than the one it had two years ago, only this time the situation is exacerbated by the fact that export revenues have been affected as well.  The higher inflation has stopped all investments in the economy, and Argentina was granted the investment rank of a “country not to be trusted”, due to the fact that they are now receiving less income from exporting meat than Uruguay does.

Perhaps it has not crossed Lula’s mind to limit food exports thanks to Argentina’s negative experience.

Brazil is one of the world’s largest food suppliers.  At a time of increased food production, it must now face a rise in food prices that is continuing to worsen.

Noting this situation, the Central Bank of Brazil has maintained a strong commitment to the stabilization of prices and it is clear from their demeanor that they are able to act independent of government constraints and that they are prepared to take whatever measures are necessary, including raising interest rates, to avoid runaway prices.

The Brazilian government’s Monetary Policy Committee (COPOM) Wednesday announced an interest rate hike of 50 points to 12.25%.

Brazil is showing how to combine long-term policies with measures directly related to the current situation… But how?

To clarify things: with this monetary policy, Brazil insures control of inflation using traditional methods. Since these efforts are directed at correcting the effect of rising prices, it fails to resolve the problems associated with the deterioration of the income level for the people.  Since taking office, Lula has been making plans to develop measures intended to address the needs of Brazil’s poor.  One of his plans is to increase the Family Scholarship Program’s funding to assist about 40 million Brazilians at a cost of around 11 billion reales (about U$S 6.75 billion) amounting to a 6% increase for each beneficiary (although Lula would like to see that rate a little bit higher).

Additionally, Lula has not only adopted a cautious position, but has also demonstrated sound judgment that has enabled him to take advantage of opportunities as they arise.  And this is important when one considers that increases in food prices are expected to continue for several more years.

As a result of this, Lula is creating programs to improve food production and the provision of necessary supplies (such as fertilizer).  Brazil is already contemplating measures to stimulate the growth of food production through its Program for Industrial Development (Programa de Desarrollo Industrial).

Brazil is doing well so far and that is why they are taking the current bad news so calmly, because the have confidence that the problems confronting them will be solved sensibly through strategic vision.

We will meet again tomorrow,

Horacio Pozzo