Brazil Turns to Austerity to Save Currency from Further Decline

The Brazilian government is likely to cut unemployment and pension benefits in an attempt to plug budget deficits and protect its currency, the real, which shrunk to 10-year low last week amid declining economic activity.

The budget cuts, meant to save up to around US$28 billion, should help the government clean up the economic mess and put the economy back on track.

Brazil’s finances took a hit when former president Luiz Inacio Lula da Silva launched a series of social welfare programs in a bid to lift millions of people out of poverty. This free cash fed inflation and widened the government’s budgetary deficit. Then, in early 2014, the country slipped into a recession with commodity prices dropping in the international market.

But the spending cuts announced earlier this year have led to increase electricity fares, and bus fares. Inflation in Brazil is already soaring at 7.33%, far above the central bank’s target range of 4.5%.

The fall in real’s value may surprise analysts, because the large decrease in fuel prices in the international market should have helped the government reign in inflation.

Brazil has raised its benchmark interest rate 12 times since April of 2013, from a record low of 7.25% to 12.25% now. Weak manufacturing figures from China, Russia’s economic uncertainty and reports that United States might raise interest rates are also factors that are hurting Brazil’s currency.

Declining prices for iron ore seem to have contributed greatly to the country’s trade deficit. Some analysts say Argentina’s economic crisis has also dealt a blow, particularly to the country’s auto-exporting sector. Argentina is Brazil’s third biggest export market after the United States and China.

New finance minister Joaquim Levy has been working to impose more rigorous fiscal discipline, but the weak international market leaves little room for Levy to drive Latin America’s biggest economy out of recession.