SAO PAULO/MEXICO CITY (Reuters) - Brazil’s inflation will likely get worse before it gets better despite government bids to drag down the headline rate with one-off measures, putting the spotlight on the need for deeper economic reforms in Latin America’s biggest economy.
Consumer prices jumped in January by the most in almost eight years, pushing annual inflation up to 6.15 percent despite a government-ordered cut in electricity tariffs which economists estimate shaved off 0.1 of a percentage point.
Although much of the rise was due to food prices, the figures also showed a worrying increase in home-grown price pressures despite weak growth, setting Brazil apart from peers which are enjoying higher growth with lower inflation and underlining the dilemma facing the country’s policymakers.
Unlike Mexico, where a new government has won in-principle support from opposition parties for major structural reforms, Brazil’s reform agenda appears stalled. Some analysts question the government’s interest in reforms that could reduce the power of the state, with Brazilian officials instead resorting to one-off measures to boost growth and curb inflation.
They include asking city governments to hold off raising bus fares and flagging tax cuts for basic foods.
“It’s a sticking plaster approach rather than the fundamental reform approach,” said Capital Economics economist Neil Shearing.
“Fundamentally the economy is supply-side constrained in a way that Mexico’s isn’t, so the underlying inflation pressures in Brazil are much greater and that will remain the case, particularly if the government is trying to pump up the economy with loose fiscal policy.”
Low-debt Brazil emerged largely unscathed from the financial crisis but failed to use years in which it reported some of the world’s fastest economic growth rates to implement reforms to help it through leaner times.
Brazil’s central bank, which slashed interest rates aggressively to a record low of 7.25 percent last year, has complained that slow growth is largely due to supply constraints and therefore out of its hands, since monetary policy tackles demand for goods and not their supply.
High January inflation raised bets the bank will raise interest rates this year, a move that could further complicate efforts to reignite the economy.
Although the central bank can adjust demand by making credit more expensive, that does not address the mismatch which generates high domestic inflation pressures with low growth - a symptom of an ailing and inefficient economy.
“It’s like using an old car: you step on the gas pedal and you may get noise, smoke, but you don’t get much faster,” said BNP Paribas economist Marcelo Carvalho.
“One can always blame international food prices or a bad harvest, but that does not explain why services price inflation is running persistently high in Brazil.”
Economists said inflation was likely to tick up towards the 6.5 percent ceiling of the central bank’s tolerance zone in the first half of 2013, before easing in the second half.
Services and non-traded goods inflation, both signs of domestic inflation pressure, are running above 8 percent and record low unemployment of 4.6 percent is keeping pressure on wages, while inflation expectations threaten knock-on effects.
Although central bank chief Alexandre Tombini says he is concerned about inflation, Finance Minister Guido Mantega told Reuters he expects January’s inflation reading to be the highest of the year.
The government’s change of heart to allow a stronger currency, which has been allowed to appreciate to around 1.97 per dollar, will help trim the cost of imported goods.
But it is no long-term fix and makes exports more expensive, dragging on an economy which is already struggling to take off.
Authorities have also tried to dampen inflation by reducing automatic price indexation, deeply entrenched after years of hyperinflation in the 1980s and 1990s.
Economists say the focus should instead be on measures to boost Brazil’s ability to supply goods. These include reforms to increase productivity; encourage new businesses; support workforce mobility; and foster investment, which is about half the level of China. All would be aimed at allowing the economy to grow faster without generating inflation.
Brazil is trying to fix the bottlenecks that make it one of the most expensive places to do business. It has extended concession periods and improved financing conditions to lure private investors into multi-billion dollar road projects.
A recent report by the Boston Consulting Group said Brazil’s top priority should be boosting productivity, for example through more investment in education. Only a quarter of the growth over the last decade, which propelled Brazil to become the world’s 6th largest economy, was due to productivity gains compared to 90 percent in China, the group found.
“In a scenario where you cannot add to the number of workers, mathematically, it has to come from productivity, otherwise we are not going to have the type of growth to which we aspire,” said Julio Bezerra, a principal at BCG in Sao Paulo.
Santander Brasil expects only “baby steps” from Congress this year in tackling reforms given President Dilma Rousseff’s poor relationship with lawmakers and acknowledgement that sweeping tax reforms are not politically viable.
Congress will focus instead on a new mining code, a simpler framework for interstate tax and changes to oil royalty distribution in what some say is a deliberate move to keep moves to a more open economy in the backseat.
“In Mexico, the economic team wants to open the economy, the market, while in Brazil there’s a view that the state should be bigger and the main leader of economic growth,” said Sergio Vale, chief economist at MB Associados.
“Not only the state should play a bigger role, but also have a stronger decision-making power. But a big state doesn’t lead to growth, it creates inefficiencies.”
Writing by Krista Hughes; Editing by Kieran Murray and Andrew Hay