Brazil: Inflation, Fiscal Sector and Selic

The BCB inflation survey suggests a gradual increase in inflation expectations. Hoewever, expectations are not a problem since they are below the midpoint of 4.5%. The IPCA forecasts for 2009 reached 4.42% and 4.33% for 2010 suggesting a mild increase from a month ago. Our forecast for IPCA inflation for 2009 is 4.1% comfortably below the center of the official target (+4.5%) and lower than the reading for 2008 of 5.9%.

From inflation to the fiscal sector, the government is denying an eventual reduction of the primary surplus for 2009 from 2.5% to 1.85% especially because the government is spending on infrastructure, on the one hand, and there has been a decrease in tax revenues due to the decline in economic activity. Even if there is no change in the primary surplus it is important to stress that the current fiscal performance is below the 2.5% target (it reached 2.3% of GDP in May). The trend is to expect further deterioration considering the mandatory spending that will happen in the near future. In brief, primary surplus over GDP should see a fall from the 4.1% in 2008 to a likely 2.2% in 2009. It remains to be seen if the government will be able to restore the 3% primary surplus next year, when economic activity improves. In turn, the public debt over GDP should increase from 42.5% in 2008 to 44% in 2009.

Considering the favorable inflation scenario, the absence of cost pressures, stability of commodity prices we believe that the Central Bank of Brazil has reached the end of the monetary easing. We expect one more round of cuts by 50 bps to 8.75% and from then on the monetary authority should maintain the Selic stable until year end.