Brazilian Economy Shows Signs Of Overheating (GS)

The excitement, which was built by Brazil’s fast economic recovery from the global slowdown, has now turned into a concern. According to the Wall Street Journal, analysts are worried that the giant South American economy has started to overheat. Worried over inflation, the Central Bank of Brazil is expected to start a series of interest rate increases from today, analysts say. According to Goldman Sachs’ (NYSE: GS) estimates, Brazil’s economy grew by at least 10% during the first-quarter of 2010. In the same period, car sales grew by 18%.

Brazil has also steadily attracted foreign direct investment, reaching $26.3 billion in the 12 months leading up to March. Although Brazilian officials play down the overheating concerns by saying that the economy is “hot but not super hot,” Alberto Ramos, a senior Goldman Sachs economist says that the economy is indeed overheating. On Monday, Brazil’s finance minister, Guido Mantega, made a forecast that the country’s GDP will grow by 5.5% this year. However, many economists expect that economy will grow at about 7%, its fastest pace in decades.

Brazil’s recovery and economic expansion highlight how the fate of emerging economies and developed economies are differing. According to the International Monetary Fund forecasts, “advanced economies” will expand by 2.25% in 2010 and by 2.5% in 2011, after a decline of more than 3% last year. Growth in emerging markets and developing countries is projected to be above 6.25% a year in the same period, following more modest growth of 2.5% last year. Fast growth and rising sales are good signs for economy, especially for the developing economies trying to lift millions of poor towards middle-class category. However, accelerated growth is also increasing inflation.

Brazil had a chronic problem of inflation until the early 1990s, when inflation rates were in four digits. Raising interest rate also has its own peril. Interest rates around the world are low, especially in the U.S., where it is close to zero. Thanks to Federal Reserve’s stance on interest rate policy, global investors are increasingly borrowing dollars at zero interest rate, and investing that money in emerging markets to get higher yields. This trend fuels inflation as it increases the money supply in the economy. It also causes the emerging markets currencies to strengthen too fast, and potentially create bubbles in hot sectors such as real estate. “Rapid improvements in emerging market assets have started to give rise to concerns that capital inflows could lead to inflationary pressure or asset price bubbles,” the IMF said in its Global Financial Stability Report, earlier this month.