Wednesday, 21 January 2009

Brazil Rate-Cut ... Despite Its Conservative Credentials, Meirelles' Boys Will Trim Selic by 75 Basis Points

A few days ago, one reader said the reasons I gave for the 75-basis-points reduction in the Selic were wrong. Espúreas, fue mi interpretación. I insist -- I put the inflation factor as first reason behind any decision to cut borrowing costs. But the second, the reader likes it or not, is linked to the ability of companies to refinance their debts abroad. Demand for Brazilian exports is weak, very weak; confidence is reaching record lows (perhaps it did already reach bottom); credit is contracting; and there's not much fiscal room to act as many assume. Despite the Monetary Policy Committee's conservative credentials, a half-percentage rate cut is quite unlikely.The situation requires action, determination. Such a cut would be seen as shy, even coward for such a conservative economic policy-making body like the COPOM.

I insist in the issue of corporate creditworthiness. One thing that Brazil cannot afford now is to see its companies falling into insolvency because of retarded government action. And this is occurring despite the administration's aggressive action to ensure that steady flow of credit reaches companies. The Copom will have to mention that at some point, because labour issues such as wages and compulsory contributions will become a burden for corporates at some point and, as we know, they are rigid to the downside. Second, because the cost of past investments will begin to haunt these companies, and force them to pare the ongoing or future projects. We know this has an effect on future inflation perceptions, via future installed capacity. The Copom is surely thinking about all this and gauging a measured yet aggressive cut. My call continues to be a reduction of 75 basis points to 13 percent -- that will have no impact on either stocks or bond prices.

On the same token, a 100 basis-point reduction -- which looks exaggerated for the Copom, -- should not be ruled out. The move would spark some optimism among Brazil's disheartened executives and workers. If such decision was to be taken, it is because the Copom would be very worried about the ongoing deterioration in business sentiment. The first catalyst would be the stock market -- so, dear reader, remain very attentive to the announcement text tonight.

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