A senior Brazilian central bank official has acknowledged that investor confidence in the largest Latin American economy has been bruised by a series of capital controls that were introduced to stem the appreciation of the currency.
A series of taxes have been imposed on capital inflows in the aftermath of the global financial crisis.
"It worked very well indeed in Brazil, we controlled financial instability, stabilized our exchange rate volatility but there’s no free lunch: we also had to pay a price in terms of foreign investors’ perception, of policy transparency and predictability and perhaps in retrospect in terms of our own 'animal spirits' at home", Luiz Awazu Pereira, deputy governor of the Brazilian central bank, said during an event of the International Institute of Finance held on the fringe of the IDB meeting in Panama.
Felipe Larrain, Chile’s finance minister, agrees that “there is no free lunch” and reckons that the costs of imposing the controls are much greater than the benefits.
“You cannot tax all types of capital,” he said. “There is no free lunch with capital controls. Some people believe that capital control is something to be done. Some say it’s progressive [policy]. I don’t understand the meaning of progressive economics. I do understand the difference between good economics and bad economics,” Larrain said.
Ramon Aracena, chief economist of the IIF, expressed concern regarding the direction of economic policy in Brazil, beyond the single issue of capital controls.
"The key question in Brazil is why the 'animal spirit' – after being so positive – has shifted and become somewhat cautious. My concern is that the business community wonders what is the actual economic policy in place, where are we going, what is the direction?" he said. "This has spooked the 'animal spirit'."
Financial investors who were previously relying on a smart combination of fiscal discipline, floating exchange rate and inflation targeting have increasingly become disorientated by bold moves from the Brazilian government, which has now been in power for 10 years, to implement its own social agenda.
"People start to be losing their illusions regarding Brazil," said Jean Louis Martin, head of emerging market research at Credit Agricole.
Meanwhile, Brazil and other emerging markets have pressed, with some success, the IMF to acknowledge the utility of limited forms of capital controls in specific circumstances, including when the developed economies adopt a very loose monetary policy combined with quantitative easing. Although there is still no consensus regarding the use of capital controls, the latest crisis has, in a way, served as a sort of learning curve. But this would also be a stake for the G20, Pereira suggested.
"We know how to do it and have the tools for that," he said. "However, this combination is risky, sub-optimal and certainly not conducive of welfare-enhancing outcomes globally."
"It might be the only possibility given the current state of the global political economy but I would much prefer a discussion –perhaps at the G20 – that considers a more coordinated and balanced framework to deal with exchange rate volatility in advanced and emerging economies,” Pereira added.
The decline in investor confidence towards Brazil has led to a substantial decline in portfolio investment since last year.
"Brazil wants to attract lots of investment and they want to increase the cost of investment. They really overdid it in terms of capital controls," said John Welch, macro strategist at CBIC World Markets.
Meanwhile, Pereira was adamant that Brazilian policy makers were aware of the existence of multiple challenges, while insisting on the “uncompromising anti-inflation consensus in society”.
"It’s difficult to fall asleep at the wheel in Brazil... There are always risks and it means that we need to be ‘ahead of the curve’ and to listen to every warning. We do, and a lot."
Pereira declined to comment on the future direction of monetary policy, following the release of the minutes of the latest monetary policy committee this week that suggested an impending hike in the central bank’s benchmark Selic rate.
Inflation in the past 12 months amounted to 6.3%, while the official target is 4.5%, plus or minus 2 percentage points.
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Picture by saepr
CORRECTION: An earlier version of this article stated that taxes were imposed on capital outflows in the aftermath of the crisis. In fact they were imposed on capital inflows.