The Central Bank of Brazil forcefully defended its position on macro prudential measures from a welter of criticism at yesterday’s business meetings of the International Institute of Finance (IIF).
Brazil progressively increased a finance tax on foreign investments in the bond market to 6% last autumn, has intervened in futures and currency markets, and stepped up micro requirements on liquidity and reserves at banks.
Luiz Pereira da Silva, deputy governor at the Brazilian central bank, predicted yesterday that inflation will converge towards the mid-point of the bank’s target towards the end of the year. He blamed a number of factors, including the great flood of liquidity and near-term price shocks from commodity prices for pushing up short-term inflation.
Da Silva argued that tightening monetary policy might trigger more capital inflows as investors sought higher yields. “No matter how much the Central Bank intensifies sterilization, a portion of inflows remain in the market,” he said. Consumer inflation was 6.13% in the 12 months to mid-March, and Brazil has some of the highest real interest rates in the world, with base rates at 11.75%.
Foreign capital inflows spill over into the economy and this means that higher rates might not prevent excessive credit growth, da Silva said. Macro prudential measures are producing positive results and Central Bank measures are equivalent to a policy rate hike of about 75 basis points.
The crisis made it clear that, even though micro measures focused on individual financial institutions are important, they are limited. They do not take into account banks that are too large to fail nor similarities in risk-taking from multiple institutions in the market that create systemic risk.
Da Silva said that Brazil has employed orthodox policies, including more liberal foreign exchange policies, and had seen declining trends in debt and lower risk premia.
Brazil has also progressively raised rates, tightening 100 basis points in its last two meetings, da Silva noted. He claimed the country was practicing fiscal rectitude – although many see the recent $50 billion budget cut as being flawed by transfers to the National Development Bank. He finally argued that the country also had a well regulated financial system and had not needed to bail out institutions.
Da Silva’s views were in marked contrast to those of Rick Waugh, vice chairman of the IIF board of directors, who has heavily criticized macro prudential measures, arguing they often act as a substitute to orthodox monetary and fiscal policy responses.
Some governments may be disappointed they are not able to control capital inflows and the carry trade, and be pushed some into inappropriate actions and policy responses, including capital controls, Waugh told Emerging Markets.
Guillermo Mondino, head of Latin America research at Barclays Capital in New York, said it is difficult to wean policy makers off macro prudential measures, which are supposed to be short-term.
“Brazil has thrown everything and the kitchen sink at the FX markets to cool its appreciated currency,” he noted.
The country adopted macro prudential measures without knowing what the results will be, he added. Many corporate debt issuers were finding their way round the fixed-income tax by issuing international issues, for example, Mondino said.