Brazil, Turkey and Russia become world’s first “reflation victims”

RIO DE JANEIRO, BRAZIL – Brazil, along with Turkey and Russia, is part of the group of the first emerging economies forced to raise interest rates in the wave of global reflation caused by the ultra-expansionist fiscal and monetary policies of the United States.

The have in common that their currencies never recovered from sharp depreciations caused by the pandemic last year, although each suffers from its own particular fragilities.

“Brazil was the first reflation victim,” says Marcos Casarin of Oxford Economics, referring to the prospect of very low inflation in advanced economies moving closer to desired values. The countdown started in January, when the election of Democratic senators in Georgia granted US President Joe Biden a congressional majority for a US$1.9 trillion stimulus package. Late last year Turkey had already raised interest rates.

Pastore & Associados, of ex-president of the Central Bank Affonso Celso Pastore, published a study a few weeks ago showing that the currencies of these three countries have decoupled from their peers. Since the pandemic, they have stopped following the dollar index currencies, hence not benefiting when the dollar lost value against the currencies of seven advanced economies in 2020.

With reflation, the dollar gained strength this year and interest rates on US Treasury bonds- Treasuries- came under more pressure. “The speed with which Treasuries have opened creates some jolts in emerging countries’ currencies and ultimately lights up the yellow for everyone,” says Andrei Spacov, chief economist at Exploritas Investimentos, a management company specializing in Brazil and Latin America.

The fragility of currencies in countries that raised interest rates is due to distinct factors. In the case of Turkey, which raised its basic rate from 17% to 19% a year, it reflects an acute imbalance in its payment account, which many are betting will soon lead it to the International Monetary Fund (IMF), as well as President Recep Erdogan’s intervention in the economy. He fired the president of the country’s Central Bank on Friday.

In Russia, which raised interest rates from 4.25% to 4.5% a year, the ruble is suffering mainly because of geopolitical issues, due to retaliation threats by Western countries. Brazil has raised interest rates from 2% to 2.75% per year, and the real’s weakness is mainly linked to the country’s delicate fiscal situation, in addition to the interest rate having fallen to historically low levels.

“In Latin America, no one except Brazil has a short-term interest rate hike outlook,” says Spacov. Casarin says that, overall, the prospects were for interest rate hikes only next year, but perhaps the reflation wave will lead to some movement in the second semester. This does not mean that other countries are immune to reflation. Both economists mention the case of Mexico, which had been expecting additional interest rate cuts, but decided to abandon them.

Spacov and Casarin also observe that Brazil is in a different position in the monetary cycle, raising rates, because its economy had much stronger support last year from fiscal programs and monetary injection than its neighbors. Mexico, for example, maintained its fiscal discipline. Chile’s main step was to allow early withdrawal of resources from retirement funds.

Interest rates in Mexico stand at 4% per year. In Colombia, the nominal rate is at 1.75%, but inflation is 1.56% in the 12 months to February, which means a slightly positive real rate. Chile has interest rates close to zero and uses unconventional monetary instruments, but has a solid fiscal position and inflation within targets.

Brazil has implemented a strong fiscal stimulus, which increased its primary deficit from 84% of GDP in 2019, to 95% of GDP in 2020. Real interest rates, before the Central Bank’s Monetary Policy Committee (COPOM) increase last week, were at a negative 2.3%, considering the SELIC at 2% and an inflation forecast of 4.3% for the next 12 months.

“Brazil, due to the stimulus measures, was the country with the lowest GDP drop,” Spacov points out. Brazil’s GDP fell 4.1% last year, less than Chile (4.8%) and Mexico (8.5%), for example. “As COPOM said, GDP is already returning to its pre-pandemic level,” says Casarin.

This does not mean that recovery is guaranteed, particularly at a time when the economy is being impacted by a new pandemic wave. But from a recovery standpoint, Brazil has outpaced its peers, and the fiscal and monetary stimuli have helped fuel inflation. Therefore, it is logical that it is closer to raising interest rates than others in the region.

Source: Valor