July deflation is synthetic and brings dangers to Brazil for 2023
- August 11, 2022
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The deflation seen in Brazil was driven by tax cuts on fuel and energy, but hides problems for next year, economists say.
The IPCA inflation in July, the main inflation index, was -0.68%, the lowest since 1980, the beginning of the historical series measured by the IBGE. A negative IPCA means that, all in all, there was a drop in the prices of the consumer basket analyzed in the index. But, in practice, analysts heard by the EXAM point out that the variation is still essentially “artificial”, resulting from tax cuts temporarily promoted by the federal government and states.
The drop in the IPCA was driven by two fronts:
- residential electrical energy (which fell by almost 5%);
- fuels (which fell by 14%).
At the other end, the index services core remained under pressure, as well as some essential foods. Milk follows the great villain of the moment, and was the sub-item that most positively impacted the IPCA. The price of milk rose by 25% in July alone and by more than 70% in the year in the face of winter and high cost of feed and other inputs.
“It’s an ‘artificial’ deflation that was largely caused by this drop in fuel and energy”, says Sergio Vale, chief economist at MB Associados.
“The great difficulty of these government measures is that they are temporary and tend to be reversed. And then, almost one point is taken from this year’s inflation and it is put into next year, as already shown in the inflation projections rising to 2023.”
The risks on the horizon
The fall in inflation is invariably positive in the short run: it can put pressure on other prices and increase the real value of wages. But, as mentioned by Vale, from MB Associados, the stakes for 2023 inflation have been rising week after week, amid the temporary nature of the tax cut and fiscal risk.
In the Focus newsletter, IPCA forecast for 2023 rose one point in two months: The consensus went from 4.39% in early June to 5.36% this week.
While projections rise for 2023, they fall for 2022. Until two months ago, the market predicted that inflation in Brazil would end 2022 at close to 9%. With the current deviation in the trajectory, these projections have dropped to 7% or 8%, depending on the house.
Is the worst of inflation over?
After 12 consecutive increases by the Central Bank, the basic interest rate, the Selicis now at 13.75%, the highest since 2016. The big question among economists at the moment is whether the rate will be raised again in September and, next year, whether it will remain higher for longer.
The deflationary result of the IPCA, a point outside the curve of the price trajectory in the country, was already expected, since July was the first month of full effect of the 17% ceiling for ICMS on essential inputs – which included fuel and energy. The Proposed Amendment to the Constitution (PEC) on the subject in Congress was approved in June and the cut is valid until the end of the year.
In the case of fuels, the international scenario also helped. The price of a barrel of oil has dropped below $100, the lowest since the start of the war in Ukraine. For this reason, Petrobras announced two cuts in gasoline tariffs in July — the first since December.
Some residue of this flurry of events is likely to continue into August. The month should have low inflation again and mark the return of the IPCA to less than 10% for the first time since September last year.
Inflationary pressure has given governments a headache all over the world, not just in Brazil. Inflation reached 9% in the US (the highest in 40 years), the UK and the European Union, also driven by high fuel prices with the war in Ukraine and the supply shock generated by the disruptions caused by Covid-19.
But the overall reading is that the worst-case scenario for the price shock may be over. As central banks around the world have raised interest rates rapidly this year, the risk of a global recession has risen. Reacting to this risk – and a possibility of weakened demand in the developed world – the price of oil has retreated in recent weeks.
Brazil, however, continues with a particular fiscal risk that could impact inflation. Changes in the ICMS tax rate on fuels were mostly supported by the states, but the federal government has also recently approved the PEC Kamikazewhich increased Auxílio Brasil to R$600 and introduced a truck driver voucher, among other measures.
“The projections for 2023 have gone up precisely because this bill will have to be paid. In addition to the fact that the ICMS reduction has a deadline, there is a lot of uncertainty for next year”, says Matheus Peçanha, from Ibre/FGV.
The next year brings up and down risks in Brazilian inflation, economists explain. The risk of a global recession pulls commodities down. The rise in interest rates puts pressure on the Brazilian exchange rate and can generate more inflation via a rise in the dollar. Furthermore, with the war in Ukraine undecided and peace talks stalled, geopolitical uncertainty continues.
Weight for the poorest
Peçanha, from Ibre, also points out that a negative highlight of the July IPCA is the ‘de-democratization’ of inflation due to pressure focused on food prices.
“With this deflation process via fuels and energy, those who benefit most are the higher income groups, who consume more gasoline and more electricity”, he says. “Food, the front that continues to rise, penalizes the poorest people more.”
Food had the biggest impact on the July IPCA, with an increase of more than 1.4% in food at home. Despite the general IPCA ending the year below 8%, food inflation should continue in double digits and close at close to 11% in the accumulated.
This month, diesel also went against other fuels and rose 5%, because it already had zero federal taxes and lower ICMS, not having been largely impacted by recent cuts. Peçanha points out that diesel has a low impact on the final IPCA basket (because it is not directed to the final consumer), but indirectly impacts the price of other goods.
In a report after the IPCA result this Tuesday, analysts at Goldman Sachs said that pressures remain “highly widespread” on fronts such as services and other consumer goods, in addition to “a tight labor market scenario and major fiscal stimulus. additional payments for the second half of 2022”. Analysts also assess that price fixing and retroactive salary adjustments can make Brazilian inflation “increasingly inertial”.
“It has an electoral effect this year, which is what the government wanted,” says Vale. “But it greatly hinders the life of the Central Bank in the medium term.”