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Inflation-Fighting in Brazil Could Be Bad News for Automakers

Inflation is our biggest fear.
China gets all the action in the developing-world automotive sweepstakes, with India a distant second. However, the Far East and the subcontinent aren't the only up-and-coming regions that carmakers are focused on. South America is also a big deal, with the hyperactive Brazilian economy driving sales. Unfortunately for the likes of General Motors (GM) and Fiat, Brazil's central bank may not want to play along with automaker plans.

In Brazil, inflation is a four-letter word
Brazil's commodity driven economy has perpetually struggled with boom and bust cycles that have created a society divided into extremes of poverty and wealth. Monetary mismanagement and political corruption has reliably led to runaway inflation in the past -- as recently as the early 1990s, Brazil had to engineer an completely new currency to escape hyperinflation and restore growth.

Central banking, then, in Brazil is perhaps more focused on inflation than in other countries. Overnight rates there are already some of the world's highest. This is creating a lot of foreign capital inflows, but also restricting the consumer credit expansion that has helped Brazil's new middle class buy cars.

Brazil isn't messing around: you're going to need to cojones of steel to go for a car loan at 25%, with two-year terms. Yikes! Might as well walk.

But growth is still growth
Carmakers from the U.S., Europe, South Korea, and Japan all still want in on the rapidly growing Brazilian market. Double-digit growth rates won't survive an anti-inflationary policy, but analysts continue to predict annual rates of 5-6%.

The obvious question to ask is whether Brazil will be too aggressive in its inflation-fighting and create an environment in which global automakers will favor exporting vehicles to Brazil rather than setting up factories in the country. GM may already be consider the possibility of using cheap labor in China to build cars destined for export to Brazil, where price is liable to be a critical issue for credit-constrained buyers.

Brazil must pass this major test
Out-of-control inflation is such a terrifying prospect to Brazil's politicians and economists that the burgeoning auto industry will just have to adapt to whatever moves the country's central bank make. Inflation is now at 6.5% and making people nervous -- which in itself shows how far Brazil has come, given that before the real was invented, inflation had peaked at the absurd rate of 6,821%.
The effect of macro-economic policy in the auto industry has been swift. Both production and sales declines by around 5% in April, according to Reuters.

The drawbacks of demand explosions
Because Brazil's economy is growing so quickly, while the economies of the U.S. and Europe are in the doldrums, the prospect of selling cars to its people will always be incredibly seductive. It's also in Brazil's interest to have a thriving domestic auto industry, even if much of it is controlled from outside the nation's borders.

The big problem, of course, is the country's lack of an established middle class. As one rapidly takes shape, it's going to see auto ownership as a key marker of success, placing constant pressure on Brazil to modulate demand for both cars and credit.

China's command-and-control economy can better handle this kind of thing. In democratic Brazil, it's always going to be tricky. So the automakers who want to do business there are simply going to have to deal with a place where inflation anxiety outpaces international economic ambition.

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Photo: Wikimedia Commons
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