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The World Price Index

Released: March 10, 2015

Sharp currency realignment forces Brazilian Real into Purchasing Power Parity undervaluation against the US Dollar

  • Brazilian external trade deficit widens
  • Economy faces stagnation
  • WPI data shows inflation in Food and Durable Goods

Real Undervalued against $ in Purchasing Power Parity Terms
The latest set of World Price Index (WPI) data indicates that the Brazilian Real is now undervalued against the US dollar in Purchasing Power Parity (PPP) terms. The methodology behind the WPI involves collecting price data for a representative basket of goods across different countries. This allows the measurement of the real purchasing value of national currencies across the world in terms of their relative purchasing power against a comparable basket of goods in the US.

A sharp currency realignment between the US Dollar and the Brazilian Real has taken place. This began in September 2014 when the market exchange rate for the Real was R$2.25 to one US$, the latest fall has finally produced a market value of R$ 2.93. At this market rate the purchasing power of the WPI basket of currencies in Brazil in terms of their relative value in the US in March was slightly less than the implied PPP exchange rate of R$2.92. This means that the market exchange rate reflects that there is little difference between relative prices in Brazil and the US for the basket of goods. In contrast, to the small PPP undervaluation of the Brazilian Real of 0.5% that now exists against the US Dollar the Real was heavily overvalued by 35% in September 2014.

Real depreciates in response to external deficit
The fall in the nominal exchange rate of the Real against the dollar has been a natural, albeit delayed, market reaction to the deteriorating external balance in the Brazilian economy which has swung from a trading surplus to a deficit in recent years. The country’s recorded current account trade surplus has shrunk from 1.6% of GDP in 2006 to a deficit of 4.2% in 2014. Trading conditions have continued to worsen into the current year despite a sharp slowdown in GDP growth. Brazilian real GDP growth has fallen from 2.5% in 2013 to an estimated 0.14% in 2014 with a consensus forecast range of between -0.5% and +0.5% for the current year.

A strong fiscal stimulus helped the Brazilian economy pull out of a recession experienced in the first half of 2014, but the government deficit exacerbated the current account deficit which recently widened to US$10.7 billion in January 2015 from US$10.3 billion the previous month. The steady depreciation of the Real against the dollar in PPP terms should have helped make Brazilian exports more competitive and imports more expensive, working to reduce this external imbalance, but a number of international factors are producing contrary tail winds.

Brazil’s major trading partners are the US, China and Argentina, which accounted collectively in 2012 for 85.9% of the country’s exports. The Real has become more competitive against all these currencies in PPP terms (See Chart), but the benefits of this favourable position on Brazil’s exports is held back by tightening restrictions on Brazilian trade imposed by Argentina and slowing Chinese growth. This means that growth in the US alone is unlikely to provide a strong enough external stimulus to return the Brazilian economy to an export-led growth path.

Business Confidence falls
Economic conditions inside Brazil are more likely to become worse before they get better. The World Economics Sales Managers’ Index (SMI) of Business Confidence in Latin America (in which Brazil contributes a major share of responding panellists) has shown a steady fall in optimism across the region since September 2013 (See Chart). In Brazil, the beneficial effects of a depreciating currency on exports and aggregate demand are being counterbalanced by the inflationary impact on the cost of goods imported. The same three countries the US, China and Argentina account for 83.0% of Brazil’s total imports and further falls in the value of the Real threaten the feasibility of the Central Bank’s inflation target of 6.5%.

Inflationary Pressures
Overall the Brazilian Consumer Price Index rose by 7.4% year-on-year in February. A breakdown of WPI data into its component parts provides an insight into the distribution and impact of these inflationary pressures across Brazil. Recent WPI data shows that prices rose in a number of sectors which account for a relatively high combined proportion of household spending in March compared to falling prices the year before. This occurred for Durable Goods (+20.2% vs -17.4%) and Food (-7.3% vs -11.2%), while in line with global trends Energy saw a fall in prices (-6.9% vs +2.4%). The fall in prices in the Hospitality sector (-28.9% vs 17.3%) was due to excess capacity following the World Cup in 2014. (See Chart opposite).

The presidential election is over and fighting inflation is now seen as a priority. On March 5, the Central Bank of Brazil raised interest rates by 0.5% to 12.5% against a global trend of falling rates. The government is also trying to tighten fiscal policy by raising taxes and cutting expenditure. The WPI data on the depreciating PPP value of the Real and these policy measures indicates that the Brazilian economy is facing the danger of stagflation which explains the decline in Business Confidence shown above.

About the World Price Index
The World Price Index (WPI) measures the value of an urban selection of goods and services at purchasing power parity (PPP), reflecting the real purchasing power of different nations, allowing for rapid and accurate international price comparisons. Under/Over valuation data is based on the difference between the exchange rate value of a currency and that of the US Dollar in relation to the World Price Index calculated exchange rate. Based on WPI global data the degree of currency under or over valuation in PPP terms by country is provided in the table and chart below.


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Notes to Editors
  • The World Price Index is based on original data collected by World Economics.
  • The World Price Index is released on the 2nd Working Tuesday of each month.
  • Latest month market exchange rates are calculated as an average of daily rates

About The World Price Index
The World Price Index is calculated monthly from a basket of internationally comparable goods and services. It is designed to alleviate the horrendous problems associated with analysing economic or market data using currency market exchange rates.

Exchange rates vary with extraordinary rapidity, frequently with little obvious link to economic reality, but fatally distorting the perception of value in markets and economies. It is vital when analysing international data, whether for market analysis purposes, or to allocate resources across the globe, to review data using an international yardstick of value. This can only be done using Puchasing Power Parities (PPP), which make allowance for the purchasing power of currencies within individual countries to make comparisons based on a standard currency, usually "international dollars".

There are various sources of PPP data, but most are of only academic interest as they are years out of date. The World Price Index is the only available index updated monthly to provide an easy way of reviewing trends or relative values of market or economic data in realistic terms.

About World Economics
World Economics is an organisation dedicated to producing analysis, insight and data relating to questions of importance in understanding the world economy. Its parent company Information Sciences Ltd has a long history of the development of key business information today used throughout the world, including the origination of the Purchasing Managers Indexes in Europe and Asia (now owned by Markit), and the development of WARC a global information provider for major corporations .

Currently our primary research objective is to encourage and assist the development of better and faster measures of economic activity. In cases where we believe we can contribute directly, as opposed to through highlighting the work of others, we are producing our own measures of economic activity.

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