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European Dilemmas

By Liam Denning

Brazilian monetary policy is determined in Brasilia, is not it? Perhaps Beijing, Frankfurt and Washington are a better answer. Foreign investors should take note.

Brazil is in a bind. Although the April data on consumer prices released last week exceeded expectations, inflation remains well above the central bank's target. Although the seasonal fall in food prices and fuel prices should help in the coming months, inflation underlying is proving a tough nut to crack.

Brazil is sensitive to that, given its history of hyperinflation. That is the reason I have a very high real interest rate of almost 6%. But this attracts foreign speculators. Although the measures were targeted as taxes, the real has strengthened steadily against the dollar. Exporters are being harmed and the head of the Brazilian division of Siemens warned that exchange controls may be necessary to avoid the "deindustrialization."

however, raise the cost adopting capital controls change does not seem a convenient option to take into account the high interest rates. The country already suffering from weak investment in fixed assets, exacerbating inflation through the logistical bottlenecks that exist due to poor infrastructure.

If Brazil remains committed to its policy of combating both inflation and exchange rate appreciation, must rely on help from others. The decline in last week's appetite for risk by investors helped on several fronts. Probably not only discouraged some income from speculative capital but also strengthening cooled to the dollar and commodity prices.

Looking ahead, it is likely that problems related to the real pressure on the Greek debt as investors buy dollars. In the end, however, Brazil needs a less lax U.S. monetary policy. A stronger dollar would reduce pressures on commodity prices and, to strengthen the yuan is tied to the dollar, making imports from China, Brazil's main trading partner, to become less competitive.

is a gamble. If the stars do not line up that way, Brazilian exporters should be prepared to suffer more and investors to higher interest rates.

Source: WSJ