MercoPress. South Atlantic News Agency

Brazil adjusts inflation targets.

Brazilian monetary authorities decided this Tuesday to readjust upwards the inflation target for the coming two years. The 2004 target was increased from 3,75% to 5,5%, with a 2,5% plus/minus tolerance, which means inflation next year will have an 8% ceiling. Similarly the 2005 target was fixed in 4,5% with a plus/minus 2,5%.

However when making the announcement Brazilian Finance Minister Antonio Palocci emphasized that the government will keep strictly to the target, "and work as if the tolerance margin did not exist".

Mr. Palocci insisted that in the medium, long term Brazil must achieve a 4% annual inflation.

The announcement follows an acrimonious debate inside President Lula da Silva's six months administration between the so called "orthodox" and "pragmatic" wings.

Mr. Palocci and Central Bank president Henrique Meirelles have steadfastly supported exceptionally high interest rates with the purpose of "eliminating" inflation" (8% target for 2003) as a first priority to ensure a long term sustained "healthy recovery".

The Selic basic rate until last week stood at 26,5% and was cut to 26% with an annualized decreasing inflation, in the range of 12%.

The more political wing of government and vice-president industrialist Jose Alencar even when recognizing the merits of improving the debt/GDP ratio and the strengthening of the Brazilian currency, are fearful of the side effects of the tight interest rate policy such as industrial and domestic consumption retraction and two digit unemployment in Sao Paulo.

The dispute began finding a way out with the timid reduction of the Selic rate, and now with the a more flexible inflation target Mr. Palocci seems to be further appeasing the political wing of the Lula da Silva administration.

When asked if the new targets were an ideal estimate for the future evolution of prices, Mr. Palocci replied that "it's very difficult to establish the optimum inflation".

The Brazilian Minister pointed out that in developed countries the target is between 2 and 2,5% and for the average developing country 3,5%, but warned that emerging countries face a "difficult equation", since foreign shocks balloon local prices, "but once the turbulence is over prices drop at the same speed".

"Actually the 2,5% tolerance margins are in the event of foreign shocks".

Mr. Palocci added that current inflationary expectations in Brazil are converging with the established targets but a too low target "could be harmful for the economy", and are consistent with a sustainable growth pattern for the Brazilian economy.

Brazilian monetary authorities have been particularly impressed (and concerned) with the extreme evolution of the local currency that reached over 4 Reales to the US dollar six months ago and now stands at 2,80 Reales.