Brazil: return of the “inflationary dragon”?

RIO DE JANEIRO, Brazil — Economic abstractions aren’t generally crowd-pleasers in major political speeches, particularly a president’s inaugural address.

But in her first public speech as president, Brazil’s Dilma Rousseff made a point of addressing worries about inflation.

“We will not, under any circumstances, allow this plague to return and corrode the fabric of our economy and punish the poorest families,” Rousseff said in a speech before the nation’s congress on Jan. 1.

To understand her peculiar rhetorical choice, it helps to keep two facts about Brazil in mind: First, the country has a traumatic history with inflation. After decades of precipitous price hikes, inflation came to be known as “the dragon” in Brazilian slang. Second, the country’s presently booming — possibly overheated — economy has some observers worried the dragon might return.

In 2010, Brazil posted its highest inflation rates in six years, 5.91 percent by December, according to one index. On Monday, another index found the rate of the price increases has accelerated in the first week of this year.

The present numbers aren’t catastrophic, but the more inflation creeps above the government’s target rate of 4.5 percent, the more analysts and Brazilians are starting to worry.

“There is no such thing as some inflation,” said Alexandre Barros, an economist and political consultant based in Brasilia. “You either have it or you don’t and it always tends to accelerate. It’s very easy to make inflation and very hard to stop it.”

Bouts of high inflation have plagued Brazil for a century, dramatically stalling the country’s growth in the 1980s and early 1990s when it peaked at more than 30,000 percent. Between 1940 and 1995, Brazil adopted eight different currencies — beginning with the cruzeiro and ending with the real — repeatedly renaming the currency rather than simply lopping off strings of zeroes.

“It was in part a psychological trick to convince Brazilians that the government was starting afresh, with new, more disciplined policies, but the result was always a failure,” author Larry Rohter wrote in “Brazil on the Rise,” a book on Brazil’s present economic boom.

When the problem was at its worst, in the late 1980s and early 1990s, Rohter wrote, “workers rushed to spend their entire paychecks as soon as they received them, knowing that if they did not, the value of their wages would erode so quickly that by the end of the month basic food staples such as rice, beans or eggs could easily double in price.”

David Fleischer, a political analyst who has lived in Brazil for more than four decades, remembers the period well. “It was extremely traumatic,” he said. “It hurt the poor the most.”

Such memories were likely close at hand when Brazil’s new president described inflation as a “plague.” A big part of last year’s increase corresponded to rising world food prices, but there’s a risk that increased food costs could in turn push up the prices of other goods and services, said Bertrand Delgado, chief economist with the research firm Roubini Global Economics. The danger is that the price hikes could spiral out of control if the government doesn’t act now.

“I think it should be the highest priority,” Delgado said, “since the new administration is pushing an agenda to eradicate poverty and we know that the worst enemy of poverty is high inflation.”

Given her government’s public statements, Rousseff seems to be taking the threat seriously.

Most analysts expect the Central Bank to raise interest rates later this month, which generally helps contain inflation by reducing lending and, thus, the amount of money in circulation. And Rousseff has also pledged to cut government spending, which increased 44 percent between 2008 and 2010.

Rousseff’s predecessor, Luiz Inacio Lula da Silva, boosted public spending in 2008 to help mitigate the effects of the global recession. But the spree continued unnecessarily throughout 2010 in a classic election-year ploy, said Tony Volpon, a Latin America analyst at Nomura Securities in New York City. Rousseff must now face the inflationary consequences of all that spending.

“It’s the hangover from the party the country had last year,” Volpon said.

He’s confident the president will follow through on promises of spending cuts, which also should help quell demand and keep inflation in check.

But in the meantime, he worries that inflation-fighting measures such as raising interest rates will exacerbate one of Brazil’s other chief economic problems: The Brazilian real has surged 39 percent against the dollar in the last two years, putting it in the running to be the most overvalued currency on earth.

Part of the cause is that Brazilian interest rates — among the world’s highest — attract huge quantities of foreign money from investors eager for returns many times higher than those in the United States and Europe. Raising rates again will only serve to attract more of this so-called “hot money” into an already inflated economy.

Analysts differ over which problem — inflation or an overvalued currency — poses the biggest risk. But Volpon says both have roots in the last few years of prolific government spending. And he says fiscal restraint is the key to getting the economy back on track.

“The inflation problem that Brazil is having is just the other side of the currency problem,” he said. “Brazil can’t go on this path for much longer without facing a fairly serious crisis.”