The external environment for Brazil has grown more challenging in the wake of the global financial crisis, which is threatening the stability of the real. Brazil’s strategy is to channel excess foreign liquidity into its own infrastructure needs, while working behind the scenes at the G20 to cool tempers between the United States and China.
Luiz Awazu Pereira Da Silva, deputy governor in charge of international affairs at Banco Central do Brasil, yesterday told an audience at AsianInvestor and FinanceAsia’s Brazil Investment Summit that the newly installed government under Dilma Rousseff would concentrate on fostering internal development, improving the quality of government spending, raising the investment rate into infrastructure, and address tax and legal reforms in order to encourage long-term foreign investment.
These will be necessary to ensure Brazil’s macroeconomic balancing act continues to succeed.
Pereira Da Silva says many emerging markets seem to have pulled off the trick of achieving what economists Robert Mundell (another former presenter at an AsianInvestor conference) and Marcus Fleming called the ‘impossible trinity’ of a fixed exchange rate, free capital movement and an independent monetary policy.
Over the past 10-15 years of reform, Brazil seems to have achieved something like it. Its exchange rate floats, but the government actively works to keep its value stable. It is mostly open to foreign investment, although recent concerns about speculation prompted the central bank to impose a 6% tax on foreign inflows. And it has achieved an independent monetary policy, epitomised by many years of relentless inflation targeting.
The result of this discipline is a Goldilocks economy that seems to have shrugged off the 2008 financial crisis. Inflation is under control, public-sector debt is modest, the global risk premium on Brazil has declined substantially and foreign currency reserves are at a comfortable $283 billion.
Perhaps most impressively, the country is no longer held hostage to its current account. Its economy is so well diversified now that the country is not vulnerable to a shock in, say, the price of oil or sugar. Unemployment over the past eight years has fallen from 12.5% to 6.2%.
This stability has allowed Brazil to reduce interest rates to a near-historic low of below 6% and, because its debt-to-GDP ratio is very low, it has plenty of room to boost borrowing to spend on investment in the country. And it has also helped the economy bounce back from the panic of 2008 with renewed confidence.
However, Pereria Da Silva recognises that the problems in the world are creating an environment less supportive of Brazilian growth.
The central bank’s priorities include preventing excessive credit growth and keeping inflation under control, despite the heavy global demand for the real and inflows of capital seeking yields higher than what the West can provide – a trend supported by America’s quantitative easing, which is expected to weaken the dollar.
Brazil is no longer vulnerable to a single shock, but it still needs to see America and the eurozone get out of their funk. Although the Brazilian finance minister, Guido Mantega, has publicly criticised the US Federal Reserve, Pereria Da Silva explains he understands the reasons for QE2 and hopes it works; he also says, however, that the uncertainty generated by the Fed’s policy implies a weaker dollar and higher prices in commodities, a development that would benefit Brazil.
Nonetheless Banco do Brasil has had to raise interest rates to prevent credit from exploding, and now its interest rates are far higher than America’s or most of its Latin neighbours. This only makes global investors more keen to put their money into Brazil, which means emerging-market currencies risk appreciating beyond the range suggested by their current-account fundamentals.
In other words, Brazil may find it increasingly difficult to maintain the value of its currency, and the golden era of achieving the trinity of stable exchange rates, free capital and independent monetary policy could end.
But if these inflows can be properly channelled into the areas where Brazil badly needs investment – most notably infrastructure, including for the upcoming World Cup and Olympic Games – then the trinity may be preserved, or at least the damage mitigated. Meanwhile, the central bank is laying down “speed bumps” in the form of taxing foreign inflows of capital to try to moderate their pace.
As an aside, Pereira Da Silva mentions the need for discussions among the G20 nations to coordinate currency policy.
Without mentioning China, he says some emerging markets like Brazil allow floating rates, while others do not. When asked to explain Brazil’s policy, Pereira Da Silva says the goal is for all G20 members to share the burden of adjustment.
The Chinese renminbi’s peg to the US dollar creates problems not just for American exporters, but for those from Brazil and other emerging economies. Pereira Da Silva, without touching on that particular issue, says he understands China’s political situation and its need to keep generating jobs. He sees Brazil’s role as keeping the lines of dialogue open among all the key parties, and is optimistic that a burden-sharing outcome will prevail.
He says the Basel 3 talks for banking rules show that such multilateral discussions can lead to practical gains, and that if everyone compromises, the outcome can be a positive sum game. Certainly this is preferable for everyone concerned to the alternative: protectionism and trade wars.