Brazil Tries to Cool Its Economic Growth

Dec. 7.10 | About: iShares MSCI (EWZ)

While the Fed tries to mechanically stimulate our economy, Brazil is trying to cool its jets as its economy expands at the fastest pace in twenty years.

The central bank increased the reserve requirement for banks to 20%, from 15%, and the move, which takes effect today, is expected to remove $36 billion from circulation. The effort is meant to calm the rapid expansion of consumer credit (and inflation), and as the central bank president said the increase “reduces liquidity in the financial markets and inhibits the formation of non-sustainable trends…the bubbles." Consumer lending is growing around 20% annually.

The higher reserve ratio will soak up liquidity…and decrease banks capacity to extend credit (outstanding consumer credit rose to a record $438 billion in October).

But what the move really did was lessen the expectation that the central bank will increase interest rates further to tighten the economy’s growth (the benchmark rate was increased to 10.75% in July). And that matters: higher rates stand to strengthen the real, which has already more than doubled against the dollar since 2003. After all, it was Brazil’s Finance Minister who warned of a global “currency war” back in September.

And while the central bank tries to rein in growth and prevent a credit bubble, government policies are causing other problems. In particular, the government’s “super crazy” tax policies are the reason Steve Jobs gave for why Apple (AAPl) hasn’t opened a store there. And that matters…a lot.

It’s matter because it speaks to a bigger problem. Taxing technology imports is a great way to prevent a country’s workforce from developing into what it needs to be to keep pace in a growing domestic, and global, economy. And today, knowledge workers are in scant supple in Brazil… and that could jeopardize growth.

Foreign Affairs put it best:

The challenge for Brazil now is to not let an exaggerated self-image eclipse its focus on balancing the constraints faced at home with the opportunities available abroad.

The bottom line: Brazil faces challenges, but as an export-oriented economy they stand to gain from global commodity demand. First, the country is the world leader in soybeans. Then there’s orange juice (80% of global supply), coffee, iron ore and sugar. And exports account for 14% of GDP (a recent central bank survey suggests GDP of 7.55% for this year).

Disclosure: I am long EWZ.