Goldfajn takes up the fight to revive Brazil

After two years of a crippling recession and a devastating political crisis that reached its climax with Dilma Rousseff’s impeachment in August, the new governor of the Brazilian central bank tells GlobalMarkets: “We have regained hope.” But how long will it take before the LatAm giant is back on its feet?

  • By Thierry Ogier
  • 04 Oct 2016
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Adriano Machado / Reuters
Brazil’s recent history has been a traumatic tale of corruption, demonstrations and impeachment.

Dilma Rousseff is now gone but political passions are still running high as corruption investigations in the Petrobras scandals, known as lava jato or carwash, bring new revelations.

Meanwhile, the economy has sunk to new lows and may only start recovering towards the end of the year. The road to recovery may be a long one and it will certainly be fraught with all sorts of difficulties. There is some confidence in the capital markets that the new government will be able to engineer a revival, but there are still a lot of question marks over the ability of the new administration to get its conservative programme approved in Congress against a background of social unrest.

Policymakers appointed by new president Michel Temer have drawn up a plan to pull the country out of recession after two years of negative growth (Temer became interim president in May and was confirmed on August 31 when Rousseff was impeached).

“Brazil is on the right track. We have entered a road that is going in the right direction. It is a long road but at least we are going in the right direction,” a confident Ilan Goldfajn, the new governor of the Central Bank of Brazil, tells GlobalMarkets in an exclusive interview. “Sometimes you may be well advanced in the road but if you are going in the wrong direction, this is no good. Now we have a long road to go but we are in the right direction,” he says.

The economic plan includes measures to stabilise public expenditures and curb the level of debt, currently at 68% of GDP. The government has proposed a constitutional amendment that will cap public expenditures to their current level. It needs a two-thirds majority to pass the amendment in each house of Congress. Urgent action is needed according to Henrique Meirelles, Brazil’s finance minister, who has argued that public spending has increased 6% annually in real terms between 1997 and 2015. The reform “would be the first structural change that affects public expenditure in Brazil since the 1988 constitution”, he says.

Meanwhile, officials are also trying to convince Brazilians that their pension system, which is a heavy burden on the public finances, needs to be fixed as the population is ageing fast. A new privatisation and concession programme has been unveiled in September to attract private investors. A labour reform that would relax hiring and firing regulations is being drawn up, although the government has said it will not be sent to Congress before the second half of next year.


Such intentions have boosted market confidence. Goldfajn says spreads on contracts for difference (CDS) have fallen by half over the last six months to mid-September to 250bp-260bp while long term interest rates have come down by 500bp. “These are significant changes in the mood towards Brazil,” says Goldfajn.

However, the central bank’s battle against inflation has proved to be tougher than expected. The benchmark inflation rate has fallen below the 10% mark but is still far above the official inflation target of 4.5%. As a result, the monetary policy committee has not found any room to cut its benchmark Selic rate, which has remained at 14.25% for more than a year.

“We have taken concrete steps for inflation to converge towards the central target. The most important step [towards this] is the fiscal reform and the proposed cap on public expenditures,” Goldfajn says. Loosening monetary policy depends on three factors. “The first one is a shock in food inflation in the very short term — we need to find out whether this is indeed a shock or a more persistent inertia or stickiness. The second is more linked to [the existence] of deeper inflation dynamics and underlying factors, and finally we would like to see the fiscal [accounts] on the right track. That will help us in terms of inflation.”

Markets have shown a great deal of sympathy towards the new administration but there is no room for complacency. “Confidence is here. We do see that the economy is at a turning point,” says Marcelo Carvalho, chief Latin America economist at BNP Paribas in São Paulo. On the political front, “the government seems to have enough support in Congress, so there is a good chance it will get passed in Congress. The essence of the reform will remain in place [even the cap on public expenditures is reduced to 10 years]. It would be a sufficient period of time for debt to stabilise and then decline after a few years,” says Carvalho. Without such reform, he says, debt would rise steadily to 100% of GDP. 

But others are not so sure. “We are at a key moment. Is Brazil going to take off again?” asks Francis Repka, head of the Brazilian subsidiary of Société Générale. There has been a lot of goodwill towards the new administration, he says. “But now it’s important to deliver. After two years of absolute stagnation, they need a concrete breakthrough in terms of reforms that will allow for an interest rate cut and pave the way for a kind of virtuous circle.”

However sympathetic investors may feel towards the new government, they will not feel complacent. “Without any adjustment measures there may be a shift in confidence and in the markets. If concrete measures are not taken within three months there may be a backlash. I’m afraid lawmakers don’t seem to be aware how urgent this has become,” he says.


Monica de Bolle, a Brazilian research fellow at the Peterson Institute for International Economics, argues that policymakers should take bold steps to loosen monetary policy. “I think the central bank should lower interest rates regardless of what happens on the fiscal front because the way the Brazilian economy is now, the way the various actors in the Brazilian economy are now, I don’t think there is any risk that an interest rate reduction would spark further inflation,” she says.

“In my view, the central bank is being way over orthodox on this issue. Much more than they should be.” The former IMF economist argues that the Brazilian crisis is so deep, including a steep rise in unemployment (at a rate of over 11%) and in corporate debt as well as a fall in household income, it is already time to loosen monetary policy.

When he was chief economist at Itaú Unibanco, Brazil’s largest private sector bank, Goldfajn also used to forecast interest rate cuts regardless of the Fed’s monetary policy action. But he has adopted a much more cautious approach since his appointment at the central bank. “We have to be sure that the interest path is done in a secure and sustainable way. In the past, we — the central bank — have had experiments where we wanted to bring interest rates down. And we indeed tried but we ended up having to reverse [the move],” says Goldfajn.

“What we all would like to see is a sustainable decline of interest rates,” he adds. “I believe that credibility comes with responsibility. If you don’t have responsibility you lose credibility. Credibility is here when people believe the central bank will act in a responsible way and this will be the case.”  In other words, the decision need not be hasty.

But de Bolle’s criticisms go deeper. “We have a team of economists who are all good but I am not sure they are very good at this type of crisis. In times of crisis you have to be innovative, you have to think of solutions. You have to do things that you should not normally do. This is precisely what the Fed, what the ECB, what the Bank of Japan does.

“Sometimes you just have to put your orthodoxy on mute and do something that you might not have done when things are normal. Things are not normal in Brazil right now. They have to be a lot bolder than they have been and I just don’t see that boldness anywhere. What I see is a lot of cheering. Everybody is cheering everything on as if that in itself would bring things forward. But I just can’t see how that would happen,” she says.

In spite of these positive expectations, the situation looks bleak in many respects. “Households don’t have the ability to consume, the government is really constrained in its ability to spend, the corporate sector is highly indebted and can’t really do anything. So honestly, if you reduce interest rates you are really doing a favour to all of these sectors because you are reducing their debt service obligations,” de Bolle says. “There is a weird juncture where actually a fall in interest rates would be very beneficial for the fiscal side not just because of the government interest bill but because it would have a beneficial effect on the corporate sector.”

But Goldfajn’s central bank looks in no mood to rush things. On the political front, Temer says his mission is to “pacify” Brazil. As a former president of the lower house he is also known for his political and negotiating skills. These are now required to deal with a fragmented and unruly Congress and push forward his very orthodox agenda. Some government officials and bankers have already described the current team of economic policymakers — headed by Goldfajn and Meirelles — as “a dream team’’. But the new central bank governor does not get carried away. “I am just part of the team,” he says with a smile. “A team that has both feet on the ground — no dreams.”

  • By Thierry Ogier
  • 04 Oct 2016

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