The odd couple

17/09/2006 | Thierry Ogier

Brazil’s central bank president Henrique Meirelles and new finance minister Guido Mantega have been spared confrontation, thanks to a resilient economy. The awkward economic duo – widely expected to clash on policy – tell Emerging Markets why they’re now singing from the same cheerful sheet

Guido Mantega and Henrique Meirelles featured as a potentially risky double act in the eyes of many investors when the former – erstwhile president of the National Economic and Social Development Bank (BNDES) – was appointed to succeed Antonio Palocci as finance minister in March.

Yet within six months, economic activity has picked up again. Real interest rates have been falling against a background of lower inflation. And unlike Turkey, Brazil has put up a brave face in the wake of international market turbulence as it emerged less vulnerable to external shocks, with its country risk premium falling towards 200 basis points in mid-August.

LOAN REPAYMENTS
“We paid back the IMF and the Paris Club. We did a clean-up of the external debt,” Mantega tells Emerging Markets. The country’s net external public debt has been eliminated. So has the dollar-indexed part of the domestic debt, whose total amount has declined to little more than 50% of GDP. The pillars of the fiscal discipline were kept in place. Primary budget surpluses actually increased to over 4.25% of GDP (which is more than the previous government delivered). GDP growth is now expected to amount to between 3% and 4.5% this year (depending on sources – Mantega himself forecast more than 4%), following 2.3% in 2005 and 4.9% in 2004.

“Brazil is not an insecure and fragile country any more. It has achieved an important leap forward in the past 20 years,” Mantega says. “It used to be seen as a short-term country, where you could make a quick buck and then go away. It is not like this any more. Brazil is regarded as a country offering a long-term perspective because it offers all the requirements for it.”

Brazil, argues Mantega, has now “turned the tables” – once dependent on international capital, the country often found itself unable to pay back and sought IMF assistance, but now the economy has “bounced back” and has ended up a net creditor after years of indebtedness. “The Treasury now has a greater level of foreign reserves than debts,” he observes.

Mantega points first to Brazil’s new-found foreign trade prowess. This, he says, “means competitiveness without the kind of artificial exchange rates that other countries that I will not mention have (it is very easy to be competitive if you have an artificial exchange rate).”

“Now, our trade balance is proportionately greater than even China’s if we compare it to the total trade transactions. This shows that Brazil has managed to insert its economy in the age of globalization, and that we are competitive in several markets. We have comparative cost advantages. What was needed was a greater monetary stability,” says Mantega.

“Until the 1990s, Brazil was the country of inflation and football; today we are neither the one nor the other!”

The battle against inflation, which threatened to run out of control again four years ago, was won thanks to tough interest rates measures by an inflexible central bank. “This is the first time in recent history that the inflation rate will end the year below the centre of the target [4.5%],” Meirelles tells Emerging Markets. As he spells out the progress that has been achieved (economic growth at around 4%, job creation in the formal sector, increase in average income, net international reserves at $67 billion, trade surplus of more than $40 billion, etc.), the president of the central bank stresses that “all that has been anchored on a current inflation path, which is consistent with the inflation target, and with expectations for 2007 which, in turn, are firmly anchored at the 4.5% inflation target.”

NO DIFFERENCE
Adds Meirelles: “All the efforts are now paying off, and we are able to show that Brazil is not different. Brazil reacts very well to well-conceived and well-implemented policies. And it is able to grow and prosper with low inflation and without crisis.”

Before his appointment at the finance ministry, Mantega himself was a fierce critic of the tight monetary policy led by the central bank. He also favoured stronger intervention in the foreign exchange markets to prevent what was seen as an excessive and damaging appreciation of the Brazilian currency, the real. Nevertheless, what has proved important to investors is that both men have been able to work together and play in the same team.

Certainly, Mantega and Meirelles are still very different in style and content (the former is an academic who is close to the domestic industry, while the latter has had a long career in international finance). But they have somewhat managed to iron out their differences. Mantega now goes as far as saying that “fiscal stability and monetary stability are neutral”. He is also closer to President Lula’s Workers’ Party (PT), while Meirelles was elected a federal deputy for the Social Democratic Party (PSDB), of former president Fernando Henrique Cardoso, in October 2002. (As Lula appointed him to the central bank shortly after, he never actually took his Congressional seat.)

Mantega has never been a great fan of the idea of central bank independence, and there has been no progress towards it during the past six months. But at the same time, Meirelles and his directors continued to enjoy the same degree of operational autonomy as in the past.

Meanwhile, Mantega is keen to talk up the government’s social credentials. “We have implemented an industrial policy and a social policy that previous governments did not have ... These are new elements; there is more credit available for small and medium-sized businesses,” he says.

The overall level of credit, which has long been very low in Brazil, has already been boosted to 33% of GDP, and Mantega is adamant that it can reach 50% of GDP during the forthcoming presidential term. The target, which has become a sort of political directive, is also defended by the budget and planning minister Paulo Bernardo Silva. At the same time, Mantega has also endorsed orthodox goals, such as the elimination of the nominal budget deficit by 2010.

Uncertainties regarding the international environment are not likely to spoil the party either, adds Meirelles. “There are some risks but no clear signal that there is any kind of serious crisis looming ahead of us. The economy is showing some signs of slowing down somewhat, but there is no clear signal of very serious crises ahead,” he says.

Not all of Brazil’s financial community agrees, however. Caio Megale, at local hedge fund Maua Invest thinks Mantega’s economic forecast is untable: “[The figures] are not realistic: they are based on far too benign projections. It’s impossible for them to materialize in the short term. There are a lot of bottlenecks (infrastructure, education, red tape, labour laws), there is no mortgage market, too much fiscal deficiency (mainly the social security deficit),” he says, “You’d really need to have widespread welfare reform to make it happen.”

Jan Jarne, managing partner at Invest Partners, a local investment-banking boutique in Sao Paulo is also doubtful about Mantega’s forecast of 5% real interest rates.
“It’s too simple a statement,” he says. “Real interest rates of 5% would be a reasonable level to expect when compared with rapidly emerging countries, but this is easier said than done. Also, actual rates for borrowers are significantly higher because of the high spreads.”

UNITED
All in all, Mantega and Meirelles insist that the Lula team is united. “We are cooperating fully; we have a very good and productive relationship. We have just issued a profound reform of the foreign exchange regulations [allowing exporters to open an account abroad to deposit up to 30% of their foreign sales receipts]. It was a joint effort ... We are very happy with such a productive working relationship, not only between the central bank and the finance ministry but [also] between Mantega and myself,” says Meirelles.

Mantega also denies any frictions. “We are part of the same group ... the central bank and the finance ministry work in perfect harmony. Each has its duties, and we work together within the national monetary council. Every week, our respective teams have lunch together to deal with issues of common interest.”

Nevertheless, Meirelles has had to put up with formidable opposition to his tough monetary policy, especially from within government circles (the so-called friendly fire). Now that economic policy has indeed started to deliver the goods, both the finance minister and central bank chief can take their share of the credit. They may never form a dream team with the same Wall Street appeal of past famous couples such as Pedro Malan and Arminio Fraga or even Antonio Palocci and Henrique Meirelles himself, but financial investors all agree that the progress achieved in the last few years has been impressive.

PROMISING FUTURE
Both Mantega and Meirelles – respectively triumphant and measured in tone – predict a bright future for Brazil’s economy, no matter what happens in the external environment. “Today we have economic growth without any distortion in the public accounts. This is a unique combination in the country”, says Mantega, who predicts Brazil will soon break the threshold of 5% economic growth and will be able to join the club of fast-growing emerging markets.

“If Brazil grows at more than 5% during 10 years, this will lead to a deep transformation of the Brazilian society. We will indeed have a sound and more competitive economy and a fairer society,” Mantega says. Meanwhile, Meirelles is more considered (although he refuses to be called “cautious”): “It’s an opportunity for Brazil to enjoy the benefit of a stable economy for the first time in many decades, with an increase in investment and eventually an elevation of the potential GDP,” he says. “We’ll keep working towards low inflation, keeping a primary surplus and implementing the necessary structural reforms to improve efficiency and boost productivity.”

In the meantime, wary investors will keep a very close eye on the level of public spending and the tax burden in next few years.

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