After a booming middle class made Brazil the world’s No.4 new-vehicle market last year and subsequently compelled billions of dollars in investment pledges from global auto makers, the country finds itself back in a tenuous state heading into 2012.

Experts blame rising inflation for the slowdown, which limits the action Brazil’s central bank can take on lowering the interest rates hiked earlier in the year to protect the country’s economy safe against possible double-dip recessions in the U.S. and Europe.

High interest rates make borrowing more difficult for Brazil’s middle-class consumers, the engine behind the country’s impressive economic growth in recent years. As a result, previously booming new-car sales have stalled.

“The interest rates are absolutely critical,” Jaime Ardila, president of General Motors South America, tells WardsAuto in a phone interview. “High inflation would be a headwind next year if it prevents the central bank from lowering interest rates and easing monetary policy.”

The problem of inflation has dogged the country for years, creating a historically topsy-turvy economy. It currently sits at more than 6%, a 6-year high and far above the government’s targeted 4.5%.

Still, Brazil’s auto makers’ group, Anfavea, expects total vehicle sales this year to climb 5% to about 3.7 million, compared with 2010. Estimated production is 3.42 million units, up 1.5% from 3.38 million in 2010.

The sales hike would represent the eighth consecutive year-on-year increase for the Brazilian industry, a streak dating back to 2004 and driven by an increase in the car-buying middle class of some 35 million people during the period.

But it also breaks the country’s string of double-digit gains dating back to 2006.

Total vehicle deliveries rose a marginal 1.7% in September compared with year-ago, according to WardsAuto data. Production declined 19.7%. With consumers unable to win credit, the sales mix has shifted at least temporarily to lower-margin fleet sales.

Brazil’s sustained growth in 2011 masks other worrisome trends central to vehicle manufacturing and sales in the country.

In addition to inflation and tight consumer credit, Brazil’s currency, the real, has weakened to a 2-year low against the dollar. The weak real compounds inflation by making goods and services more expensive for consumers and imported items such as vehicle parts more costly for auto makers.

GM this month reacted with a voluntary worker-severance program at a central operation in Brazil to offset higher prices for “raw materials and general supplies,” as well as a more competitive market with the recent influx of foreign-built vehicles.

Import sales in August more than doubled from year-ago to 20,420 units from 10,007, the Brazilian Association of Vehicle Importers says. Consumers are gravitating to imports from China’s Chery and Korea’s Kia and Hyundai for their novelty and sticker prices as much as 30% lower than domestic-built products.

A dip in commodity prices also risks damaging the country’s economy, which as a major exporter of raw material such as oil and gas, iron ore for steel making and soybeans and beef for food products, has grown to the world’s seventh-largest.

Ardila remains bullish on Brazil long term, despite these concerns. GM forecasts a flat sales year for the industry in 2012 and 3% to 5% growth for several years to come.

“None of our forecasts point to a big drop to the levels of five or six years ago, nor are we forecasting the peak cyclicality,” says Ardila, who expects the government will continue with recent steps to ease credit qualifications. “The demographics are very stable.”

For example, the average age of a Brazilian is 29 years, compared with nearly 37 in the U.S. Delinquency rates of 4% on car loans are low for emerging countries.

Brazilians’ average debt-to-income level of 20% also is relatively low and, contrary to reports, the middle class has over-leveraged itself in recent years. Unemployment sits at 6.4%, an all-time low.

In addition, Brazil continues to boast a relatively tiny car parc. It has about eight people per car, compared with two per car in the U.S., WardsAuto data shows.

“That leaves a lot of room for growth,” says Ardila, who is not alone in his outlook.

Roland Berger, an a automotive consultancy firm, sees Brazil’s vehicle sales growing to as many as 6.6 million units annually by 2020, and the country surpassing Japan as the world’s third-largest market behind the U.S. and China by 2015.

Brazil LV Sales Forecast - 2012
2012 3,600,000
2011 3,400,000
2010 3,329,170
2009 3,009,482
2008 2,671,338
2007 2,342,059
Source: *2007-2010 is actual light-vehicle data from WardsAuto; 2011 estimate and 2012 forecast by AutomotiveCompass.

“Thanks to strong economic growth and rising affluence among Brazilians, the car is gaining a completely new status,” says Stephan Keese, partner at Roland Berger and author of a recent study of the market.

Roland Berger expects growth at both ends of the market segment. While premium cars accounted for 150,000 deliveries in 2006, the segment reached 670,000 sales last year and likely will hit 1 million in 2014, the consultancy estimates.

“Brazilian consumers used to be quite happy with outmoded technology,” Keese says in the study. “But they now demand cars that are both good value and state-of-the-art.”

In the nearer term, pressure on established auto makers in the country such as GM, Volkswagen and market-leader Fiat is building as Asian brands make their push into the market. For now, the Big Three continue to rule the passenger-car market, according to data from Fenabrave, the industry’s vehicle distributors group.

Through September, The VW Gol was the best-selling car with 222,936 units, followed by the Fiat Novo/Uno Mille with 205,439 and the Chevy Celta with 110,375. GM in October launched the Chevy Cruze in Brazil.

Yet, sales this year in Brazil will outpace production for the first time in 15 years. The country carries an automotive trade imbalance of close to 170,000 cars because of the influx of foreign brands.

Hyundai, for instance, has expanded its dealership count over the past three years to 89 stores from 176 and wants 300 by 2013. Sister-brand Kia has similar ambitions.

“We are concerned about the significant advance in car imports, which caused the automotive sector to record a $2 billion trade deficit,” Alessandro Teixera, secretary of the Ministry of Industry and Commerce, said in August.

To stem the tide, the government earlier this year hiked the tax on goods sold in Brazil that were produced outside the country by 30%. Cars and trucks, specifically, must contain 65% local content to escape the levy.

In reaction to the tax, foreign auto makers pledged to make local investments, and the Brazilian government replied in kind by suspending the tax for some manufacturers. Some industry insiders expect the tax to see even looser administration in the future.

Analysts expect the move will accelerate decisions to produce locally. Roland Berger estimates Brazilian market leaders from the U.S. and Europe will see their share of production fall to 70% of the annual total by 2015, from 84% five years ago.

Ardila does not see the threat from foreign competition that others might.

“I would rather have them producing here, paying Brazilian wages and adhering to Brazilian regulations, paying for logistics costs here, rather than shipping cars from (Asia),” he says.

Industry consultants estimate auto makers will invest upwards of $21 billion to set up shop in Brazil by 2014. Suppliers will account for another $5 billion.

Newcomers either confirmed or reported to be joining the roster of producers there include Hyundai, Kia, Nissan, BMW, Chery, BYD, Geeley, Jianghuai, Tata and Mahindra and Mahindra. Mazda plans to open a sales operation in the country. Renault, Toyota and Honda are expanding operations.

Yet as attractive as Brazil’s future appears to outsiders, the country continues to struggle with two longtime bugaboos – high wages but with low productivity, and an antiquated infrastructure.

While Brazil boasts 1 million miles (1.6 million km) of roadways, just 12% are paved. Its rail system is underdeveloped and port capacity is constrained. But expect significant upgrades with the coming of the World Cup soccer tournament in 2014 and the Summer Olympics in 2016.

“Brazil is attracting a lot of investment,” Ardila says. “There is going to be a lot of public spending next year.”

Wages in Brazil between 2002 and 2010 grew 125%, from BR14 ($8) an hour to nearly BR32 ($18), Roland Berger estimates, while productivity has risen just 22%.

Auto makers and suppliers seek to solve half the wage equation by moving their footprint away from the pricy capitol city of Sao Paulo to lower-cost regions to the north.

“Brazil does continue to have significant disadvantages that continue to make it uncompetitive in those areas, and manufacturers have not quite figured out how to overcome that,” Ardila says.

jamend@wardsauto.com