Exit Strategy Has begun in Brazil, Inflation Surprised to the Downside in Mexico


The central bank increased reserve requirements (RR) on bank time deposits by BRL 34 billions, to be effective on April 9, and on additional requirements on time deposits and on demand deposits by BRL 37 billions, to be effective on March 22.   The actions will withdraw a total BRL 71 billion in liquidity from the system.  The RRs were lowered by Q4 2008 in order to provide liquidity to the financial system (BRL 100 billion) during the crisis; however, the central bank considers that the financial system is very liquid and that those measures are no longer necessary. 

In RGE’s view, this indicates that the central bank is reacting to the rapid deterioration in inflation expectations and it is getting ready to tighten the monetary policy rate (SELIC).  Needless to say, this action buys the central bank some time to digest upcoming growth and inflation data likely avoiding a hike next month.  Thus, RGE maintains the view that the COPOM will likely hike interest rates in April, most likely by 50 basis points.

The current account (CA) deficit shrank to US$ 3.8 billion in January 2010 from a US$ 5.9 billion by the end of 2009. The January result was smaller than expected. The sharp reduction in the net services and income deficit, mainly on the back of smaller profit repatriation of US$ 0.8 billion from US$ 5.3 billion in December, eased the pace of deterioration in the current account.  The latter was strong enough to compensate for the sharp deterioration in the merchandise trade balance, which moved to a US$ 0.2 billion deficit from a US$ 2.2 billion in December. On a 12 month rolling basis, however, the current account deficit widened to US$ 25.1 billion (1.56% of GDP) from US$ 24 billion in 2009. Meanwhile, the capital account surplus shrank to US$ 6.2 billion from US$ 11.1 billion in December as FDI dropped significantly to US$ 0.8 billion from US$ 5.1 billion and Brazilians invested abroad US$1.2 billion. Portfolio inflows stayed strong at US$ 3.7 billion from US$ 3 billion in December. In sum, the balance of payments posted a smaller US$ 2.2 billion surplus in January from US$ 4.4 billion in December while international reserves increased to US$ 240.8 billion after the central bank bought US$ 1.77 billion at the beginning of 2010.

RGE maintains the view that the current account deficit will likely widen to about US$ 49 billion (3.1% of GDP) in 2010 from US$ 25 billion in 2009, as domestic demand grows stronger than external demand. High foreign investment and a solid international reserves position (20% of GDP) should ease concerns about balance of payments risks, though as the CA widens the more dependent the economy becomes on external financing and the more vulnerable it is to swift changes in risk appetite and global liquidity conditions.  The CA deterioration is one of the main weakening drivers for the local currency.

FGV’s consumer confidence index (CCI) retreated 2.2% m/m s.a. in February to 110.2 mainly affected by a 3% m/m s.a. deterioration on expectations about the future, despite a 0.8% m/m s.a. improvement on current conditions.  On a yearly basis, CCI increased 15.3% y/y driven by current conditions, up 24.2% y/y, and to a lesser extent by expectations, up 10.2% y/y.

In RGE’s view consumer confidence remains at elevated levels and the deterioration is likely to be in response to high actual inflation and a sharp deterioration in inflation expectations so far this year.

The consolidated primary surplus increased sharply in January to BRL 16.2 billion (6.1% of GDP) from a BRL 7.36 billion (3.1% of GDP) surplus posted in January 2009, mainly as a result of a sharp increase in the central government primary surplus to BRL 13.5 billion (5.1% of GDP) from BRL 4.8 billion surplus in January 2009.  Strong economic activity is boosting tax collections (17.6% y/y vs. 17.3% 3MMA) while the government somewhat contained spending (2% y/y vs. 11% y/y 3MMA).

As expressed in RGE’s Q1 2010 Brazil Outlook, the strong economic recovery should have a positive effect on the government’s income and fiscal spending will likely accelerate as general elections approach, bringing the primary surplus to around 2.7% of GDP. The high fiscal primary surplus printed in January should ease excessive market concerns on Brazil fiscal management. The government expects a 3.3% of GDP consolidated primary fiscal surplus.  

The unemployment rate surprised positively to the downside by posting 7.2% in January (Bloomberg consensus 7.6%; RGE 7.7%).  The unemployment rate was 8.2% in January 2009 and 6.8% in December 2009.  The rapid increase in employment (2.1% y/y) and in the labor force (1.1% y/y) pushed unemployment lower on a yearly basis, thus, lowering the number of unemployed people by 11% y/y.  Meanwhile, real wages increased 1.1% m/m s.a. but dropped 0.4% y/y, according to IBGE.

The low unemployment reading in January suggests that labor dynamics continue to improve rapidly and will support consumption.  RGE expects average unemployment to drop to 7.6% in 2010 (8.1% in 2009) and the economy to expand 5.3% in 2010.


Inflation for mid-February surprised positively by printing lower than expected readings and indicating that demand pull inflation is contained so far.  Lower inflation prints in the goods (tradable) and services categories (non-tradable) within the core component, together with a decline in agricultural prices, limited upward inflation pressures stemming from regulated prices. That is stable/strong currency and slowly closing of the output gap, along with the easing of recent adverse weather conditions on fruits and vegetables prices, contained the effect of the higher taxes and public fares on headline inflation.

The trade balance for January posted a US$ 333 deficit, shrinking the 12 month rolling basis deficit to US$ 3.45 billion in January from a US$ 4.68 billion deficit in 2009.  Strong manufacturing exports, driven by strong U.S. demand and high oil prices kept total exports growing at a faster pace.  Concurrently, surging consumer and strong intermediate imports boosted purchases from abroad.  However, capital imports deteriorated further.

The current account (CA) deficit for Q4 2009 came in worse than expected at USD 690 million (Bloomberg consensus -US$ 175 million; RGE –US$ 200 million); however, it improved compared to a US$ 3.7 billion and US$ 6.7 billion deficits posted in Q3 2009 and Q4 2008, respectively.  The much smaller trade deficit and net transfers lowered the CA shortage.   The rapid recovery in manufacturing and oil exports helped the trade deficit while lower family remittances affected net transfers.  In 2009, the current account shrank significantly to US$ 5.2 billion (-0.6% of GDP) from US$ 15.9 billion (-1.6% of GDP) in 2008 as domestic demand collapsed pushing imports deep in the red.  Meanwhile the capital account (KA) surged in Q4 2009 to US$ 13.8 billion from US$ 6.5 billion in Q3 2009 and US$ 12 billion in Q4 2008.  Strong foreign investment, particularly private and public borrowing, together with solid portfolio inflows pushed the KA upwards, balancing the sharp drop in FDI to US$ 0.7 billion from US$ 1.6 billion in Q3 2009 and US$ 6 billion in Q4 2008. In 2009, the KA shrank to US$ 14.5 billion (1.7% of GDP) from US$ 24.5 billion (2.4% of GDP) in 2008 mainly because of Mexicans direct investment abroad (USD 7.6 billion vs. US$ 1.1 billion in 2008) and softer foreign investment (US$ 26.7 billion vs. US$ 28 billion in 2008).  In sum, the balance of payments dropped slightly to US$ 5.3 billion (0.6% of GDP) in 2009 from US$ 7.4 billion (0.7% of GDP) in 2009, while international reserves increased by US$ 5.4 billion to US$ 90.8 billion in 2009.

The inflation reading for mid-February indicates that upward pressures on prices that appeared in January are wearing out and strong demand pull inflation pressures are still absent.  This is in line w
ith RGE’s view that the central bank will wait until perhaps H2 2010 to start withdrawing excess accommodation.  RGE expects Mexico’s central bank to tighten the “tasa de fondeo” by at least 50 basis points from the current 4.5% by year end. The international trade figures suggest that consumption (consumer imports) and the industrial sector (intermediate imports) continue to grow strongly at the beginning of 2010; however, investment (capital imports) appears to be somewhat sluggish, despite improving business confidence.  RGE points out that total trade (exports plus imports), which accounts for about 70% of GDP, continued accelerating to 21.6% y/y from -0.2% 3MMA, signifying positive momentum for the service sector. Finally, RGE expects the current account deficit to widen sharply to US$ 11 billion (1.3% of GDP) in 2010 as domestic demand rebounds and grows faster that external demand.  On the KA, FDI should bounce back on expectations of strong economic activity in 2010 while Mexicans repatriate their capital.  The main risk to this scenario is a “W” business cycle in the U.S and a dramatic deterioration in global risk appetite and global liquidity conditions.


The central bank of Chile released its semi-monthly expectations survey for CPI, Monetary Policy Rate (TPM) and Exchange Rate. Market expectations for the following 12 months dropped to 2.50% (RGE 2.6%) rate from 2.60% in the last survey. Expectations for the TPM are on the rise and somewhat more aggressive than in the previous surveys, as analysts are expecting the central bank to start hiking rates. The TPM for 6 months is expected to be in 1.25% vs. 1% previously, while the 12 months-ahead rate remains unchanged at 2.75% (RGE 3%).  However, the 24 months-ahead rate (year-end 2011) climbed to 5.25% (RGE 5%) from 5.00%. Exchange rate expectations for year-end 2010 remain anchored at USD/CLP 525 (RGE CLP 5.13), although expectations for the short run have climbed slightly, from USD/CLP 5.20 to USD/CLP 5.25 for the three-months-ahead rate.

What else is cooking in LatAm?

When Will Brazil’s Central Bank Start the Tightening Cycle?  

What Is Argentina Doing to Re-enter the International Capital Markets? What About the IMF?  

Uruguayan Presidential Elections: Will there be Continuity?

PDVSA and Venezuela’s Fonden

Free Trade Agreements for Andean Countries and the Rest of the World



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