Emerging Inflation `Danger’ as Brazil’s Fraga Assails Controls on Capital

Emerging markets face a “definitive danger” from accelerating inflation and should resist the temptation to impose capital controls to stem currency gains, said Arminio Fraga, the head of Brazil’s stock exchange and a former central bank president.

The Bank of Korea raised interest rates for the second time this year yesterday after inflation exceeded its target ceiling for two consecutive months, joining Thailand and Vietnam in lifting borrowing costs this week amid a surge in oil prices. Brazil boosted rates five times in the past year after annual inflation quickened to the fastest pace since November 2008.

“There is a definitive danger and I think we have to watch it,” Fraga, 53, told investors at an event at JPMorgan Chase & Co. in New York yesterday.

Inflation is picking up after crude oil in New York jumped about 25 percent in the past year and futures touched $106.95 on March 7, the highest intraday price since Sept. 26, 2008. In developing nations, growing domestic demand and increased foreign inflows lured by higher yields at a time when U.S. and European interest rates are near zero are also fueling price increases.

Investors withdrew $2.5 billion from emerging-market stock mutual funds in the week ended March 2, the sixth straight week of outflows, according to a March 4 Citigroup Inc. report that cited data from research firm EPFR Global. Investors are paring bets on shares in the fastest-growing economies after pouring more than $90 billion into emerging-market stock funds last year, the biggest-ever annual inflows, according to EPFR data.
Capital Controls

Fraga, chairman of BM&F Bovespa SA, Latin America’s largest exchange, said he is also worried that countries may be enticed to impose more capital controls to stem currency appreciation as rising interest rates lure speculators. The Brazilian real is up 40 percent in the past two years, second only to South Africa’s rand among 25 emerging-market currencies tracked by Bloomberg.

Countries from Brazil to South Korea have taken steps such as raising taxes on foreign purchases of bonds to stem currency gains that hurt export growth. While capital controls may work in the short-term and for individual countries, economic fundamentals need to be addressed longer-term, Fraga said.

“It is also one of those things that tend to be a temptation in the short term,” he said. “We used it in Brazil. But long term, it doesn’t work, and you really have to address the true problems. In the case of Brazil, very high interest rates need to be addressed with solid fundamental responses in order for us to attract less short-term money.”
Central Bank Target

Brazil is taking the right steps to curb inflation, which is being fueled by outside factors as well as by strong domestic demand in Latin America’s largest economy, and price increases should move toward the central bank’s target, Fraga said.

Banco Central do Brasil raised its benchmark overnight rate on March 2 by a half-point to 11.75 percent to cool inflation that accelerated to 6.01 percent in February on a year-on-year basis, from 5.99 percent in January. The central bank has an inflation target of 4.5 percent, plus or minus 2 percentage points.

As the head of Brazil’s central bank from 1999 to 2002, Fraga halted a plunge in the real and curbed inflation, paving the way for an economic recovery following the country’s decision to devalue the currency and let it trade freely against the dollar in 1999.

Inflation is like “a disease, a virus — it’s there and you can never kill it,” Fraga said. “If you relax, it comes back.”