Oct. 19 (Bloomberg) -- Brazilian officials are turning away from a 15-year old formula for success as worldwide financial storms erode faith in three core policies that ended decades of economic crisis, according to former policy makers and analysts who lived through the turmoil.
The so-called tripod of inflation targeting, low budget deficits and a floating exchange rate has supported the longest period of growth in Latin America’s biggest economy since the 1970s, helping to lift millions out of poverty and winning Brazil its first-ever investment grade rating.
While President Dilma Rousseff’s government says it still adheres to the three policies, its actions contradict this, said Edmar Bacha, an architect of the Real Plan in 1994 that tamed hyperinflation. The central bank -- which may cut interest rates again today -- is tolerating faster price increases as it lowers rates with inflation at a six-year high, Bacha said. Spending pledges are putting at risk budget goals, while efforts to curb currency gains are protecting uncompetitive industries, he said.
“It’s not a rupture, the way you have in Argentina or Venezuela,” said Bacha, a member of the opposition Social Democracy Party, referring to nations with policies unfriendly to investors and where inflation is in excess of 20 percent. “It’s more like a bend than a break up to now.”
Investors in Brazil fled to inflation-protected assets after the central bank on Aug. 31 cut the benchmark interest rate by a half-point. The decision surprised all 62 analysts surveyed by Bloomberg who expected bank President Alexandre Tombini to leave the rate unchanged for a sixth straight meeting as inflation, which surpassed the 6.5 percent upper limit of the bank’s target range in April, continued to accelerate.
Inflation Expectations
Inflation expectations, as reflected in the yield gap between fixed-rated bonds and those linked to the benchmark IPCA price index, rose to 6.22 percentage points from 5.86 points on Aug. 31. Inflation expectations for Mexico and Chile declined over the same period.
Rousseff cheered on policy makers after the rate cut, telling a group of business leaders last month that Brazil can’t miss the opportunity provided by the European debt crisis and global slowdown to lower borrowing costs that are the highest in the Group of 20 nations.
At today’s meeting, policy makers are expected to cut the Selic another half-point to 11.50 percent, according to the median estimate in a Bloomberg survey of 66 analysts.
‘Dangerous Bet’
The central bank cited a “substantial deterioration” in the world economy as the reason for its rate cut, adding that “moderate adjustments” to the Selic won’t compromise its goal of bringing down inflation to 4.5 percent in 2012. Economists forecast it will run faster than that until 2014 and expect the government to miss its target this year for the first time since 2003, according to an Oct. 14 central bank survey.
The policy of relying on a global meltdown to ease price pressures is a “dangerous bet,” Bacha said in a telephone interview from Rio de Janeiro.
“If there is no disaster abroad, the inflationary situation in Brazil is very worrisome given our past,” said Bacha, who also served as president of Brazil’s state development bank.
Brazil had accumulated inflation of 13.3 trillion percent and used five different currencies in the 15 years before the Real Plan, according to “Brazilian Saga,” a best-selling book published in May by journalist Miriam Leitao about the country’s recent economic past. The years of stability since have led Brazilians to forget the wage freezes and confiscation of savings that once tormented families, Leitao wrote.
‘Responsible’ Rate Cuts
Press officials at the Finance Ministry and the central bank declined to comment in e-mails sent to Bloomberg News asking whether Brazil was backsliding on its low inflation commitments. Rousseff in a Sept. 30 speech said government efforts to contain spending this year are creating space to begin a “cautious” and “responsible” cycle of rate cuts.
Brazil’s inflation-targeting system, which dates from 1999, has been weakened by the central bank’s pursuit of other goals, such as maintaining growth and managing the exchange rate, said Alberto Ramos, a senior Latin America economist at Goldman Sachs Group Inc. in New York.
“The central bank became less predictable,” Ramos said in a telephone interview. “Because it added other objectives, it seems that the inflation target is now a soft one.”
Brazilian assets have underperformed their emerging market peers amid the global financial turmoil. The benchmark Bovespa stock index has fallen 21 percent this year, more than stocks in Russia, India, China and South Africa, the other BRICS.
Fiscal Concerns
“Alarm bells are going off” on fiscal policy as well, said Thomas Trebat, director of the Brazilian studies program at Columbia University in New York.
Since the passage in 2000 of the so-called fiscal responsibility law, governments of all political stripes have bound themselves by spending limits at federal, state and municipal levels. That’s allowed government debt to fall to 39 percent of gross domestic product from 60 percent in 2003.
Still, investors are concerned Rousseff’s pledge to raise pension payments by 14 percent in 2012 and revamp roads, airports and infrastructure ahead of its hosting of the 2014 World Cup will make it difficult to meet the government’s budget surplus target before interest payments next year.
The government resorted to special accounting rules to meet its primary surplus goal last year as it kept in place fiscal stimulus as growth topped 7.5 percent, the fastest in two decades. Next year’s budget proposal presumes economic growth of 5 percent, higher than the 3.6 percent forecast by analysts.
“The government caught a huge break because of the rise in commodities prices and the surge in economic activity,” said Trebat, a former Citigroup Inc. analyst. “It should have been saving. Instead it has been spending transitory income.”
Investor Support
Investors are still showing some signs of confidence in the government. Even with the global selloff, the central bank last month raised its forecast for foreign direct investment this year to a record $60 billion from $55 billion. The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell to 232 basis points from 428 at the end of 2008, according to JPMorgan Chase & Co.
As to the third leg of the tripod, Brazil has been more aggressive than its emerging market peers in trying to curb currency gains fueled by abundant global liquidity.
Since October of last year, the government has tripled a tax on bond purchases by foreigners, raised levies on loans taken by companies abroad and boosted reserve requirements for banks betting against the dollar in the futures market. The central bank also bought $48 billion in the spot currency market this year to stem a 50 percent rally in the real from the end of 2008 until July 26, when it reached a 12-year high.
The weakening of the tripod could increase the risk premium investors demand to hold Brazilian assets, said Christopher Garman, a director for Latin America at Eurasia Group, a Washington-based political risk group.
“It’s a false dichotomy to think that you grow a little bit more by accepting more inflation,” Garman said. “If this strategy goes wrong, the government is going to have to take harder measures to bring inflation back under control.”
Source: www.businessweek.com
The so-called tripod of inflation targeting, low budget deficits and a floating exchange rate has supported the longest period of growth in Latin America’s biggest economy since the 1970s, helping to lift millions out of poverty and winning Brazil its first-ever investment grade rating.
While President Dilma Rousseff’s government says it still adheres to the three policies, its actions contradict this, said Edmar Bacha, an architect of the Real Plan in 1994 that tamed hyperinflation. The central bank -- which may cut interest rates again today -- is tolerating faster price increases as it lowers rates with inflation at a six-year high, Bacha said. Spending pledges are putting at risk budget goals, while efforts to curb currency gains are protecting uncompetitive industries, he said.
“It’s not a rupture, the way you have in Argentina or Venezuela,” said Bacha, a member of the opposition Social Democracy Party, referring to nations with policies unfriendly to investors and where inflation is in excess of 20 percent. “It’s more like a bend than a break up to now.”
Investors in Brazil fled to inflation-protected assets after the central bank on Aug. 31 cut the benchmark interest rate by a half-point. The decision surprised all 62 analysts surveyed by Bloomberg who expected bank President Alexandre Tombini to leave the rate unchanged for a sixth straight meeting as inflation, which surpassed the 6.5 percent upper limit of the bank’s target range in April, continued to accelerate.
Inflation Expectations
Inflation expectations, as reflected in the yield gap between fixed-rated bonds and those linked to the benchmark IPCA price index, rose to 6.22 percentage points from 5.86 points on Aug. 31. Inflation expectations for Mexico and Chile declined over the same period.
Rousseff cheered on policy makers after the rate cut, telling a group of business leaders last month that Brazil can’t miss the opportunity provided by the European debt crisis and global slowdown to lower borrowing costs that are the highest in the Group of 20 nations.
At today’s meeting, policy makers are expected to cut the Selic another half-point to 11.50 percent, according to the median estimate in a Bloomberg survey of 66 analysts.
‘Dangerous Bet’
The central bank cited a “substantial deterioration” in the world economy as the reason for its rate cut, adding that “moderate adjustments” to the Selic won’t compromise its goal of bringing down inflation to 4.5 percent in 2012. Economists forecast it will run faster than that until 2014 and expect the government to miss its target this year for the first time since 2003, according to an Oct. 14 central bank survey.
The policy of relying on a global meltdown to ease price pressures is a “dangerous bet,” Bacha said in a telephone interview from Rio de Janeiro.
“If there is no disaster abroad, the inflationary situation in Brazil is very worrisome given our past,” said Bacha, who also served as president of Brazil’s state development bank.
Brazil had accumulated inflation of 13.3 trillion percent and used five different currencies in the 15 years before the Real Plan, according to “Brazilian Saga,” a best-selling book published in May by journalist Miriam Leitao about the country’s recent economic past. The years of stability since have led Brazilians to forget the wage freezes and confiscation of savings that once tormented families, Leitao wrote.
‘Responsible’ Rate Cuts
Press officials at the Finance Ministry and the central bank declined to comment in e-mails sent to Bloomberg News asking whether Brazil was backsliding on its low inflation commitments. Rousseff in a Sept. 30 speech said government efforts to contain spending this year are creating space to begin a “cautious” and “responsible” cycle of rate cuts.
Brazil’s inflation-targeting system, which dates from 1999, has been weakened by the central bank’s pursuit of other goals, such as maintaining growth and managing the exchange rate, said Alberto Ramos, a senior Latin America economist at Goldman Sachs Group Inc. in New York.
“The central bank became less predictable,” Ramos said in a telephone interview. “Because it added other objectives, it seems that the inflation target is now a soft one.”
Brazilian assets have underperformed their emerging market peers amid the global financial turmoil. The benchmark Bovespa stock index has fallen 21 percent this year, more than stocks in Russia, India, China and South Africa, the other BRICS.
Fiscal Concerns
“Alarm bells are going off” on fiscal policy as well, said Thomas Trebat, director of the Brazilian studies program at Columbia University in New York.
Since the passage in 2000 of the so-called fiscal responsibility law, governments of all political stripes have bound themselves by spending limits at federal, state and municipal levels. That’s allowed government debt to fall to 39 percent of gross domestic product from 60 percent in 2003.
Still, investors are concerned Rousseff’s pledge to raise pension payments by 14 percent in 2012 and revamp roads, airports and infrastructure ahead of its hosting of the 2014 World Cup will make it difficult to meet the government’s budget surplus target before interest payments next year.
The government resorted to special accounting rules to meet its primary surplus goal last year as it kept in place fiscal stimulus as growth topped 7.5 percent, the fastest in two decades. Next year’s budget proposal presumes economic growth of 5 percent, higher than the 3.6 percent forecast by analysts.
“The government caught a huge break because of the rise in commodities prices and the surge in economic activity,” said Trebat, a former Citigroup Inc. analyst. “It should have been saving. Instead it has been spending transitory income.”
Investor Support
Investors are still showing some signs of confidence in the government. Even with the global selloff, the central bank last month raised its forecast for foreign direct investment this year to a record $60 billion from $55 billion. The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell to 232 basis points from 428 at the end of 2008, according to JPMorgan Chase & Co.
As to the third leg of the tripod, Brazil has been more aggressive than its emerging market peers in trying to curb currency gains fueled by abundant global liquidity.
Since October of last year, the government has tripled a tax on bond purchases by foreigners, raised levies on loans taken by companies abroad and boosted reserve requirements for banks betting against the dollar in the futures market. The central bank also bought $48 billion in the spot currency market this year to stem a 50 percent rally in the real from the end of 2008 until July 26, when it reached a 12-year high.
The weakening of the tripod could increase the risk premium investors demand to hold Brazilian assets, said Christopher Garman, a director for Latin America at Eurasia Group, a Washington-based political risk group.
“It’s a false dichotomy to think that you grow a little bit more by accepting more inflation,” Garman said. “If this strategy goes wrong, the government is going to have to take harder measures to bring inflation back under control.”
Source: www.businessweek.com
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