Putting on a brave face
GlobalMarkets, is part of the Delinian Group, DELINIAN (GLOBALCAPITAL) LIMITED, 4 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 15236213
Copyright © DELINIAN (GLOBALCAPITAL) LIMITED and its affiliated companies 2024

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement
Emerging Markets

Putting on a brave face

Despite its stunning turnaround in recent years, Brazil’s economy remains vulnerable to a global downturn. Finance minister Guido Mantega and central bank governor Henrique Meirelles tell EM why they’re better prepared this time

By Thierry Ogier


Despite its stunning turnaround in recent years, Brazil’s economy remains vulnerable to a global downturn. Finance minister Guido Mantega and central bank governor Henrique Meirelles tell EM why they’re better prepared this time


The improvement in Brazil’s macroeconomic fundamentals in recent years may have been spectacular, but it has still fallen well short of protecting the country’s finances from the ripple effect of the global market turmoil.


On September 29, when the US House of Representatives rejected the $700 billion bank bail-out package, the Sao Paulo stock exchange hit the circuit breaker, and trading had to be suspended after the Bovespa index took a 10% dive. Meanwhile, the local currency suffered its biggest slide in six years, plunging by 6% against the dollar in a single day’s session.  


The meltdown occurred a couple of weeks after the central bank first moved to try and prevent the local currency, the real, from depreciating too quickly.


Only a few days after stopping to buy dollars and boost its international reserves, which exceeded $200 billion, the bank announced a U-turn in its exchange rate policy and started to sell dollars to provide liquidity to the forex market in mid-September. But the impact of the measure proved short-lived.


Credit has also been hit. Costs rocketed and the crunch exposed middle market banks. Again, the central bank stepped in and cut compulsory reserve requirements to those institutions in late September, in a move that was equivalent to injecting some 13.2 billion reais ($7.3 billion) in liquidity. 


 “It is a sign that smaller banks are in trouble,” says Carlos Lessa, who was president of the state-owned national development bank (BNDES) at the start of the Lula government in 2003.  


The credibility of the Latin American giant has been enhanced lately thanks to sound policies, yet there is no room for complacency: the current account deficit is accelerating fast and has to be monitored closely; structural reforms are still lacking; and the threat of inflation is never far off.


“The international crisis is more serious that we originally thought,” finance minister Guido Mantega tells Emerging Markets.  “The credit crunch has developed into an economic crisis. Emerging markets will suffer some contagion as a result of the commodity prices, but the consequences will not be the same as for the G7 countries.


“No one will escape from the impact of the global crisis. There is now a decline in the price of commodities and an increase in global financial costs,” he says. “Emerging markets will have to slow down the pace of economic growth to correct imbalances and address bottlenecks. What is at stake is to slow down without aborting the dynamism of emerging markets.”


Mantega was adamant that Latin America’s largest economy was in a favourable position. “There is no decoupling, but we are not in the same boat as the most advanced countries. We have a much more balanced scenario in Brazil, and adjustments will be less severe, mainly thanks to the vitality of our domestic market,” he says.


“The government is vigilant, and we have been monitoring the situation to see whatever problems may arise,” says Mantega. “We do not have any pre-established scheme.” Nevertheless, more pro-active policies may be needed to cope with the magnitude of the international crisis.


Yet the official stance has not impressed everyone. “It is a lie to say that Brazil is going so well,” says Lessa, now an academic at the Rio de Janeiro university. “So-called ‘gypsy capital’ is already on its way out, and there will be a sharp economic slowdown.”


Beyond credit, the international crisis is also expected to have a severe impact on foreign trade and the price of commodities. The current account deficit is already expected to amount to $33 billion next year, according to central bank figures.


This year, 2008, Brazil is going to register its first current account deficit since 2002 (1.5% of GDP, according to official forecast), due to a surge in profit and dividend remittances, as multinational companies send cash back to their home countries. This will put pressure on the currency, although government officials reckon such a deficit will be entirely financed by large inflows of foreign direct investment.


“The exchange rate, which used to be a central bank ally in its anti-inflation drive, may become an enemy,” says Armando Castelar, an analyst from the Gavea hedge fund in Rio. Castelar reckons that economic growth will be inferior to 3.5% next year, following 6.1% during the first half of 2008 (compared to the same period in 2007).   


This will have a detrimental impact on tax collection. For the time being though, the government has shown no inclination to rein in public spending.


Still, Brazil is undoubtedly better positioned than in previous crises. “Brazil used to be a large net international debtor. Not anymore. On the contrary, it is now a net creditor. So the impact of currency depreciation would not have a negative fiscal impact,” says Castelar.


“Brazil is going to feel some impact of the crisis, but it is in a much better position than it has been in the past 30 years. It is in quite a comfortable situation in terms of balance of payment financing,” he says.


Softening the blow


The financial crisis has taken its toll on the equity market. Many foreign investors, which account for 35% of local trade, have pulled out of the Bovespa stock exchange in Sao Paulo, putting an end to five years of continued growth. The Brazilian IPO market, which was buoyant last year, with 64 transactions, has ground to a halt.


But the blow has been softened by the investment-grade status (BBB-) granted by Standard & Poor’s and Fitch last May. “The most important impact of becoming investment grade was the improvement in the quality of capital inflows,” says central bank governor Henrique Meirelles.


“We have longer-term investors, types of funds that were not able to invest in Brazil before because Brazil was not investment grade. Now they can come and invest in longer-term projects, and that makes for a more stable balance of payment flow, and for money available for longer-term investments ... including infrastructure.”


Brazilian policy-makers often disagree about the degree of extra care that needs to be adopted in a troubled external environment, but they have so far managed to balance their acts in a rather elegant way.


Inflation is now expected to remain with the upper inflation target range as a result of the decline in commodity prices and a tough monetary policy (the benchmark IPCA inflation rate posted a 6.2% increase during the 12 months to the end of August, and a 4.5% increase during the first eight months of the year – the inflation target stands at 4.5%, plus or minus two points).


Against all odds, in the company of an expansionist finance minister and of a monetarist central bank governor, president Luiz Inacio Lula da Silva may have obtained the best of both worlds: a growing economy and inflation under control.


“Investment has increased by an annual rate of 13%, and the growth potential of the Brazilian GDP is already in excess of 5%,” says Mantega.


Yet the central bank has sought to prevent overheating – industrial capacity reached 83% in recent months and credit continues to grow at an annual rate of 32.7%, including 41% for corporate loans, during the 12 months leading to the end of July.


Further tightening


In the midst of a new international crisis with all emerging markets being put on a red alert against inflation, Meirelles and his central bank directors launched another round of monetary policy tightening this April.


“We have had two things happening at the same time. Domestic absorption was growing at a higher rate than supply, and that gap has been filled by an increase in imports,” says Meirelles. “Since this is not sustainable in the long run, it is only natural that the central bank begins to provide adjustment of the domestic absorption.


“It is important that we balance that in due time, even though investment in productive capacity is increasing. At the same time we have the commodity phenomenon, which is affecting everybody. Both factors are important, and we are addressing them both.”


Nevertheless, Meirelles insists that the “tightening has so far been smaller than in recent Brazilian history”. “In the previous tightening cycles of 1999, the Selic base rate reached 43%; in 2003 it reached 26.5%; in 2005 it reached 19.75%; and now it is at 13.75% as a result of a more predictable inflation path.


“The persistence of inflation in Brazil has declined in recent years. If we compare nowadays with the past episodes of inflation in Brazil during previous decades, we can clearly see that inflation persistence is clearly coming down,” he says.


Mantega is even more upbeat, as he points at the recent decline in inflationary trends: “The worst is over. Inflation is not entrenched, as it has been falling along with commodity prices,” he says. “There is an old view that is still strong in Brazil, according to which a little bit more inflation would not do much harm and maybe be even good.


“There is still this idea that inflation could be allowed to go up in order to enjoy the benefit of a loose monetary policy without paying the price.” Meirelles, who has enjoyed Lula’s full support in his fight against inflation, refuses, somewhat diplomatically, to comment on specific government policies or the level of public spending: “I am talking about the society in general,” he says.


Instead of addressing frequent criticisms, Meirelles has sounded quite philosophical lately. “Every central banker in the world could say that he could get more help from the fiscal policy, and evidently every finance minister in the world could say that he or she could get more help from the central bank. This kind of trade off is normal,” he says. “Evidently what is important is that we take all the data and we take the proper decision without passing judgment on other government agencies’ policies. It is as valid for Brazil as it is in other countries.”


Many think that the government could help alleviate the pressure on monetary policy if public spending was curbed. “We welcome any kind of help,” says Meirelles. The positive point in this regard is that the government has committed itself to a primary budget surplus of 4.3% of GDP (before interest rate payments).


“It is important that we keep a declining debt to GDP ratio: this is the main target,” says Meirelles. This ratio, which exceeded 60% during the worst of the Brazilian financial crisis in 2002, is now declining towards 40%.


Nevertheless, the size of the public debt is still large, and market jitters have forced a review of the projected debt profile.

Debt securities that are indexed to the benchmark Selic rate, which is on the rise, will account for more than 31% of total debt (between 31% and 34%), as opposed to less than 30% in the Treasury’s forecast (between 25% and 30%) last year. Meanwhile, pre-fixed securities will account for less than 32% of total debt (between 29% and 32%), as opposed to more than 35% in the previous forecast (between 35% and 40%). In other words, the cost of debt will increase.


Both Mantega and Meirelles are agreed on one strategic policy decision: “We are going to reach a nominal budget surplus in 2010. This is my target,” Mantega says.


The deficit has already been cut to 1.5% of GDP in the 12 months leading to the end of July 2008. Clearly it will be tough to eliminate it against a background of falling economic growth and declining tax revenues, and perhaps for this reason, Meirelles would rather call it a “medium-term target”.


Gift this article