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IF 200 -- August 29, 2011 -- 19/20


Brazil, along with other Latin American countries and generally emerging economies, is confronted with accelerating inflation (6.87% in July, year-on-year, well above the 4.5% official inflation target -- prices increased for the 12th consecutive month).    Monetary policy tightening alone seems to be rather ineffective in the government efforts to stem the rising inflationary pressure.    In fact, inflation is still running high despite a 175 basis points increase in the central bank’s reference “Selic” rate in 2011 to 12.5% (10.75% in December 2010).    Meanwhile inflation continues to accelerate, but domestic demand slowed sensibly in the second quarter, as evidenced by retail sales growing only 7.9% year-on-year in Q2:2011, down from the 10.3% pace of a year earlier.    In Brazil, developing economic imbalances could lead to asset bubbles and, eventually, a hard landing following torrid growth in the 2009-2010 years.

Undoubtedly, Brazil has a dilemma. Government spending could hardly be cut, as the newly elected President, Dilma Rousseff, committed to maintain the expensive social programs (successful, so far, to buy social peace and to keep high Brazilians’ approval of government policies).    Moreover, with the 2014 World Cup and the 2016 Olympics fast approaching, Brazil needs to spend heavily to modernize its frail infrastructure -- see also my notes on the INFERENTIAL FOCUS #199.    As a consequence, keeping inflation in check will require more than just monetary policy tightening.    Will Brazil consider as well some unpopular fiscal measures in the future, i.e, reviewing the pension system?


Uruguay’s destiny is intimately tied to its unique geography.    The nation is hugely dependent on its neighboring countries’ ability to continue their economic growth at the current strong pace.    However, should Brazil and/or Argentina be facing a hard landing, or should the European and U.S. sovereign debt crises bring about a global recession, then Uruguay will be affected as well.    The economy of Uruguay is growing solidly, thanks to a favorable fiscal environment, a large and wealthy middle class willing to consume, and an attentive diversification of export markets.    Yet, the country faces an inflation rate running above the upper limit of the central bank’s inflation target rate (6%) and a strong Uruguayan Peso, both of which the Banco Central del Uruguay (BCU) tries to maintain under control with the usual monetary policy tools at hand.    Since the beginning of the year, the reference interest rate has been raised by 150 basis points to 8% and reserve requirements for banks have been also increased.

As a consequence of lower commodity prices (Uruguay exports agricultural products) and aggressive monetary policy tightening, economic growth will inevitably moderate during the second half of the current year and in 2012.    Private consumption, which remains a strong driver of the nation’s overall growth, is slowing already.    Fortunately, inflation might moderate too as a result of tame domestic demand and generally lower crude oil prices (Uruguay depends exclusively on imports to satisfy crude oil needs).    As the global economy might suffer a few years of slower growth or stagnation, Uruguay has consistently worked to diversify its trade -- meat is exported to over 100 countries around the world -- in order to be better armed to fight the global crisis pointing its nose on the horizon.

Private debt (households and business) represents only 20% of GDP, compared to the 45% of December 2001, according to BCU’s President Mario Bergara.    The nation’s sovereign debt fell to 57.7% of GDP in the first quarter of 2011, down from the 64.2% of GDP in the first quarter of 2010.    As reported by the local newspaper El Pais, Mr. Fernando Lorenzo, Minister of Economy and Finance, stressed publicly that the budget deficit was reduced to only 1.6% of GDP in 2010, down from 2.1% of GDP in the previous year.    Mr. Lorenzo is confident that state coffers might not need additional external financing (IMF) in the future.    As a result of the rigor exhibited in fiscal policy, the spread between yields on Uruguay’s sovereign bonds and U.S. Treasuries has fallen substantially in recent years.

According to Moody’s, Uruguay’s economy should grow 5.4% in 2012, a level still above trend, even though government might reduce spending, but consumption is expected to continue to drive economic growth.    In the previous years, real GDP growth run at a torrid 8.5% in 2010, following 2.6% in 2009, 8.5% in 2008 and 7.5% in 2007.    Economic growth might have slowed, however, to a 5% pace in the current year.    On July 25, 2011, the rating agency Standard & Poor’s raised its foreign and local currency sovereign credit ratings on the Oriental Republic of Uruguay to “BB+” from “BB” and the outlook was confirmed as “stable” thanks to the implementation of prudent and consistent economic policies.


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