Written by E.C.

Pricing in Brazil can be a bit…surreal.

A Brazilian friend of mine recounted a classic example of this at the canteen of his Federal University. The menu included everyday snacks which included (i) a cheeseburger, (ii) an egg and cheeseburger and (iii) a fried egg as a side order.

The pricing of the menu was such that the egg and cheeseburger was more expensive than ordering a cheese burger and a fried egg separately. Therefore, the very logical reaction of students who wanted an egg and cheese burger for lunch, was to order the component parts as separate items and then assemble them at their tables immediately prior to consumption (they were studying Economics).

When the canteen’s management got wind of this, fearing a loss in profits, they prohibited the practice notifying the students that from then on the egg and cheese burger could only be purchased as a single unit. Canteen staff kept a watchful eye over side orders of fried eggs to make sure they were not placed in any burgers.

But this created all sorts of headaches as the students attempted to get around the ban by sending different people to buy different component parts. Inevitably, the policy provided enormous entertainment value for the students and was impossible to enforce for the canteen.

House prices in Brazil seem just as bonkers at the moment. They rose 165% in the city of Rio de Janeiro and 132% in the city of São Paulo between February 2008 and February 2012.

The main justification for this growth is the rise of the so-called Brazilian middle class and its increased spending power. The significant growth of this group is centered on what is known in Brazil as Classe C, i.e. households earning 3 to 5  minimum salaries (R$622) a month according to the Brazilian Institute for Geography and Statistics (IBGE). Household income in this group is therefore approximately US$ 12,129 and US$ 20,125 per year (13 monthly salaries at US$ 1 – $2).

But middle class in this case is a misnomer. In the United States, for example, this socio-economic group would at the bottom 25% of households and classify as low income.

It should also be stressed that Brazilian consumers face a considerably higher tax burden than Americans for example (on goods) and receive a lower level of public services – which often requires them to pay for everything from school buses, private education, healthcare out of their net salaries – placing further strain on household budgets.

The danger here is that the term `middle class´ is used to describe these consumers´ spending habits not their incomes.

So, how might low-income Brazilian consumers acquire middle class spending habits?

By assuming significant amounts of debt. In August 2012, for families earning up to 10 minimum salaries (R$ 6,200 a month – that´s Classe D, C and Classe B i.e. the vast majority of Brazilian households) 30.1% of income was spent on debt servicing. Closer inspection reveals that a hair-raising 18.2% of this demographic is spending more than half their monthly income to service debts.

Evidence would also suggest these consumers after years of easy credit may now have overextended themselves (below – in blue) i.e. 23.7% of this demographic reported debt repayments in arrears in August.

The continued rise in spending power of Classe C should not be overestimated nor should their ability to keep the Brazilian real estate bubble inflated, particularly in the event of any increase in interest rates.

This month a study by the Brazilian Applied Economics Institute (IPEA) stated the “concrete possibility that there is a real estate bubble in Brazil” which is likely to burst on any increase in interest rates.

This would not only put this ‘middle class’ under more financial stress but also means investors that had migrated from the long established Poupança savings account and into property portfolios may very well migrate back again.

And that would really burst the bubble.

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