SÃO PAULO — Brazil on Wednesday became the first major economy to raise interest rates this year, a harbinger for other developing countries that may be forced to increase borrowing costs and put in danger their fragile economies.
The central bank’s decision to raise its policy rate to 2.75% from its all-time low of 2% comes as inflation hit a four-year high in Latin America’s largest economy in a context of weakening currency and sharp rise in fuel prices. On top of that, Brazil records nearly a third of all daily Covid-19 deaths globally.
Economists say the tightening of monetary policy in Brazil underscores the risks to emerging markets, many of which have dire prospects compared to developed countries. A strong recovery in the United States drives up long-term bond yields, prompting more investors to buy dollars at the expense of emerging market currencies. This could lead other developing countries to raise their interest rates to stem capital outflows, stifling the economic rebound these countries are counting on.
Brazil’s currency has depreciated by around 10% against the dollar over the past three months as investors pull their money out of riskier markets that got into debt during the pandemic, pushing consumer prices higher as imports become more expensive. Rising oil prices, driven by a strong recovery in Asian demand, also pushed up fuel costs in Brazil, which helped push inflation up to 5.2% in February, near the peak of the central bank target range.
“The global monetary backdrop is changing, and as it always does, unfortunately the most vulnerable economies are the ones that need to respond,” said Alberto Ramos, Goldman Sachs economist. “Brazil falls squarely into this category. “
Brazil is by far the largest emerging market to have raised interest rates in recent months. Ukraine’s central bank surprised economists this month by tightening monetary policy to fight rising inflation. Turkey sharply raised its benchmark interest rate in November and is expected to raise rates again on Thursday as inflation rises.
The sharp rise in US bond yields in recent weeks has awakened memories of the ‘taper tantrum’ of 2013 when US government bond yields rose sharply after the Federal Reserve said it was considering cutting back on buying of bonds, sending shock waves around the world.
The result was a widespread decline in emerging market equity and bond prices and a weakening of emerging market currencies. Some central banks have raised their key interest rates in response, fearing that a sharp drop in their currencies will make it difficult to repay US dollar debts, weaken their financial systems and push inflation up.
This year, the Institute of International Finance, which represents banks, warned that a repeat of the taper tantrum was possible if US bond yields rose too quickly as emerging markets experienced a capital outflow.
In Brazil, growth projections are being stifled by an upsurge in coronavirus infections. As of Tuesday, 2,841 deaths were recorded and health officials expect the number of daily deaths to continue to rise.
This has forced authorities to implement new restrictions on businesses, as President Jair Bolsonaro faces growing anger over his handling of the pandemic.
Mr Bolsonaro has long played down the health risks of the pandemic as he sought to protect the economy by opposing lockdowns and rolling out one of the developing world’s largest stimulus packages. Brazil’s gross domestic product contracted 4.1% in 2020, a much smaller drop than in the rest of Latin America.
But economists say the president’s minimization of the health risks of the pandemic backfires as the economy crumbles and support for Mr Bolsonaro crumbles. A Datafolha poll released on Tuesday found that 54% of Brazilians believe its handling of the pandemic has been bad or very bad, up from 42% in December.
Selma Marconi, a 59-year-old retiree in São Paulo, said she had to cut spending to pay for rising food prices. And she deplores the management of Mr. Bolsonaro.
“It really messed up the economy,” Ms. Marconi said. “I no longer buy products based on the brand, I only look at the price. “
Hopes of quickly ending a pandemic that has killed an estimated 280,000 people here are eroding as government efforts to get enough vaccines collapse. Jason Vieira, chief economist at Infinity Asset Management in São Paulo, said: “The pandemic is hitting hard and we are begging to buy vaccines.
Mr Bolsonaro’s office declined to comment, but Brazil’s health ministry has defended the federal government’s performance, saying it has provided “unrestricted support” to states, cities and the Federal District to fight the pandemic.
The pandemic is forcing Brazil to increase public spending after last year’s stimulus package pushed national debt to record levels, raising concerns about the fiscal position.
Congress approved a new round of emergency household payments last week. Although lower than the cash payments made to millions of families last year, the payments are seen as another driver of inflation.
Investors are also concerned about efforts to control inflation through greater government intervention in the economy. In February, Mr Bolsonaro appointed an army general to replace the managing director of state-controlled oil producer Petrobras after the current market-friendly CEO ignored the president’s criticism of price increases .
Economists say the only way to turn the tide is to stop the spread of the deadly virus. “The best fiscal policy is to vaccinate the population quickly,” Bruno Funchal, Brazilian Treasury chief, told the O Globo news agency.
—Paul Hannon contributed to this article
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