Hot spots: Brazil.(international)

What a difference a few years can make!

The economy is about to enjoy another year of strong growth with relatively low inflation. Real gross domestic product expanded by 5.4% in 2007. While wage increases that outstripped inflation powered consumer spending, business outlays were encouraged by a steady decline in interest rates, as the Central Bank (CB) lowered its benchmark Selic rate 18 times from 19.75% to 11.25% in the two years through last September. Household consumption was up 8.6% in 2007's final quarter. Gross fixed capital formation was some 16% higher. And bank lending rose by 27.3% last year, for the largest annual advance since 1995.

At this point, both the industrial and agricultural sectors are continuing to put in an impressive performance, and there is talk that the country will create a record number of new jobs this year, to the tune of 1.8 million versus 1.62 million in 2007. Foreign demand will stay brisk for Brazilian export products and commodities as diverse as soy, ethanol and iron ore. Indications are that the local credit markets are not seriously affected by the U.S.-spawned subprime debt crisis and are maintaining (to a large extent) business as usual, although spreads are up a bit and the pace of activity has shown some signs of slowing. As a rule, Brazilian companies have relatively little debt and the country's total stock of credit, at roughly 35% of GDP, is much smaller than in many other lands.

It may well rise to 40% of GDP in the current year. There is plenty of liquidity available from domestic sources, relatively unaffected by international conditions, and corporate loan demand is strong even though the average annual interest rate Brazilian banks charge customers has edged up to 37.4% from 37.3% in January. There is some risk that if rainfall remains scarce in the weeks ahead and reservoirs do not recover enough to carry the country through the dry season (between May and October), Brazil will be short of energy and may have to impose some sort of preventative rationing. Hydroelectric plants provide 85% of electricity, and while the government has sought to plug the gap with thermal power plants, Bolivia has not been fulfilling its contracts for the supply of natural gas.

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Also to be considered, the failure of the legislature last December to extend the validity of the CPMF financial transactions tax is taking an estimated 40 billion reais out of the government's pocket this year. Efforts to make up the shortfall with other taxes and spending cuts have run into resistance in the Senate. The rapid further decline in interest rates on which the government had been counting to strengthen the fiscus is not, now, likely to materialize. Quite to the contrary, the CB will be sorely tempted to hike rates to constrain inflation. But these trends are not threatening to put the authorities into a difficult fiscal position. The primary balance will remain in surplus. The worst that the CPMF defeat is apt to accomplish is a delay in Brazil obtaining the coveted investment-grade credit rating.