UPDATE 3-Brazil aims to help energy sector without stoking prices

Thu Mar 13, 2014 7:41pm EDT

By Alonso Soto and Leonardo Goy

BRASILIA, March 13 (Reuters) - Brazil unveiled measures on Thursday to help electricity distributors struggling with high power costs caused by drought, a move aimed at combating inflation by delaying increases in electricity rates until next year.

The government said it will provide an extra 4 billion reais ($1.7 billion) and allow the country's electricity clearing house to seek up to 8 billion reais in private financing to support the distributors. The companies are paying for costly thermal power to cover a drop in hydroelectricity output.

Gradual electricity rate hikes will be allowed next year, cushioning the immediate impact of price volatility on consumers and avoiding inflationary pressures in an election year in which President Dilma Rousseff will seek a second term.

Policymakers said the new measures will have no impact on Brazil's fiscal accounts at a time when investors are worried that its deteriorating finances could lead to a credit rating downgrade.

Still, some analysts believe the measures are a short-term fix that may not be enough to contain prices in coming years and solve recurring problems buffeting Brazil's electricity sector.

"The measures may ease inflation in the short term but repress inflation in the medium to long term," said Andre Perfeito, chief economist with Gradual Investimentos in Sao Paulo. "We need to see how the market reacts tomorrow. Inflation expectations may not drop."

Brazil's power generation depends mostly on hydroelectric dams. Low levels in many reservoirs have raised the threat of energy rationing this year, prompting the government to activate costlier backup thermal plants.

As part of the measures the government will auction excess electricity in April to provide distributors with cheaper power.

The surge in energy costs, which started last year, led to increased government subsidies to the sector, burdening the finances of a country that has failed to meet its fiscal target in the last two years.

The government wants to save 1.9 percent of GDP in 2014 before debt interest payments, or 99 billion reais.

The extra energy costs could climb as high as 18 billion reais ($7.6 billion) in 2014, according to some private estimates. The government paid about 10 billion reais in energy subsidies last year during another drought.

Treasury chief Arno Augustin told reporters the 4 billion reais in subsidies for distributors will be covered by an extension of a corporate tax settlement program and possible tax increases this year. He decline to say which taxes would go up.

The announcement came just hours after Finance Minister Guido Mantega and central bank chief Alexandre Tombini met separately with Standard & Poor's Corp analysts.

S&P last year placed a negative outlook on its rating for Brazil, raising fears among investors and Brazilian authorities that the country's rating could be cut as early as this year.

A downgrade could further erode investor confidence in Brazil's macroeconomic policies and raise debt costs, making it tougher for Rousseff to spur economic growth.

INFLATION FEARS

A hike in energy rates would have pushed up consumer prices at a time when the Brazilian central bank is raising borrowing costs to curb inflation, which for the past few years was in the upper end of the target range between 2.5 and 6.5 percent.

An increase of 1 percent in electricity fares adds 0.03 percentage points to the IPCA, the country's benchmark consumer prices index, according to Andre Braz, an economist with research group Fundação Getulio Vargas, or FGV.

"Inflation will be a key challenge for policymakers this year. It may easily end the year above 6 percent," said Braz, who gathers price data for FGV. "We need more clarity from the government so that the market can better predict inflation and help monetary policy control inflation expectations."

Brazil's inflation rose 5.68 percent in the 12 months through February.

Uncertainty over government policy and future rainfall sent investors fleeing from Brazilian electricity stocks.

Shares of distributor Eletropaulo Metropolitana Eletricidade de Sao Paulo SA fell 37 percent in the past 12 months, while those of Rio de Janeiro-based distributor Light SA dropped by more than 17 percent. A broader index of electricity shares Brazil's Bovespa exchange, including generating firms and distributors, was down 21 percent.

Spot market energy rates shot up to a record 822 reais/MWh in February due to the drought, pushing many distribution companies closer to insolvency.

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