Despite the higher foreign exchange rate in the last few days, it’s still down more than 10% this year. The lower level takes time to be seen in inflation, as the Central Bank has stressed recently, including in recent private meetings in Washington. With commodity prices still high and the prospect of weak economic growth in Brazil this year, however, economists estimate a very limited contribution.
Considering commodities prices in reais – a barometer for imported inflation –, the higher exchange rate and the state of the economy (measured by the output gap), Alexandre Teixeira, an economist at MCM Consultores, calculates that the exchange rate will ease Brazil’s official inflation index IPCA by only 0.13 to 0.15 percentage point in four quarters.
“The exchange rate pass-through to domestic inflation depends on the combination between it and the prices of commodities in dollars. When commodity prices rise, the real typically appreciates, driven by a better perception of external accounts and growth conditions,” Mr. Teixeira said.
Bradesco estimates that the recent drop of about 6% in commodities in reais would bring IPCA down by 0.18 pp over the next three months. That help could be even greater. “Taking into account only the recent drop in commodities in reais, and considering a linear pass-through to inflation, it would be down 0.33 pp,” Felipe Wajskop, Marcelo Gazzano and Myriã Bast wrote in a report.
However, as the pass-through to domestic prices tends to be smaller with a stronger real or when the variations of commodities in reais are lower than 8.4%, the impact on inflation would be closer to 0.22 percentage points, the economists wrote. In addition, Brazil’s slow economic growth may encourage companies to try and rebuild their margins instead of passing on cost reductions to consumers, they say. “Thus, the 6% drop in commodities prices in reais would result in a 0.18 pp relief for the IPCA.”
The study by MCM also sought to find “nonlinearities” in the exchange rate pass-through. Mr. Teixeira concluded that the pass-through depends on the output gap (a measure of economic slack), and is more intense when it is positive – in other words, when activity is above the potential GDP. Using data from 2002 to 2019, he estimated 0.44 pp of relief on the IPCA in case of an exchange rate 10% lower. The impact would be 0.75 percentage points if the economy was overheating, and 0.22 points in the opposite case.
Another nonlinearity seen is related to the exchange rate. When the real loses ground against the dollar, the pass-through is stronger. If the opposite occurs, the relief on prices is smaller. According to MCM’s calculations, a 10% depreciation of the exchange rate results in a 0.66 percentage point pass-through, while the opposite reduces inflation by only 0.16 pp.
“All this suggests that the current exchange rate appreciation is expected to have a limited impact on inflation, especially because the prices of commodities in reais have not fluctuated so much,” Mr. Teixeira said. In the same vein, Bradesco economists say that “global inflation remains under considerable pressure, and as long as there is no greater relief from commodities in reais, the effect of the appreciation will be limited.”
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In last December’s Inflation Report, the Central Bank calculated that an exchange rate variation of 10% causes an effect of up to 1.1 percentage point on the IPCA, recalled economist Marco Maciel, a partner at Kairós. Using as parameters an exchange rate that went to R$4.9 to the dollar from R$5.3 – a variation of almost 8% – and the pass-through modeled by the monetary authority, he estimated that the relief on the IPCA in 12 months totals 0.83 percentage point. “I think that a good part of the economists underestimates the effect calculated by the Central Bank,” he said.
This range is explained, Mr. Maciel said, by the fact that exchange rates at R$5.70 to or R$4.60 to the dollar, as seen this year, are likely to be outliers. All other things being equal, the economist calculates a pass-through of around 0.7 percentage points, which, considering the same range of exchange rate variation, brings the IPCA down by 0.53 points.
The point is that, as the exchange rate appreciates during the year, the price of commodities rises. “When I put these effects together, an exchange rate variation of 10% would have an impact of 0.4 percentage points on inflation. So that 8% drop in the exchange rate means 0.3 pp on the IPCA,” Mr. Maciel said. With that in mind, he projected 2022 inflation at 7.8% rather than 8.1%. “But the impact of the exchange rate appreciation is relatively small in my projection.”
Besides the level of activity, the volatility of the exchange rate itself – which Mr. Maciel says is high – is a complicating factor for pass-through. “There was a strong devaluation [of the real] in the last two years. Then it suddenly appreciated, and now it has started to depreciate again. Volatility matters and tends to impact inflation. If you passed on to the chain an exchange rate increase to R$5.2 to the dollar and the rate went back to R$5, you will pass it on again, but not the whole difference,” said Lucas Godoi, an economist at GO Associados.
Gustavo Arruda, BNP Paribas’s head of research for Latin America, highlighted another factor. According to him, the fact that inflation expectations lost their anchors in Brazil also influences the agents’ decision on whether to pass on this improvement. “The higher exchange rate takes some pressure off the cost, but if agents are not confident about the inflation’s trajectory and about how other costs are going to move, they are less willing to pass on this relief,” Mr. Arruda said.
“Looking at Brazil today, where expectations clearly lost their anchor, impacts such as the current appreciation of the exchange rate are likely to be smaller than expected,” the economist said. That is why he still sees the IPCA at 8.5% this year, even as other risks have diminished, such as that of surging oil prices. “Any return of the exchange rate to R$4.6 to the dollar will not change our minds.”
Source: Valor International