Gasoline mega-rise could set off a vicious cycle of more inflation, interest rates and public debt

The mega-increase in fuels by Petrobras boosted inflation expectations for 2022 and has the potential to deteriorate Brazil’s macroeconomic scenario until the end of the year, in a vicious cycle of more public debt and pressure on the dollar and food prices.

The impact of gasoline, cooking gas and diesel adjustments is estimated at 1.5 percentage points by Ibre-FGV (Brazilian Institute of Economics of Fundação Getulio Vargas).

That alone, not counting the effect on freight and urban transport, raises this year’s IPCA estimate from 6.2% to 7.5% — but there are banks considering 8.5%.

In addition to fuels, food has already been pushing inflation beyond expectations, which tends to be exacerbated by the current generalized rise in agricultural and metallic commodities.

According to André Braz, inflation analyst at Ibre-FGV, the biggest impact of fuels will be in March (+1.05 percentage points), with an aftermath in April (+0.47%). “But this does not take into account the effects of the ‘spreading’ of fuels on other prices in the economy,” he says.

Rising inflation may require the Central Bank to reinforce interest rate hikes throughout 2022 — and keep the rate high for longer next year.

This year alone, taking into account an average Selic rate of 12% before the mega-increase, Brazil would spend around BRL 900 billion more in public debt interest — twice as much as last year. Considering the estimated primary deficit (revenues minus expenses, not counting interest) of R$ 90 billion for the year and the low growth forecast for the economy, public debt could jump from the current 80% of GDP to almost 85% by the end of 2022 .

For José Francisco de Lima Gonçalves, chief economist at Banco Fator, the increase in public debt (combined with the scenario of low or zero growth this year) could renew pressure on the exchange rate, increasing the value of the dollar further ahead — and putting pressure on it again inflation.

Interest rates (and Brazilian public debt) may rise further considering that the US central banks (Fed) and the Eurozone (ECB) must raise their rates at a faster pace to contain inflationary pressures in their economies – also impacted now by higher prices for gas, gasoline and diesel.

In the US, inflation in February reached 7.9% in the 12-month period – the highest level in 40 years. In the euro zone, it closed at 5.8% in the same period. But the indicators have yet to capture the recent rise in fuel prices triggered by the war in Russia or the new disruptions to global production chains that the conflict is generating.

“Can’t expect anything other than that. [mais juros no Brasil e no mundo para conter a inflação]. And there is no prospect that rates will drop anytime soon,” says economist Affonso Celso Pastore, former president of the Central Bank.

Pastore says that, in addition to the fuel price shock, Brazil has been experiencing upward pressure on food since the end of last year.

Although the dollar has fallen about 12% this year (from R$5.60 to R$5), which makes agricultural commodities cheaper in reais, the international prices of these products jumped 20% in the period. On average, therefore, food (with a weight of 21% in the IPCA) continues to rise in reais.

In this scenario, the surge of more than 30% in the prices of some fertilizers (with production and exports concentrated in Russia) is yet another reason for future concern for food inflation.

As an aggravating factor, the expectation is that the dollar will appreciate again against the real as the Fed and ECB accelerate the withdrawal of monetary stimuli in the US and Europe and start to raise interest rates – attracting international capital to their economies.

“A good part of the dollar’s fall this year has to do with the inflow of money from investors on the US stock exchange to emerging markets such as Brazil. From now on, considering a scenario of possible global recession and high interest rates abroad, buying Brazil no longer seems like a good idea”, says Gonçalves.

In this context, the dollar would have the potential to rise again in Brazil — also putting upward pressure on inflation, interest rates and public debt.