Brazil must tighten as Fed tapers U.S. stimulus -professors

SAO PAULO, Sept 24 Tue Sep 24, 2013 6:43pm EDT

SAO PAULO, Sept 24 (Reuters) - Brazilian policymakers will need to raise interest rates, restrain government spending and intensify a fight against inflation to avoid a steep currency drop when the U.S. Federal Reserve tapers off its monetary stimulus, two prominent Brazilian economics professors said on Tuesday.

Central bank efforts to stem a slump in the Brazilian real will only work if policymakers keep raising the benchmark overnight Selic rate into next year, when the Fed is expected to start removing part of its asset purchase program, said Eliana Cardoso, a former International Monetary Fund economist who is now a professor at São Paulo-based Fundação Getulio Vargas.

The real shed 7 percent this year as expectations of tighter global liquidity conditions forced companies and banks to step up demand for U.S. dollars. The currency plummeted 18 percent between April and September, when investor confidence was shaken by a series of government decisions and a deteriorating current account position.

On Tuesday, the real remained flat at 2.20 to the dollar.

Over the past month, the central bank has relied entirely on intervention in currency markets aimed at providing companies and banks with liquidity in U.S. dollars. Cardoso and Eduardo Giannetti da Fonseca, a professor at Insper business school, said the success of that strategy depends on the intensity of the Fed's tapering as well as policy thrift in Brazil.

"This policy will only, in my view, have the desired effects as long as it is accompanied by higher interest rates," Cardoso said at an event sponsored by non-profit group IDS. The central bank raised the Selic four times this year from a record low, and is now at 9 percent.

The central bank, led by economist Alexandre Tombini, has embarked in one of the world's most aggressive cycles of rate hikes this year. This process risks dampening an already slow recovery in Latin America's largest economy. In the minutes of its last monetary policy meeting, the bank signaled it might raise rates again in October but left doubts on whether it will continue tightening monetary policy after that.

Giannetti da Fonseca, a Cambridge University-trained economist renowned in Brazil for his works on philosophy and economics, said is it "unlikely that the government might engage on further rate increases next year, when we have an election here." Rousseff is expected to run for re-election.

The economist called Rousseff's economic policy framework "blurry" called for a more vigorous inflation-fight.

After cutting rates to record lows, the central bank this year has hiked rates by 175 basis points to counter expectations for high inflation this year and next.

Although the benchmark IPCA consumer price index has shown recently some signs of abating, and inflation has lost steam as a result, data points to a pick up in prices that will likely keep inflation closer to 6 percent at the end of this year. The central bank targets inflation of 4.5 percent with a leeway of plus or minus two percentage points.

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