For the third month in a row, the Brazilian PPI inflation index (IGPM) showed deflation, -0.07% for May 2009. It was the fifth negative figure in the last six months. Since the beginning of 2009, accumulated deflation has reached -1.14%.

In fact, the IGPM index is highly influenced by the currency, and with the appreciation of the Brazilian real in the last weeks it seems that deflation will continue for the very short-term.

In the second half of 2009, the economic recovery in Brazil should help to stop IGPM deflation. According to the weekly focus survey conducted by the Brazilian Central Bank, the market expects IGPM to reach 1.69% for 2009.

The interesting point about the IGPM is that this index is used to calculate the tariff adjust for electric utilities in Brazil, like Cemig (CIG), Copel (ELP) and CPFL (CPL). During 2008, IGPM inflation was under pressure in the first three quarters of the year due to the strong economic growth, and in September, October and November it was under pressure because of the sharp devaluation of the Brazilian real. That was great for electric utilities.

Just as an example, CPL recent released the final indexes for the tariff Revision of CPFL with an annual Tariff increased 21.22% for CPFL Paulista, effective as of April 8, 2009. Short-term earnings of Brazilian electric utilities will be positively affected in the following quarters by this adjustment. However, for 2010 it will be quite different.

Indeed, with a very low IGPM and all the other adjustments calculated by ANEEL (Brazilian electric agency) we expect a tariff adjustment close to zero for 2010. For sure this is a concern, nevertheless we still believe that the valuations of all three electric utilities (CIG, ELP and CPL) remain quite attractive and dividend yields are very appealing too.

All considered, we still have a very positive view on Copel, Cemig and CPFL. We believe all three stocks are a good way to have an exposure to Brazil with lower than average risk exposure.

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