The Copom (Brazil's Monetary Policy Committee) decided to reduce its central policy rate by 50 basis points to 12% on worries about international economic forecasts deterioration.
Headline inflation in Brazil stood at 7.23% year-on-year for July, above the upper limit of 6.50%.
The committee took this preemptive action on worries that the transmission of external developments for the Brazilian economy may materialize through several channels, among others: the reduction on the current trade, moderation of investment flow, more restrictive credit conditions and a deterioration in the consumer and business sentiments. The committee also stated that the threat of a global slowdown had indeed contributed to lower projections for the Brazilian economy, which in the forecast period contributes to a favorable inflation outlook.
Brazil has hiked rates by 175 bps since the beginning of the year, and feels this “moderate adjustment” wouldn’t compromise its target in the forecast period. This strategy may be consistent with the announcement by Brazil's finance minister Guido Mantega on 29 August that the government plans to contain spending - raising the primary surplus target for the central government (i.e. before interest payments on its sovereign debt) by 10 billion reais, equivalent to between 0.25% and 0.30% of GDP.
Only India had tightened policy to a comparable magnitude. Inflation in India has remained elevated and persistent for over 18 months now, despite aggressive monetary tightening, and stood at 9.2% year-on-year in July. The medium-term objective of the Reserve Bank is to bring inflation down to 3.0%, which is consistent with India’s broader integration into the global economy.
The Indian economy continues to show strength. The August PMI remained expansionary, having declined from 53.6 in July to 52.6 in August - mainly on a sharp decline on new export orders, which declined from 49.2 to 45 in August. Manufacturing production expanded 8.8% in July, up from 5.6% in June. This means that Indian monetary authorities have some room to further tighten policy to contain inflation, but it is unlikely that they would, given the world economic backdrop.
Like India, China is currently outside of its inflation target, despite its own tightening. However, analysts have been calling for monetary easing, and there have been rumours that the Peoples Bank of China (PBoC) would loosen reserve requirements for certain banks.
However, authorities may be loosening in other creative ways. According to a Bloomberg report, the PBoC conducted another bigger net injection of liquidity of 100 billion yuan ($15.7 billion), compared to 25 billion yuan a week ago. This has contributed to easier liquidity conditions in a very tight environment. The seven day repurchase rate, which measures interbank funding availability, dropped 35 bps to 4%.
To curb the country’s persisting inflation (6.4% y/y July) the PBoC has raised the benchmark interest rate three times this year, and increased reserve requirements for banks six times. Although food prices have eased domestically in China, cost pressures from higher wages and rentals are still very high, putting further upside pressures to inflation, which has remained persistently outside the 4% informal target.
It is clear that the threats within the developed world of deceleration or even recession, along with Europe’s persistent debt issues, are weighing heavily on the minds of emerging market authorities. World Food prices have stabilized and also eased slightly, which provides some comfort for inflation.
At this stage, it is unlikely that other emerging markets, apart from Brazil, will loosen monetary policy. A more probable strategy is one where monetary authorities hold policy and assess global developments for the remainder of the year.
Xhanti Payi
Assistant Economist
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