Brazil's economy and risks

SAO PAULO Mon Mar 28, 2011 7:15am EDT

SAO PAULO (Reuters) - Brazil's economy was among the world's fastest-growing last year, but now analysts see expansion slowing to a more sustainable pace.

While challenges still exist -- including a slate of long-sought structural reforms -- Latin America's biggest economy is becoming a global heavyweight on the back of its brisk expansion and considerable natural resources.

Following are some key facts about Latin America's largest economy:

ECONOMIC EXPANSION

Brazil's economy grew 7.5 percent last year, its fastest expansion in 24 years. The economy has since shown signs of slowing, with the government expecting growth of around 4.5 percent to 5 percent this year.

Brazilian consumers have led the way to economic expansion, as a growing middle class stocks up on status symbols and domestic comforts once out of their reach.

But industry has struggled to match that growing demand, hampered by a strong currency that's fueled a wave of cheap imports.

For a graphic on Brazil's economic growth, see r.reuters.com/tux38r

INFLATION

The same shoppers who helped the economy grow also pushed up prices, with the benchmark IPCA inflation index dangerously near a government ceiling.

In its most recent reading, annual inflation hit 6.13 percent through mid-March. This year the central bank is targeting inflation of 4.5 percent, plus or minus 2 percentage points.

Policy-makers have raised benchmark interest rates twice so far this year in a bid to contain rising consumer prices, to 11.75 percent from an original 10.75 percent in January.

Yet the central bank has acknowledged the 12-month inflation rate is likely to stay lofty until the fourth quarter, when policy-makers expect the index to ease.

FOREIGN EXCHANGE AND CAPITAL INFLOWS

A flood of foreign money has helped buoy Brazil's currency, the real, as investors chase higher yields in the country's strong economy. The real more than doubled in value against the dollar since former President Luiz Inacio Lula da Silva took office in 2003 and is widely considered overvalued.

But while that ever-stronger real has boosted imports, it has hit exporters in their wallets. Frustrated with what Finance Minister Guido Mantega has called an "international currency war," the government has adopted a slew of measures to brake the real, including a hike in capital inflows taxes.

Economists are skeptical of the long-term benefits of such measures, but government officials have held that they remain open to more action if they think it necessary.

FISCAL POLICY

At 40.1 percent, Brazil's debt-to-gross domestic product ratio makes it the envy of many countries. But public finances, in fact, have become a source of concern recently. The government ramped up spending last year ahead of October presidential elections in a bid to boost ruling party-candidate and eventual winner Dilma Rousseff.

Critics have also accused the government of using creative accounting measures, rather than fiscal discipline, in trying to meet its primary surplus target.

Rousseff has vowed to cut $30 billion from the budget this year to cool the economy and restore fiscal discipline, but markets remain skeptical, and will likely stay so until seeing solid results.

LENDING GROWTH

Bank lending slowed in January from December, and economists pointed to the central bank's efforts to clamp down on credit as the culprit.

The central bank in December made banks hold onto more of their deposits instead of lending that money out in a bid to cool inflationary pressures.

Credit jumped in recent years as the central bank hacked its benchmark interest rate to a record-low 8.75 percent to jump-start the economy during the global economic crisis.

But with the economy now growing briskly, rising consumer prices have come more acutely into focus.

TAX BURDEN

Brazil's tax system -- larded with red tape and Byzantine rules -- has long drawn criticism from business people and economists. Steelmaker Gerdau (GGBR4.SA), for example, employs about 200 people to handle its taxes in Brazil, compared with one part-timer in Canada, headquarters of the company's North American operations.

Reforming that sometimes-antiquated system has been a perpetual agenda item for Brazil's government, although results have been few. Rousseff has pledged to push a tax reform bill in her first year in office.

CURRENT ACCOUNT AND FOREIGN DIRECT INVESTMENT

The stronger currency has fed a widening current account gap, with imports surging and Brazilians taking their more-valuable reais on shopping sprees abroad. Brazil's current account deficit stood at 2.31 percent of GDP in the 12 months through February.

That's a worry for the government. Because portfolio investment has been funding a large part of that deficit, Brazil has become more vulnerable to the whims of investors abroad, who could pull their money out at a moment's notice to chase higher returns elsewhere. Foreign direct investment, in contrast, tends to be longer-term and less volatile.

The central bank expects Brazil to attract $55 billion in foreign direct investment in 2011, with a current account deficit of $60 billion for the year.

MAJOR EXPORTS

Brazil is a commodities powerhouse, ranking as the world's top exporter of coffee, orange juice, sugar and beef, and the second-biggest of soy.

With its voracious appetite for commodities, China has now become Brazil's main trading partner, surpassing the United States. China is also a major customer for mining company Vale (VALE5.SA), the world's largest producer of iron ore, a key ingredient in steel.

Nevertheless, some economists worry that Brazil's dependence on commodities means industrial production could lag in the future. Brazil has already put some protectionist measures in place, such as tariffs on imports of Chinese shoes to protect the domestic footwear industry.

(Reporting by Luciana Lopez, Editing by Todd Benson and W Simon )

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