Brazil’s dilemma: how to contain growth (inflation) in an electoral year

The minutes released Thursday morning show that even though inflation forecasts remain near the 4.5% target for 2010 and 2011, Copom sees increasing risks of rising prices as idle industrial capacity diminishes.

“Faced with signs of recovery in domestic demand ... evidenced by indicators of utilization of industrial capacity, the job market, and the recent behavior of inflation expectations, the risks may be rising for the achievement of a benign inflation scenario,” policymakers wrote.

As a result, the Copom will be watching to see “if the perspective of an intensification of pressures from consumer demand is confirmed” and “will continue to monitor with particular intention inflation expectations, which have risen.”

Policymakers also pointed out that their inflation projection for 2010 has risen since their December meeting, but “is still near the central value of 4.5% that is the target.”

The Copom restated its evaluation from earlier minutes that “the contraction effects of the international crisis on the domestic economy ... may prove persistent, but will not be permanent”.

But most economists agree that the Brazilian economy cannot keep growing at its current rate of over 5% without inflation, although they disagree as to how long idle capacity from last year's recession might permit this growth to continue.

On Tuesday Central Bank Henrique Meirelles said that wages, retail sales, and credit were all growing at paces above their potential, leading many to presume that he too agrees that the economy could soon be reaching an overheat situation. Copom meets again March 17.

According to Brazil’s central bank's own Focus survey of private sector financial institutions, the consensus forecast is for the Selic basic rate to rise to 11.25% by the end of the year. But the government has been pressing on the Central Bank to leave rates unchanged, with Finance Minister Guido Mantega asking Meirelles, in front of television cameras, not to raise the Selic.

 The government has also announced spending cuts and a winding down of fiscal stimulus. Anyhow most private analysts forwarded their forecast for the Brazilian central bank’s fir rate increase of 2010 from April to March, probably taking the Selic basic rate to 9.25%.

Last but not least 2010 is presidential election year in Brazil and President Lula da Silva will be campaigning strongly to ensure his Workers Party and coalition victory, so a blend of strong growth even with a slight blend of contained inflation could be helpful.