Thursday, October 18, 2012

Brazil Drops Rates 25 Basis Points

Last week, the Brazilian Central Bank dropped rates 25 basis points.  Here is their statement:

The Copom decided to reduce the Selic rate to 7.25 percent, without bias, with 5 votes for the monetary policy aciton and 3 votes in favor of maintaining the Selic rate at 7.50 percent.

Considering the balance of risks for inflation, the domestic activity recovery and the complexity that surrounds the international environment, the Committee understands that the stability of monetary conditions for a sufficiently long period of time is the most adequate strategy to guarantee the convergence of inflation to the target, even in a non-linear way.

The following members of the Committee voted for the reduction of the Selic rate to 7.25 percent p.a.: Alexandre Antonio Tombini, Governor, Aldo Luiz Mendes, Altamir Lopes, Luiz Awazu Pereira and Luiz Edson Feltrim.

The following members of the Committee voted for the maintenance of the Selic rate at 7.50 percent p.a.: Anthero de Moraes Meirelles, Carlos Hamilton Vasconcelos Araújo and Sidnei Corrêa Marques.

The October Copom Minutes will be released in Portuguese next Thursday, October 18.

Let's take a look at some the macro level data to show why this is happening.

The two charts above highlight a central problem.  First, the top chart shows the overall level of industrial production while the bottom chart shows the year over year percentage change.  To put it bluntly, Brazilian IP has been contracting on a Y/O/Y basis for the last year.  That shows the impact of the overall world slowdown on a natural net exporter.

The above two charts of GDP show the central problem.  The top chart shows that the quarter/quarter GDP change is very weak which is leading to a drop in the year over year GDP growth (bottom chart).

The above indicator is the level of economic activity indicator from the Brazilian Central Bank.  Notice that it's been decreasing for a little more than a year. 

Finally, we have a general decrease then leveling off in the inflation rate, allowing the central bank to lower rates.

Brazil is entering a new phase of growth.  Up until now, they have grown by selling raw materials (commodities) to China and other up and coming economic producers.  However, with China slowing, that is no longer a possible path of growth.  In short, Brazil needs to come up with a new way to expand GDP.