A reform programme to insure Brazil against shocks
In a wide-ranging interview with GlobalMarkets, Brazil’s central bank governor Roberto Campos Neto explains how he has worked alongside the finance ministry and other agencies to help drive through structural reform that will deliver stronger growth, higher levels of productivity, greater financial stability and a sustainable fiscal position
Interview with Roberto Campos Neto, the president of the Central Bank of Brazil (BCB)
GM:Under which circumstances did you arrive at the presidency of the Central Bank of Brazil, and what was the situation at the time?
RCN: I was part of a group of volunteers that helped craft an economic agenda for the new government, under the coordination of [Minister of the Economy] Paulo Guedes. But within the group there was a clear understanding that taking part in the elaboration of that economic agenda did not mean participating in the government.
It was a great honour to be appointed Governor of the Central Bank of Brazil, a highly regarded institution both in Brazil and among its peers. We acknowledge the good job on the conduct of the monetary policy and the improvement in communication promoted by the former Governor, Ilan Goldfajn, and his team. As well as the importance of their agenda for the financial system, mostly focused on assuring access to payment services and credit markets.
At the same time that we acknowledge previous results, we are expanding on the agenda of microeconomic reforms of the financial system. For that, we consider crucial the technological evolution. Our work has been organised along four dimensions under the Agenda BC# structural reform programme:
- Inclusion: to give simple access to markets for all investors — domestic and foreign, large and small;
- Competitiveness: to improve price formation through instruments of competitive access to markets;
- Transparency: to enhance the provision of information from the market and about the actions of the Central Bank;
- Financial education: to promote the market participation of all types of agents, and to foster a culture of savings.
GM: Economic reforms are well underway. Why does GDP growth is still around 1%? What is the outlook for the Brazilian economy?
RCN: Since 2018 the Brazilian economy has been through a series of shocks that probably prevented more robust growth. Some of these shocks were global in nature, and some were local, such as the truck drivers’ strike in May 2018, the uncertainties surrounding the presidential election, the Brumadinho disaster, the deepening of the economic crisis in Argentina, and the stagnation of the construction sector.
Apart from these shocks, Brazil still needs to address its fiscal deficit, which restrains investor sentiment and overall macroeconomics conditions that could push the economy to a higher growth path. The persistence of uncertainties regarding fiscal sustainability tends to be contractionary. These uncertainties affect investment decisions that involve a high degree of irreversibility and, therefore, require greater predictability of future scenarios.
There have been important steps towards a solution. The constitutional amendment that limits federal expenditures, and, more recently, the approval by the Chamber of Deputies of the pension system reform are both evidence that the political institutions in Brazil are capable of building a path towards fiscal sustainability.
Our baseline scenario at the BCB assumes that recovery will occur at a gradual pace. We understand that an acceleration of this pace to more robust levels depends on reforms and adjustments that promote the sustainability of fiscal policy. But it also depends on other initiatives aimed at productivity increases, efficiency gains, greater flexibility of the economy and improvements in the business environment. Initiatives in the structural agenda of the BCB contribute to this process.
GM: What is being done to enhance the credibility of the Brazilian economy amidst volatility in the global economy and in emerging markets?
RCN: The Brazilian economy is prepared to withstand a setback in the international scenario. Brazil has a robust balance of payments, low level of inflation, anchored inflation expectations, volume of international reserves of around $390bn that works as an insurance with an adequate coverage against eventual external turmoil, and prospects of resumption of economic growth.
The government and the BCB have also put in place a set of structural reforms to improve economic fundamentals, and to increase efficiency and productivity of the Brazilian economy, which enhances confidence in our country amid this volatile global outlook.
These reforms are organised in four groups. In the first group are reforms on the fiscal side. The advancement of such reforms, in particular the public pension reform, is crucial to reduce uncertainties and to increase confidence and investment.
The second group, the group of administrative reforms, is important to reorganise the public sector and to increase its efficiency. This, together with the fiscal initiatives, will reduce the government size and its burden on the society, opening up space for private entrepreneurship to flourish.
The third group of reforms is aimed at increasing productivity, efficiency gains, flexibility of the economy, and at improvements in the business environment to support free market outcomes. A broad tax reform and the Agenda BC# of structural microeconomic reforms for the financial system, that I mentioned before, fits into this group.
The fourth and final group includes initiatives to increase the openness of the Brazilian economy.
GM:Why did you decide to go for a direct intervention on the exchange rate market in August?
RCN: First, it is important to highlight that Brazil operates with a floating exchange rate regime, which is the first line of defence against external shocks. The BCB does not target any specific level for the exchange rate. Within this regime, the BCB may intervene on the local FX market in case it detects adverse conditions that impede the regular operation of the market.
The decision to intervene on the spot market is part of the continuous improvement on the use of intervention instruments by the BCB, which also includes FX swaps and repo lines of credit. In particular, the recent interventions are a response to the lower demand for hedge through FX swaps and the higher demand for spot liquidity and does not affect the net FX position of the BCB.
GM:What is the impact of the trade war between the US and China and how can Brazil position itself to prevent any collateral damage?
RCN: There is still great uncertainty about what the final outcome of the trade dispute between the US and China will look like — how much tariffs will rise, which products will be affected, how global supply chains will adapt. It is also unclear how long it will take for some kind of deal to be reached.
Another important element we should closely monitor is the dynamics of investments. Until recently there was a view that changes in global value chains and trade disputes would affect investments more strongly in some countries and less in others, depending on the degree of openness of their economies. However, subdued investments have been observed worldwide, which means that investors in all economies are waiting for uncertainties to dissipate before putting their investment plans into practice.
The dispute may affect the Brazilian economy through multiple channels. Higher bilateral tariffs may increase demand for Brazilian exports, but a further slowdown in global growth may compensate this direct effect. Apart from the trade channel, the immediate impact of the trade dispute seems to be a response by some central banks in advanced economies towards a more accommodative monetary policy stance, which is partially compensated by higher volatility and risk aversion.
Brazil has strong fundamentals, such as a robust balance of payments and international reserves that amount to approximately 20% of GDP. But the BCB has repeatedly emphasised the importance of the continuation of the process of reforms and adjustments, especially those that contribute to the sustainability of fiscal policy. These reforms should, to some extent, mitigate the risk of episodes of large risk premium increases, as witnessed in 2018.
GM:There has already been a slowdown in global trade and there is also a threat of recession on the horizon. What is the impact of all this on the Brazilian economy?
RCN: When analysing the effects of the current global scenario on our economy we have to contrast the strengths of two forces: the trade channels and the financial linkages. The Brazilian economy is relatively closed to international trade. Therefore, the impacts of global activity on the Brazilian economy through trade is usually low. In contrast, the financial channels are more important: they operate rapidly and with stronger effects.
Therefore, the net effect of the slowdown in the global economy and the easing of global financial conditions on the Brazilian economy seems to be positive.
However, geopolitical problems and the trade tensions may contribute to lower growth in important commercial partners and an even lower global growth, which would increase the impact of global activity on the Brazilian economy through trade channels. Uncertainty and lack of confidence generated by the trade disputes may also compromise capital inflows.
GM:Would you say such environment is benign or challenging (and why)?
RCN: We believe the global outlook is benign for emerging markets. Central banks of several economies — some major economies included — have provided additional monetary stimuli, which contributed to easing global financial conditions.
Nonetheless, it is important to notice that, although negative rates have been a positive experience in stimulating growth and sustaining inflation, the space for monetary policy interventions in those economies is being reduced, and now it is seems to be time for the fiscal policy to take charge, as recently stated by the Governor of the European Central Bank, Mario Draghi.
On the other hand, most emerging market economies, as it is the case for Brazil, face a different situation and the monetary policy is still effective while space for fiscal actions is reduced.
Therefore, as the risks associated with a slowdown in global growth remain. Economic policy and geopolitical uncertainties — notably trade disputes and geopolitical tensions — may contribute to even lower global growth. Given the risks still present in the external scenario, it is important for Brazil to continue advancing its agenda of reforms and adjustments.
GM: What is the impact on Brazilian monetary policy, at a time when inflation is well under control?
RCN: We have emphasised that our baseline scenario encompasses risk factors in both directions. And the downside risk includes the interaction between domestic developments and the global scenario. On the one hand, the high level of economic slack in the Brazilian economy may continue to produce lower-than-expected prospective inflation trajectory. On the other hand, a possible frustration of expectations regarding the continuation of reforms and necessary adjustments in the Brazilian economy could affect risk premia and increase the path for inflation over the relevant horizon for the conduct of monetary policy. This risk intensifies in case of reversal of the benign outlook for emerging economies. However, we reiterate that the next steps in the conduct of monetary policy will continue to depend on the evolution of economic activity, on the balance of risks, and on inflation projections and expectations.
GM:Which initiatives are being taken to deepen capital markets — such as securitization, home equity, etc — and to what end? Could you please give me a few examples?
RCN: The literature shows a clear positive correlation between the size of capital market and economic growth, and much of our economic agenda contributes to the development of the capital markets in Brazil.
From a macro perspective, the fiscal adjustment initiatives reduce the need to finance government spending and thus promote the availability of capital for households and entrepreneurs. This process allows greater diversification of products in the capital market and an increase in the number of transactions. The reduction of earmarked lending by Brazil’s national development bank (BNDES) has already opened up space for the capital market to provide alternatives of longer-term financing for private enterprises.
From the perspective of the Central Bank of Brazil, as I already mentioned, we have been promoting a structural reform agenda for the financial system, the Agenda BC#, which also aims at the development of the capital markets. Within this agenda, the Capital Markets Initiative (Iniciativa de Mercado de Capitais – IMK) is a joint effort of the BCB, the Finance Ministry, insurance and securities regulators (CVM, SUSEP) and market institutions to promote changes to the regulation of capital markets.
We have already mapped a number of proposals, but I would like to highlight the development of a regulatory sandbox, the regulation of home equity products, the improvement of long-term FX hedging instruments, and the reduction of costs and bureaucracy for non-residents to invest in the local market.
Along this line, we are working towards the full convertibility of the Real. The general objective here is to simplify bureaucracy and to reduce costs both for foreign capital, willing to access the Brazilian market, and for Brazilian entrepreneurs with operations abroad. The changes are expected to increase local market liquidity and depth, helping to reduce markets volatility and, ultimately, turning the Real into a potential reference currency for the South America.
The BCB is also proposing new model for its liquidity assistance facility. Securities, other than government bonds, will be used as collateral by banks in liquidity assistance operations provided by the BCB. This new framework has two positive effects: it creates structural conditions that allow a future reduction on bank reserves requirements; and it further incentivises the capital market, since banks would not need to keep only government bonds to assure the desired liquidity, stimulating a more diverse banking portfolio.
In addition, we have recently approved regulation that allows banks to offer housing finance indexed to the Brazilian CPI index. This offers greater flexibility for the market to provide housing finance products and increases the funding possibilities for this segment by facilitating the securitization of loans.
Finally, the efforts to promote financial disintermediation using new technologies and platforms — for instance, by stimulating the fintech sector — will have a democratising the effect on capital market, allowing the resources to flow directly from investors to entrepreneurs, especially for small players. I believe that, apart from the transparent and firm conduct of the monetary policy, an important contribution the BCB currently can give to the country is to prepare our financial system for a technological and inclusive future.