Brazil’s booming economy

WHILE the developed world tries to stave off a wave of sovereign debt defaults in Europe, the Brazilian economy is partying like it’s 2008. Consensus forecasts for real GDP growth this year have now reached a brisk 6%, and the most bullish estimates project a percentage point more—the best performance since 1986.

But many analysts reckon that multiple inefficiencies mean that the economy can only grow at 4.5% or so without triggering inflation. On April 28th the Central Bank recognised the danger of overheating. Its monetary-policy committee raised the SELIC benchmark interest rate by 75 basis points to 9.5%, its first increase in a year and a half. It is expected to tighten much more in coming months. But whether that will be enough to avoid a hard landing remains in doubt.

The boom is based on solid foundations. Global demand for Brazil’s farm exports, oil and iron ore, led by China’s voracious appetite, has been growing rapidly. Its manufacturers, like Embraer, a maker of jet aircraft, have remained competitive in foreign markets despite a strengthening currency. And millions of Brazilians have left poverty and begun to consume more, thanks in part to an expansion of bank credit. When the world recession briefly hit Brazil in 2008, the government of Luiz Inácio Lula da Silva responded by cutting sales taxes and increasing lending by state-owned banks.

But growth in productive capacity, which determines long-term economic performance, remains limited. Brazil’s investment rate has increased in recent years, but at its pre-crisis peak, it was still just 19% of GDP, less than half the corresponding figure in parts of Asia. The government’s costly entitlement programmes, particularly pensions, leave little room in the budget for much-needed infrastructure improvements. Decades of inflation made private firms wary of sinking capital into long-term projects. And lacklustre schools turn out poorly educated workers, limiting productivity gains.

When consumers demand more goods and services than producers can provide, the result is higher prices. And Brazil’s closely monitored inflation rate is indeed creeping up. At 5.2% over the last year, inflation is a far cry from the four-digits spirals of the past. But it has already exceeded the Central Bank’s target of 4.5%. In services, the figure is near 7%.

By starting the process of monetary tightening with a such a big rate hike, the Central Bank’s governor, Henrique Meirelles, is attempting to reassure markets that he will not let the boom get out of hand. Nonetheless, given that changes in rates take over a year to work their way through the economy, many observers say he waited too long before putting on the brakes. Moreover, he is unlikely to get any help from the government, given that a presidential election is due in October in which Lula’s chosen successor, Dilma Rousseff, faces a tough fight.

Brazil has shown it is willing to suffer sky-high interest rates in order to keep a lid on prices: shortly after Lula took office, they reached 26.5%. But while a stiff dose of monetary discipline may be a short-term fix for overheating, the challenge in the long run will be removing the obstacles to a faster growth rate. That would require deeper reforms to a sprawling state than Lula has been willing to push so far.