Brazil: Growth to slow, inflation to rise

<a href=www.upi.com>By Bradley Brooks, UPI Business Correspondent From the Business & Economics Desk Published 3/31/2003 4:41 PM

RIO DE JANEIRO, Brazil, March 31 (UPI) -- Brazil's central bank on Monday cut its forecast for economic growth and raised its prediction of inflation for 2003, a sign that hikes in the key interest rate might be in store.

Brazilian officials and analysts blamed the impact that the war in Iraq is having on the global economy, specifically oil prices and emerging-market investors' appetite for pumping cash into Latin America during a time of turbulence.

The developments come at a pivotal moment for Brazil, the region's largest economy, just as a new president is gaining the trust of investors with economic austerity.

Its neighbors are looking to Brazil to be the engine that pulls South America out of an economic slump, as Argentina languishes and Venezuela remains mired in internal disputes.

In its quarterly report, the central bank said Monday inflation could hit 10.8 percent this year, up from earlier forecasts of 9.5 percent. The official inflation target, however, remains 8.5 percent.

As for economic growth, the bank has now revised that down to 2.2 percent for 2003. Earlier, bank officials forecast growth at 2.8 percent.

The likely outcome, analysts say, is that the benchmark interest rate -- now 26.5 percent -- might be hiked to battle inflation.

Since last October, the central bank has raised interest rates five times. The campaign and ultimately the election of leftist President Luiz Inacio Lula da Silva sent the local currency into a 35-percent plunge, sparking inflation.

Lula and his economics team have repeatedly said their top goal is to keep inflation at bay, though it is clear they are eager to cut rates, which they see as stifling economic growth.

This, in turn, ratchets up the political pressure on Lula, who was swept into office on sweeping promises to change the social situation in Brazil, where divisions between rich and poor are among the world's widest.

Lula desperately needs growth to pay for his social programs. If he can't make good on those promised programs, analysts say his political base will slip out from under him.

"Government popularity will take another hit," said Marcelo Ribeiro, an analyst with the Pentagono brokerage firm in Rio de Janeiro.

"This is worrisome because government popularity is already deteriorating, according to the polls. And they have enormous challenges ahead -- like fiscal and social security reforms, when all the support will be needed."

This conflict between campaign promises and economic realities reared its head Monday, as Lula announced an increase in the monthly minimum wage from $60 to $72 a month. While still low by Western standards, the minimum wage is used as a base for many other upper-tier private- and public-sector salaries.

Economists fear that the pay hike might have the short-term effect of fanning inflation as consumer demand increases. That would increase investors' wariness of Brazil, compounding a delicate economic situation and potentially leading to a self-fulfilling debt default.

This is much less of a concern now than last October, but analysts are watching the situation closely.

The central bank said its revisions were largely a reflection of continued global uncertainty stemming from the war.

Most immediately, higher world oil prices hit Brazil, and other Latin American nations, hard. Such hikes quickly spark inflation in countries that are highly vulnerable to oil price fluctuations.

For Latin America -- still trying to regain foreign investors' trust after Argentina's disastrous default in 2001 -- anything that worries these investors bodes ill for economies that are just now recovering.

Ribeiro, who closely tracks Brazil's essential oil and aviation sectors, said he is more concerned about the central bank's lower growth forecast than about higher inflation.

"These sectors are already plagued by overcapacity in Brazil, and all over the world," Ribeiro said. "A lower GDP growth means more unemployment and less public support."

Since taking office on Jan. 1, Lula and his team have gone a long way in easing investor concerns. The central bank quickly hiked interest rates after Lula's inauguration, and fiscal austerity has been the rule.

Under normal conditions, analysts say, this would mean brighter prospects for Brazil, as it begins emerging from a tough 2002 that saw its markets plummet and foreign credit lines snap.

For instance, after months of finding it impossible to raise funds abroad, Brazilian corporations announced in the past few weeks that they've raised upwards of $2 billion in fresh foreign capital.

But Ribeiro and other analysts fear that should the Iraq war drag on, sentiment could sour against just as quickly, sending Brazil's economy back toward the brink of collapse.