Sergio Resende waved his hand vaguely in the direction of three small displays of postal supplies in his spotless, brightly lit store, a Brazilian franchise of the US chain PostNet.
“I am going to have to figure out what to do with the prices,” said Resende, the store’s owner. “Maybe I should take off all the stickers and just keep them on the computer.
“The problem is,” he added, “that when you do that, people think that you are making up prices as you go along.”
For local store owners and consumers alike, the January free fall of the real has set off fears of the return of a ghost that was once considered long dead: Inflation.
Brazilians’ paranoia about inflation is as justifiable as it is unmistakable. Resende’s tiny, handwritten price stickers are an important reminder of the success of the country’s Real Plan, which brought inflation down from 310% a year in 1994 to a negative 1.8% last year, according to the Fipe index.
Before stabilization, prices would change every day, and often several times a day, meaning that shopkeepers had to come up with ingenious pricing schemes just to keep up with the growing numbers.
The large majority of Brazilians who didn’t earn enough to protect their wages in a bank account were forced to purchase a week’s or a month’s supply of groceries as fast as they could run to the store. Middle-class consumers learned to pay for all of their purchases with checks or debit cards from funds in their savings accounts. It was only just recently that paper currency had started to reappear in wallets and pocketbooks throughout the country.
After the Asia crisis hit 18 months ago, though, Brazilians began to get jittery again.
And President Fernando Henrique Cardoso, who had engineered the Real Plan, capitalized on those nerves to get himself re-elected last October, despite a deepening recession and extremely unpalatable fiscal adjustment measures.
But as soon as Cardoso won the political game, he lost the economic one. Less than two weeks after his January inauguration to a second four-year term, the central bank’s palliative 8% widening of the exchange rate bands flew wildly out of control, forcing the government to let the real float. By the end of January, the value of the currency had fallen by 40% in relation to the dollar. And the government and the markets were still waiting for the currency to find its equilibrium point.
For Brazilians, what started as a bout of nerves threatened to turn into a full-fledged panic attack as it became clear that the Real Plan was teetering precariously close to failure. Because the plan had always been so closely tied to the taming of inflation, it seemed logical that the end of the exchange rate mechanism would bring the return of price hikes.
“Everybody knows that in a country that has a history of inflation, the expectations are hard to beat,” said Jaime Sanz, head of Latin American sovereign ratings at Duff&Phelps. “The psychology forces everybody to the extreme.”
So far, though, the country seems to be adopting a wait-and-see outlook.
“I have been watching prices in São Paulo for twenty years,” said Heron do Carmo, coordinator of the IPC inflation index at the Foundation Institute of Economic Research (Fipe) at the University of São Paulo. “And what we used to notice was that the same day that prices were increased on, say, gasoline, there would be similar increases in products that were completely unrelated. So if gas went up 20%, floor wax would go up 20% also.
Despite the exchange rate, we are not feeling any of this type of generalized pressure on prices.”
Part of the reason for the lack of general inflation pressure was the end of price indexation that occurred when the real was introduced in 1994. As long as the government doesn’t try to reinstitute some form of price controls-and it vows that it won’t-economists say that the days of irrational inflation are over.
But in order to calm consumers and manage expectations, the government has been outwardly critical in recent weeks of companies that may try to take advantage of the current exchange environment by hiking prices.
Cardoso himself sparked the war of words when, in a January news conference, he threatened to lower import duties to punish any industries that attempted to unfairly increase domestic prices. Whether he will follow through with his threats is not entirely clear.
“It is all done with mirrors here,” said Paul Bydalek, president of Atlantic Rating and a 40-year resident of Brazil. “There is always much more appearance than substance in Brazil.”
But when General Motors, in the first week of the real float, announced that it would increase prices by 11%, the uproar in the government and the media caused the company to beat a hasty retreat, reducing its expected price hikes to a little over 5%.
Although the government didn’t officially intervene in the General Motors case, the Justice Ministry, in conjunction with the Brazilian Institute of Geography and Statistics (Ibge) and the Institute for Applied Statistics (Ipea), has since launched action to punish companies that undertake what are considered to be abusive price increases.
Under the new system, the Justice Ministry selectively chooses among consumer complaints and can apply fines of up to R$3 million.
“We are trying to undertake a project that is more educational than repressive,” said Eliane Thompson, the acting head of the economic rights department at the Justice Ministry. “We want to explain to the economy that for the simple fact that there has been a devaluation does not mean that all of the sectors have to readjust.
“Certainly the companies that have imported components are going to have to do some readjustment if the market allows,” she added. “What we can’t allow, and what the government won’t accept, is from one hour to the next, companies acting as if the economy were dollarized. There is no justification for this.”
But economists worry about the government wielding too heavy a hand in the free market.
“I think that it is important that the government abandons that type of discourse,” said Fipe’s do Carmo. “The more the government announces that it is going to control something the more it contributes to the increase in prices.”
He argues that prices of tradable and non-tradable goods must be allowed to find their natural equilibrium so that the economy can renew growth.
Just how much prices are expected to increase is the question on everyone’s mind.
Dalton Gardiman, chief economist at Deutsche Bank in São Paulo predicts “less than double digit” inflation as long as the exchange rate settles back to around 1.50 or 1.60 at its equilibrium.
At Fipe, do Carmo projects about 12% inflation among non-durable goods, which he says should be partially counteracted by 0% or negative inflation for durable items. Overall, he expects a total of about 8% for the year.
Less optimistic economists quote figures up to 15% for the year, which are more daunting, but nowhere near the sky-high rates of the early 1990s.
But while the path seems to be clearing up, there are sure to be serious pitfalls along the way.
“We needed to correct the exchange rate, which was clearly overvalued,” said Gardiman. “Now the whole trick is to turn the nominal devaluation (into) a real one and the only way to do that is through fiscal reform, tax reform, social security reform.
“If we can fix the fiscal fundamentals, we have a high degree of chance that inflation won’t return,” he said.
That is, if Brazilians can be convinced to weather still one more storm. And they have little choice.
“People in Brazil have made a lot of sacrifices for the real,” said Resende. “We fought too hard to get where we are now to have to give it all up.”