Directions (Next Ten Questions) : Read the following passage carefully and answer the questions. Certain words/phrases are given in bold to help you locate them while answering some of the questions.
Brazil does not look like an economy on the verge of overheating. The IMF expects it to shrink by 3% this year, and 1% next (The country has not suffered two straight years of contraction since 1930-31). 1.2 m jobs vanished in September, unemployment has reached 7.6%, up from 4.9% a year ago. Those still in work are finding it harder to make ends meet real (i.e. adjusted for inflation) wages are down 4.3% year-on-year. Despite the weak economy, inflation is nudging double digits. The central bank recently conceded that it will miss its 4.5% inflation target next year. Markets don’t expect it to be met before 2019. If fast-rising prices are simply a passing effect of the Brazilian real (R$) recent fall, which has pushed up the cost of imported goods, then they are not too troubling. But some ‘economists have a more alarming explanation: that Brazil’s budgetary woes are so extreme that they have undermined the central bank’s power to flight inflation—a phenomenon known as fiscal dominance.
The immediate causes of Brazil’s troubles are external: The weak world economy, and China’s faltering appetite for oil and iron ore in particular, have enfeebled both exports and investment. But much of the country’s pain is self-inflicted. The president could have used the commodity windfall from the first term in 2011-14 to trim bloated state, which swallows 36% of GDP in taxes despite offering few decent public services in return. Instead handouts, subsidized loans and costly tax breaks for favoured industries were splurged on. These fuelled a consumption boom, and with it inflation, while hiding the economy’s underlying weaknesses: thick red tape, impenetrable taxes, an unskilled workforce and shoddy infrastructure. The government’s profligacy also left the public finances in tatters. The primary balance (before interest payments) went from a surplus of 3.1% of GDP IN 2011 to a forecast deficit of 0.9% this year. In the same period public debt has swollen to 65% of GDP, an increase of 13 percentage points. That is lower than in many rich countries, but Brazil pays much higher interest on its debt. It will spend 8.5% of GDP this year servicing it, more than any other big country. In September it lost its investment-grade credit rating.
Stagflation of the sort Brazil is experiencing presents central bankers with a dilemma. Raising interest rates to quell inflation might push the economy deeper into recession; lowering them to foster growth might send inflation spiralling out of control. Between October last year and July this year, the country’s rate-setters seemed to prioritise price stability, raising the benchmark Selic rate by three percentage points, to 14.25%, where it remains. The alluring real rates of almost 5% ought to have made the Brazilian Real attractive to investors. Instead, the currency has weakened and rising inflation despite higher interest rates, combined with a doubling of debt-servicing costs in the past three years has led to the diagnosis of fiscal dominance. The cost of servicing Brazil’s debts has become so high, that ates have to be set to keep it manageable rather than to rein in prices. That, in turn, leads to a vicious circle of a falling currency and rising inflation. There is no question, however, that Brazilian monetary policy is at best hobbled. State-owned banks have extended nearly half the country’s credit at low, subsidized rates that bear little relation to the Selic—at a cost of kmore than 40 billion R$ ($ 10 billion) a year to the taxpayer. As private banks have cut lending in the past year, public ones have continued to expand their loan books. All this hampers monetary policy and if left unchecked, this spurt of lending may itself threaten price stability.
