Inflation and Demand in Brazil

I've written about consumer debt and the high cost of living in Brazil before, and it's popping up in the news again as prices rice higher and Brazilians continue to spend. Despite the fact that São Paulo is still the financial hub of the country, Rio is on the rise as a business destination, and with new businesses in town, costs are increasing even more.

The Financial Times reported this week that the cost of office rental space has drastically increased in Rio de Janeiro, and is now more expensive than in New York, Paris, and Milan. Rio office rental prices increased 47 percent in 2010, and now cost $1,321 per square meter, compared to $1,260 per square meter in Midtown Manhattan. The FT also published a story this week warning that Brazil is showing similar signs to the US before the crash, and that there are signs of a potential subprime crisis. Between inflation, credit growth, high consumer debt, and poor consumer credit protection, some economists believe Brazil's credit bubble could burst if there is any blip in the economy, be it a slower growth rate or a decrease in employment.

Meanwhile, inflation is increasing, a cause for concern for some. Inflation in 2011 has hit the poor and middle class in particular, hitting the highest rate for middle income earners in eight years. Inflation has made food more expensive, putting a strain on low income families but also worrying business leaders, who fear consumers spending more at the supermarket will spend less on larger purchases. Speaking of food, Estadão recently reported that Rio de Janeiro is the most expensive city in Brazil for eating out in restaurants, with an average cost of R$26.57 for a meal (including a main course, non-alcoholic beverage, dessert, and coffee).

With a larger pool of consumers buying products like washing machines, air conditioners, TVs, and computers, energy use per capita is increasing and infrastructure deficiencies are becoming more apparent. There was a major blackout across the Northeast a few weeks ago, and blackouts have hit Rio and São Paulo several times recently during the hottest summer months. While occasional summer blackouts have been a reality for years, the government is grappling with how to tackle energy issues as more and more Brazilians "enter the grid" or require more and more electricity.

Inflation and taxes continue to keep the cost of living and consumer goods extremely high in Brazil, but sometimes, there are other elements at play. While inflation is always a worry, I believe that in certain, specific situations, prices may not only come from larger macroeconomic forces but from a simpler concept: demand. Brazilians, like Americans, are opportunists, and savvy businesspeople know how to take advantage of higher demand. It's a bit like Carnival: with Brazilians on vacation and lots of tourists in town, Rio's prices skyrocket, especially for accomodations but also in other areas. Businesses know they can change the prices without question, since it's high season. So the same idea can apply to a booming economy. More multinationals flocking to Rio and need offices? Jack up the prices! More jobs, so more office workers eating out for lunch? Charge more! Where there's demand, there's opportunity, and when people are willing to pay, the only thing to lose is potential revenue. However, lack of competition goes hand in hand with demand, and only makes it easier to manipulate prices, which is a whole other concept worth investigating, especially in sectors like telecommunications and internet services.

In Rio, though, pricing can take on a whole other dimension. Sometimes, prices are used as a deliberate barrier to keep people out, like expensive covers at nightclubs or membership fees at ritzy gyms. In the same vein, prices sometimes are meant to reflect quality: the more you paid for something, the higher its perceived worth, even if the actual quality is not terribly different from a nearly identical, cheaper item or service. Value is attributed to having the ability to pay high prices, and social position and ascension derive in part from the willingness and pride to shell out the big bucks. While people are more than willing to spend less on certain overpriced items - say, on computers and iPods while on vacation in the US - having the ability to travel denotes financial resources and the willingness to pay in some capacity. I'd say this idea of higher pricing is more true of consumer goods, vacations, dining, and leisure than of basic living costs, like rent or groceries, and that this idea is based on my own observation and speculation. But it seems to me that in Rio, if you want to attract a certain type of consumer for a certain type of purchase, just sometimes, a slightly higher price may work more in your favor - especially now, with a growing middle class and a booming economy.

Comments

[Ray Adkins]

I am not so concerned about the accelated consupmtion in Brazil. However I see a huge risk on the outrageous and senseless real state speculation that is going on in every part of the country.

[Rachel]

The value of my apartment has almost doubled in almost 3 yrs. It is insane in Rio right now. For my sake, I hope it doesn't burst, just levels off.

[Henrique]

Rachel. It's cyclical. It will burst when some crisis comes up, but it falls like 30% to grow more 60% right afterwards. Real estate is still a great investment in Brazil because it doesn't lose value in the long term, from Brazilian experience. In time, a subprime crisis is not likely to happen here because not everyone can take a loan and they're not affordable as in the US. Banks here make a lot of money on extremely high rates and they're not likely to break unless rates go down to almost 0% like in the US. Again, that's not happening because that'd make inflation even higher and the government's main tool to control inflation is the rate itself, so, Financial Times knows about finances, but still, Brazil is not for beginners. The inflation goals are linked to an "ever-crisis" policy, which means Brazil is always in crisis, even now. The reason rates are still so high here is to offset public debt, but that's also going down (went down 1/3 on Lula's 2nd term). Perhaps in the future, consumer goods will be more affordable. The good part is knowing that whenever a crisis hits Brazil, the government has a lot of "fat" to burn in case it's needed and they have shown they know how to do it.
Unlike Japanese, Brazilians spend whatever is the price and that's why this macroeconomic logic works here. It just doesn't make sense to pay 2000 reais for a usd 500 computer. but we do. or how about spending USD 25000 on a car that's not even new? we do! had we had the chance to know how it's like to pay 18,000 for a sonata, we'd miss that and riot. but u don't miss what u never had and, because brazil is still an "island", low-searched tourist destination and maintains very high import duties, people here will be happy to buy whatever, just because they feel they can pay the "prestação" (monthly fee).

[Ray Adkins]

Rachel,

Sell now and you could probably buy a couple apartaments in the US and then when the real state bubble pops in Brazil you sell in the US and buy 4 in Rio! :)

[Ray Adkins]

Rachel,

I am just kidding. Rio has some special factors going on right now that justify a price hike...so even if there is a bubble in Rio it shouldn't be too bad.

[Ray Adkins]

Henrique,

How do you explain real state prices that keep going up without any solid justification, salaries and income are not going up how can prices keep rising? Do you see an end ever? or will people pay 1 million Reais for a one bedroom apartment in Rio just because they don't know how much an apartment costs in Dallas?
Sorry, I can't follow your logic...
How can real state prices keep rising out of control?

[Rio Gringa]

@Henrique I'm going to take this opportunity again to ask if you're interested in writing a guest post : )

[Henrique]

Rachel,

Thank you. I'll think about it... :)

Ray,

As a matter of fact, they do have a solid justification. It's called scruple. Which is non-existent in capitalism, therefore, it happens not only here, it happens everywhere. It's just that Brazilians embrace an opportunity more fiercely than others when it comes to making money. It's not savvy, It's swindle, "malandragem", "jeitinho". The only people who could stop it are the buyers, but the buyers are not caring apparently and behave in a haste - feeding yet more the acceleration of increases -, so people are testing the limits. That's my view... It's not that it's out of control here. It's out of control everywhere!

Whereas salaries may not be going up to upper classes, every single penny left-over for people in classes C, D and E creates a booming market for a variety of products and services and, therefore, the continuous increases on minimum wage above inflation that we've been experiencing here since 2004 is in fact the cause for the excessive demand. If they lowered taxes here from one day to another, we'd experience hyper-inflation once more. Brazilian demand has been hindered since 1994 with Plano Real. People want to buy cars and houses since forever. Credit, however, has not been available for long.

If the government makes public policies to help people buy houses, the first thing to increase are house prices. Credit is expensive, but is available. And both the real estate entrepreneurs and Casas Bahia know about the Brazilian mentality: "if it fits my budget to pay the monthly fees, I'm in!" Savings are still practically non-existent to Brazilian lower classes, and all income received feeds back the system in form of demand.

[Adam Gonnerman]

My wife and I are hoping to buy a house in her hometown (Uberlandia), but we keep hearing about the prices being ridiculously inflated. I'd hate to get stuck with a home that will cost us more than it will be worth after the upcoming mortgage bubble burst in Brazil.

[RFS]

There are always two sides in a discussion, specially one about economics. In China there's the very same debate: some people argue that the biggest Chinese cities - mainly Shanghai and Beijing - have huge real estate bubbles. Many Chinese who live in big urban centers have complained about how difficult it is getting for them to afford a home. There are arguments about there being a bubble in China - so much so, that now there are hedge funds betting on a bubble burst in China within the next four years. But of course, there are good arguments against the existence of such a bubble, or at least a huge bubble, in the Chinese real estate market. There are also those who say that a Chinese bubble burst would be much less threatening to the world economy - or even to the Chinese economy - than the US bubble. Others, on the other hand, say China is the biggest bubble in world history and that, when it finally pops, it will bring down world economy with it.

On Brazil, the FT.com published today a counterargument by Barclays Capital (BarCap), an investment bank, about a real estate bubble in here. They conclude: "So far, beyondbrics thinks BarCap’s arguments are stronger than Marshall and Rajpal’s. But we doubt the debate is over."

http://blogs.ft.com/beyond-brics/2011/02/28/brazils-subprime-crisis-disproved/

Some Brazilian market analysts also fend off the existence of a bubble based on facts that Marshall and Rajpal did not address and/or don't seem to be knowledgeable of - for instance, that mortgage credit in Brazil equals less than 10% of total credit; that interest rates on bank loans in Brazil, in contrast to what happens in the US, do not vary according to the market's whims, that is, whether or not the Central Bank increases the benchmark interest rate makes no difference to the proportion of defaults on credit; that Brazilian banks always see that they can negotiate with the borrower extensive guarantees in case the borrower doesn't meet his obligations (for example, in case the borrower defaults, the bank can legally take ownership of some of his personal goods such as houses or cars); and finally, that high interest rates make standard loans so profitable for banks, that the temptation to invest in risky businesses is not high. The FT.com article also points that the proportion of debt service as a percentage of total household income has been stable the since the late 2006.

Anyway, as I said, there are always two sides in discussions about economics. Economics is not an exact science - as Delfim Netto says, it is 90% art and 10% science. As such, I think it's fair to say that this debate - whether or not Brazil (or, for that matter, China) has a real estate bubble - will only be settled if or when the hypothetical bubble pops.

[James Miller]

Remember, Brazil is a developing country and it will always be a developing country. Eventually this little bit of prosperity will end and people will stop talking about Brazil as the country of tomorrow. We were told the same story in the 80's and look how that turned out. Spend a little time there and see how the place really functions.