Business Outlook: BRAZIL
ANOTHER DEVALUATION, FEW TREMORS
Brazil's sixth currency in a decade, the real, was a year old on July 1. So far, so good. Inflation is down to 30% per year from 50% per month a year ago.
But now, rampant consumer-led growth is fueling imports, causing a $3.5 billion trade deficit through May--Brazil's first gap in eight years. To close it, the government devalued the real on June 22 for the second time in four months. The real's trading band was shifted from 88 to 93 centavos per U.S. dollar to 91 to 99 centavos. The devaluation follows other import curbs, including tariffs on many goods and quotas aimed at cutting car imports.
But because the devaluation of up to 6.5% was small, the financial markets barely blinked. The real, at 92.38 centavos on July 11, remains within the old band. The central bank is expected to hold interest rates near 60% and spend some of Brazil's $32 billion in foreign exchange reserves in order to keep the real near its current level.
But to keep investors happy, the trade balance will have to show true improvement. Already, tight credit has slowed consumer demand sharply, and the Finance Ministry projects lower second-half imports. Although the June trade deficit is expected to widen further, the July gap could post a surplus.
Another investor worry, stoked by the devaluation, is inflation. It's expected to accelerate to a monthly rate of 3.5% in July, after June's 2.66% rate. But with food costs under control, the pace should slow after July. Also, the government abolished the long-held practice of indexing pay scales and other transactions to prices. That action is critical for the real's success, and it will ease inflationary pressure going forward.
In an ironic twist, the devaluation, while relatively painless for Brazil, may hurt Argentina, which needs to export to stave off recession and ease its current-account deficit. With the Argentine peso hard-pegged to the U.S. dollar, its exports to Brazil, which are a fourth of all Argentine exports, are now more expensive. To help, on July 12, Brazil exempted Argentina from the auto-import quotas.