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With High Inflation and Low Growth Brazil Doesn’t Know What to Do With Its Interest Rate

Inflation fear in BrazilBrazilian analysts believe Brazil’s central bank will leave its benchmark interest rate unchanged at 11% this week, with the world’s seventh-largest economy caught between rising inflation and sluggish growth. But given the persistence of inflation it should not come as a surprise if the monetary policy committee raises Selic to 11.25% after its two-day meeting this week.

Analysts surveyed in the weekly Central Bank Focus poll said the bank would likely leave the rate unchanged. The rate has been at 11 percent since early April, when the bank raised it 0.25 percentage points in the last of nine consecutive increases aimed at stopping inflation.

Brazil registered annual inflation of 6.28% in April, up 0.67 points and dangerously close to the official maximum target of 6.5%.

In effect although economic activity is weak and that could lead the bank to leave the rate unchanged, the inflation situation is very worrying.

The decision comes at a delicate time, with President Dilma Rousseff seeking reelection in October.

Economic growth, after hitting 7.5% in 2010, slowed sharply over the next three years and came in at just 2.3% last year. The central bank is forecasting growth of 2% this year.

Consumption is a major engine of the 200-million population economy and when Dilma took office the bank sought to spur growth with a cycle of expansionary monetary policy, cutting the Selic to an all-time low of 7.25% over the course of a year. But in April 2013 the bank began raising the rate again when inflation started climbing.

The performance of the economy is also eroding Dilma’s bid for re-election with a sustained drop in opinion polls, although still manageable. But her political allies are nervous and a “Come back” Lula campaign had to be aborted by the former president himself. Lula da Silva is the political mentor of Dilma.

Pre-salt Projects

Brazil’s government is considering proposals to open operatorship of its pre-salt projects to companies other than state-run Petrobras and this change might be made, Mayer Brown partner Alexandre R. Chequer told the law’s firm’s annual energy conference in Houston last week.

“There is too much oil for one company to develop,” Chequer said. “I think the government realized it made a big mistake” in stipulating that Petrobras operate all pre-salt projects offshore Brazil.

While Brazil was establishing a new policy structure for pre-salt developments, its oil and gas bid rounds were stopped for 5 years.

The Brazilian government is the controlling shareholder of Petrobras. Chequer said he believes Brazilian officials realize Petrobras needs help with finances and technology on developing the pre-salt resources.

“They realize they need private companies, they need investors,” Chequer said. Petrobras plans to invest 221 billion dollars total during 2014-18 with 154 billion earmarked for exploration and production activities, including development of pre-salt resources in the Atlantic Ocean’s deep water offshore southeastern Brazil.

Chequer noted that Brazil’s government has honored all the oil and gas contracts that it has signed. Brazil has a presidential election scheduled for this year, but Chequer said he doubts that the election results will have any impact on existing contracts.

Petrobras has encountered a series of delays in the Atlantic’s deep waters. Meanwhile, Brazil’s production has stayed flat because of faster-than-expected declines in Campos basin oil fields.

Mercopress

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