Brazil Risks Recession to Raise Interest Rates

March 5, 2015Brazilby EW News Desk Team

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Brazil, Latin America's biggest economy, is risking a recession as politicians and policy makers make a desperate gamble to bring down inflation. The push is led by Brazilian President Dilma Rousseff who has promised to do "whatever it takes" to lower inflation and win back investor confidences.

The move comes as other major central banks around the world are cutting their interest rates. Most other major economic players have lowered rates in response to the dramatic drop in oil prices and forecasts of slower global economic growth. These include Canada, Denmark, India, and Turkey, as well as the European Central Bank which introduced a massive bond buying initiate.

For the short term, the strategy appears to be paying off. Investors, have been cautiously buying Brazilian government bonds and driving long-term interest rates lower. The Brazilian Real has gained 3 percent since the start of the new year and local-currency government bonds are showing returns of 4.9 percent in dollar terms.

Brazilian President Rousseff has generally had to contend with a weak economy, spiraling confidence from the business sector, corruption scandals, and energy blackouts. As such, the boost presented by this bold policy is a rare bright spot in her administration. 

Dollars have been flowing into the Brazilian economy as investors try to take advantage of one of the world's highest interest rates. Still, this policy sets Brazil's Central Bank on a very dangerous path that could lead to a massive recession for the second time in less than two years. Should things turn sour, many question whether Rousseff would have the ability to stick with unpopular measures, like the rate hikes. Such a reversal, coupled with a pullback from recent austerity measures could put Brazil's economy into a tailspin as investors yank their money back out of the country. 

The rising interest rates have diminished Brazilians' buying power, making retail sales, mortgages, and other expenditures increasingly painful. This has led many financial analysts to predict a tough year ahead for Brazil in 2015. This, coupled with a recently uncovered, and still widening corruption scandal at the state-run oil company, Petrobras, which has greatly diminished investments in Brazil's oil sector, has many dubious of the Rousseff plan's long-term benefits. 

Nevertheless, the Central Bank appears poised to raise the base Selic rate by another 50 basis points. As a result, many banks around the world are slashing their forecasts for Brazil's economic growth. Some have even predicted an economic contraction for 2015.

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