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Inflation, growth and foreign exchange: Risks and problems

By Thiago de Aragao.

Amongst the risks and problems that surround the Brazilian situation, the top three are: inflation, growth and foreign exchange. Thiago de Aragao assesses each of these in a new article for the Foreign Policy Centre.

Inflation

Last week, the headlines gave great importance to inflation. On TV, Jornal Nacional (TV Globo) pointed out food price hikes. On the other hand, the printed press published a few articles indicating a drop in inflationary pressure, but the majority addressed the issue with concern.

In light of the fact that inflation represents the greatest threat to the government's popularity, this is the number one issue on President Dilma Rousseff's agenda. "My administration is aware of all the inflationary pressures known to exist at the present moment", stated the president, who has already made use of several weapons to fight it, amongst which higher interest rates, credit restriction and reduction of the price of gasoline and alcohol.

The issue's permanence in the order of the day is producing highly disagreeable repercussions, such as: a) the government applying psychological pressure on sectors that are theoretically "inflating" prices; and b) labor union pressure for wage hikes to make up for losses due to accumulated inflation.

Even though the Central Bank's expectations in relation to inflation are that the worst has already passed, the government continues to be cautious and may announce new measures whose impact may displease the business community (higher interest rates and credit restrictions) and political circles (expenditure cutbacks).

Within the short-term scenario, the possibility of a worsening and loss of control is low. According to the last Focus survey, and for the first time in two months, analysts and economists have reduced their projections for inflation for this year from 6.37% to 6.33%.

Growth

Because it is the greatest threat to our situation, the fight against inflation is the government's priority. However, the "growth" issue is also of concern in light of the fact that economic indicators have already shown discrete deceleration. It is worthwhile highlighting that the FGV Industrial Confidence Index retreated by 1.1% from March to April and that this was its fourth consecutive drop.

The April drop was attributed to less positive expectations for the following months. Concerned about the dissemination of a psychologically negative atmosphere, last week Dilma Rousseff made a clear manifestation addressing the issue, suggesting that controlled inflation and growth are compatible and priority targets within her administration.

Over the short-term, an eventual deceleration should not lead to politically tragic consequences in light of the fact that the government has margin for maneuver to maintain the economy at a good performance level.

Foreign exchange

Despite pressure from exporter segments, the trend over the short-term is the maintenance of current policy. Obviously, the Minister of Development, Industry and Foreign Exchange, Fernando Pimentel, reaffirmed that foreign exchange policy will not change and that "we will have to live with it, because the world trend is devaluation of the dollar".

In light of the fact that the export industry will continue to suffer with the foreign exchange issue, the government has signaled that it will seek to attenuate the effects of the devaluation. It will do this both on the external front – where it will pressure the World Trade Organization (WTO) to include the foreign exchange issue as an element of assessment of trade practices – and internally with actions such as taxation unburdening and also protection of domestic products.

For the business sector, the unburdening issue on exports is a pacific point. However, when dealing with protectionist measures, reactions are antagonistic. There are at least three sectors involved: those that import on a large scale; those that export on a large-scale; and those that import and export on a large scale.

The foreign exchange issue is not popular, even though it has an impact on price behavior. Considering that inflation is the priority, the trend is that foreign exchange policy will continue to be used in favor of lower prices.