1. Brazil: Economic Challenges in 2012 and Beyond Monica Baumgarten de Bolle Galanto Consultoria 19/01/2012

2. And the crowds kept looking for pharmacies where the bitter tropics could be found... Federico García Lorca

3. The Brazilian Elixir...  Sustained growth, even in the midst of an extremely difficult global environment.  A resilient consumer, spurred by income growth, favorable labor market conditions, the availability of credit, and income transfer programs.  A government with the ability to ease policies to boost growth, if needed. A rarity these days... Galanto Consultoria3

4. But Recent Changes in the Policy Framework are Worrisome  2011 – a substantial shift in economic policy, motivated by: An increasingly hostile external environment; The desire to promote growth, despite the existing structural bottlenecks. Fatigue with the so-called policy triad, particularly with the “strict” inflation targeting regime adopted from 1999 until 2010. Galanto Consultoria4

5. In a Hostile Environment…  Preserving growth is a sound and legitimate objective. But: Too much emphasis on how the international crisis might affect activity in Brazil (understandable); an unduly “modest” concern about inflation. Inflation is symptomatic of a number of structural problems which are not being addressed; it is not just the result of a series of idiosyncratic shocks:  Very low labor productivity in an extremely tight labor market – bad price-wage dynamics, particularly in the labor-intensive services sector.  Lack of infrastructure and onerous tax structure – high production costs and low competitiveness. 5

6. Structural Problems Affect The Cost of Living Galanto Consultoria6

7. Structural Problems and Competitiveness Galanto Consultoria7

8. Productivity and Real Wages Galanto Consultoria8

9. Desire to Promote Growth  In this context, the desire to promote growth without regard to the existing structural impediments will tend to amplify these imbalances.  Particularly since the government´s “growth formula” appears to be a mix of income transfer policies + cheap public credit, and a model of growth fueled by consumption. The stock of household debt is not high, but flows are compromised by high and rising debt service obligations. Galanto Consultoria9

10. Inflation Targeting Fatigue without a Growth Agenda  The Central Bank is operating a de facto dual mandate: growth and inflation (or “flexible inflation targeting”). Change is driven by concerns over the external outlook, particularly the effects of the European crisis.  But change has also been influenced by the government´s disappointment over the very slow reduction in nominal and real interest rates. Hence the revision of the “policy mix” – less fiscal, more monetary.  Big and looming questions over “less fiscal”.  Piecemeal policies to boost growth, monetary and credit easing, and difficulties in maintaining fiscal restraint = entrenched inflation. Galanto Consultoria10

11. Despite all of this... ...in a deteriorating global environment, driven by a contracting and highly indebted Europe, a still weak US economy (not to mention political difficulties in key countries), and a decelerating China...  The crowds will still flood the pharmacies, looking for that bitter tropical elixir.  (And only a few will fret over the worsening growth-inflation trade-off). Galanto Consultoria11

12. Obrigada! Galanto Consultoria12