Poor government policy and slowing demand for natural resources are plaguing the world’s 7th largest economy.
Brazil’s central bank now forecasts that the once high-flying emerging market economy will shrink by 2.7% this year—the worst contraction in a quarter century, Fortune reported.
The revised forecast comes as Brazil’s currency, the real, has reached new lows against the dollar, and the unemployment rate has surged, hitting 7.6% in August, the eighth-straight month of increase.
The troubles in the world’s 7th largest economy are the result of a slowdown in growth in places such as China, which has been a key source of demand for Brazil’s natural-resources industry. But Brazilian policy is also to blame, as its significant budget deficit of 8% of GDP has helped feed inflation and higher interest rates.
“I am disillusioned and upset with what’s happening,” reformist economist Edmar Bacha, told the Wall Street Journal. “All the work that we all did to create the real, to create stability, was destroyed” by poor policy.
Brazil is just one of many emerging market economies—along with Turkey, Russia and China—that have seen sharp slowdowns in growth. While this trouble abroad has yet to significantly hurt growth in the US, there are reasons to believe that trouble in developing economies could eventually wash up on American shores. That’s because most of the investment growth in the global economy since the financial crisis has been driven by the emerging world.
Inflation to Rise
Brazil’s Central Bank has increased once again its forecast for inflation this year. According to the latest quarterly inflation report, released on Thursday by the institution, inflation in 2015 should increase to 9.5% from the 9% forecast in June, while the Selic (benchmark interest rate) should remain at 14.25% until the end of the year.
In a surprising move, Central Bank President Alexandre Tombini himself attended the press conference to talk about the details of the report and answer questions by reporters.
According to Tombini, Brazil’s monetary policy strategy is to maintain the current 14.25% Selic ‘for a prolonged period of time’. The Central Bank president told reporters that the volatility seen in markets in the past week would not guide the future trajectory of the Selic, “It (increased interest rate) will not serve to guide the monetary policy during the upcoming months,” he stated.
Tombini also told reporters that the Central Bank was working with the treasury department and would be willing to sell international reserves to decrease the strong volatility seen in the foreign exchange market in the past few days. The Brazilian real opened down on Thursday and before the press conference was at R$4.24 to US$1. After the meeting the dollar currency registered a slight depreciation, closing the day at R$3.99 to $1.
The central bank stated in its report that after a period of high volatility the rhythm of economic activity should once again start to increase. In the medium term, concludes the report, consumption tends to grow and investments should increase.
Domestic Turmoil
The selloff in Brazilian assets has picked up pace as President Dilma Rousseff fends off impeachment speculation less than a year into her second term and struggles to win lawmakers’ support for measures to shore up the nation’s accounts, Bloomberg reported.
“What is really amazing about it is the speed of the deterioration since the election,” says Geoffrey Dennis, the head of global emerging-market strategy at UBS Securities. “All the sources of growth in Brazil have disappeared.”
Brazil’s domestic turmoil couldn’t come at a worse time. Emerging markets around the world are declining on speculation that slowing growth in China will damage the global economy and that an increase in US interest rates will lure capital away from developing nations. Still, Brazil’s decline has been more pronounced.
