For Brazils authorities, discussions on the impact of
the global financial crisis on emerging market economies are
increasingly irrelevant when applied to Brazil. The country
appears to have shrugged off the economic downturn and is now
on the verge of a new growth cycle.
Apart from a few corporate disasters due to bad bets in
exchange rate derivatives at the end of last year, the Latin
American giant has rebounded better, and more quickly, than
most could have expected. Moodys became latest ratings
agency to upgrade Brazil to investment grade in September.
Brazil will show solid growth rates in coming
years, Henrique Meirelles, governor of the Brazilian
central bank, tells Emerging Markets in an interview.
The second quarter annualized GDP growth rate was 7.8%.
Expectations for the third quarter are also very
positive, he says.
Finance minister Guido Mantega says: Brazil has
completed a negative, recessive cycle in just two quarters
Q4 2008 to Q1 2009 while other countries have had
to cope with negative growth for four or five
Brazilian president Luiz Inacio Lula da Silva is triumphant
over the way the country has overcome the financial crisis.
Lula has repeatedly complained that he used to be ridiculed by
critics when he predicted that the global crisis would only
cause a ripple when it hit the Brazilian shores.
The time when Brazil was catching pneumonia when the
US was catching a cold is over, he says. The time
when Brazil was sinking every time Russia was in crisis is
over. Thats over too. This country has learnt
self-respect. Brazil was the last country to be hit by the
crisis and will be the first one to emerge from it.
And planning and budget minister Paulo Bernardo Silva tells
Emerging Markets that although public debt is
going to increase this year following six consecutive years of
decline, it has been a relatively small price to pay to rescue
our economy and keep it out of the global turmoil.
Trouble in store
But not everything is rosy. The Brazilian government has
made a deliberate policy option to boost public spending to
support domestic demand, while a decline in interest rates has
alleviated the pressure on debt servicing. The official primary
surplus target was slashed to 2.5% of GDP in 2009, from 3.8%
last year, and is 3.3% of GDP in 2010.
The government has used this to increase current
public spending. They are setting up a fiscal time bomb
here, says Gustavo Loyola, a former central bank
president. Such public spending will weigh permanently on the
budget, he argues, and may curtail much-needed investment in
infrastructure, especially if the economic recovery is not as
strong as the 4.5% GDP growth that is expected by the
government in 2010.
Angel Gurria, the OECDs secretary-general, noted last
summer: Brazil is facing structural challenges to
strengthen its long-term growth potential. One issue that has
to be addressed without delay is related to the increase in the
share of public spending to the GDP. This is a concern that has
to be addressed.
Moreover, fiscal accounts have deteriorated faster than
expected due to a sharp 7% decline in tax revenues during the
first half of the year, compared to the same period in 2008.
The primary surplus target only amounted to 1.8% of GDP in the
12-month period leading to the end of June, while the net
debt-to-GDP ratio has been increasing steadily since last
December and reached 44% in July 2009.
The debt dynamics may not get out of hand, but they
are wasting a great opportunity to reduce the tax burden and
increase public investment, says Loyola, now a consultant
with Tendencias in Sao Paulo.
There will be a price to pay, he warns. Fiscal
exaggerations will probably demand a more conservative attitude
from the central bank, which has already had an impact on
interest rates and more broadly on the yield curve.
Indeed, Brazil may not be facing the kind of solvency issues
that it used to have to deal with. This, in itself, is a
Nevertheless, the long-term sustainability of Brazils
broader current fiscal strategy looks questionable, according
to Marcelo Carvalho, Morgan Stanleys Brazil economist.
Relying on a steadily rising tax burden to compensate for
steadily rising fiscal spending does not seem to be a strategy
that can be sustained indefinitely without entailing an
undesired crowding out of the private sector, he
Government officials dismiss such fears, and Mantega has
repeatedly shrugged off concern about fiscal complacency, while
the IMF has acknowledged that Brazil still has further leeway
to implement counter-cyclical policies both monetary and
fiscal if circumstances demanded them.
In its latest Article IV consultation review, the IMF
highlighted the importance of instituting a sound
medium-term fiscal framework and efforts to reinvigorate the
reform process, including with respect to tax and pension
reform. A gradual reduction of revenue earmarking and
expenditure rigidities would also be desirable.
A relaxed Mantega would rather sound more upbeat. If
you hear comments about our fiscal problems, dont believe
them. When I was appointed in 2006, people were saying that I
was not going to hit the fiscal target, that I was a big
spender but we have had a series of the best fiscal
performances on record since, he says.
Last year was excellent, and we put an extra 0.5% in
the sovereign fund. Without the crisis, we would have a zero
budget deficit this year.
But times have changed. According to the IMFs
forecast, the budget gap should expand to 3.2% of GDP in 2009,
before falling to 1.3% of GDP next year.
While some economists predicted a long and deep recession
due to its new position in the global economy, the Brazilian
government acted on the monetary and fiscal fronts, with the
support of the international financial community. The strength
of the Brazilian banking industry and the size of the domestic
market allowed the economy to bottom out.
Central bank chief Meirelles says credit was the key:
We acted directly on the transmission channels of the
crisis. The central bank signalled that it was ready to
sell up to $50 billion in derivatives it was able to do
that because it was already $22 billion long in the futures
market, he says.
It also lent its reserves to banks, lowered their compulsory
reserve requirements in local currency terms to restore
liquidity and boosted their export credit lines. We
tackled the roots of the problem, he says, instead of
relaxing monetary and fiscal policies immediately.
The Brazilian central banks policy record and its
hard-won credibility also helped.
The central bank acted quickly internally to supply
liquidity in the interbank market especially to smaller
banks that were having problems funding their portfolios
and help bigger banks absorb those portfolios if they wanted to
buy them, says John Welch, chief economist of the private
banking division of Itau Unibanco in New York.
As panic threatened to spread from the capital and foreign
exchange markets to the real economy, the Federal Reserve
announced a $30 billion swap agreement with its Brazilian
counterpart last October. This helped avert a collapse of the
The Brazilian currency has since appreciated strongly.
Brazil used to be fragile from the exchange rate point of
view, says Mantega. Any crisis would trigger a
capital flight and a lack of confidence. Now maybe for the
first time in 30 or 40 years, we have not had such a reaction.
There was some capital flight as in other emerging markets, but
on a small scale.
Foreign reserves have reached a record $210 billion. This
key shock absorber has also confirmed Brazils position as
a net external creditor.
Brazil was late to loosen monetary policy compared to other
countries, but that was part of a cautious strategy. This
would have only created collateral effects, says
Meirelles, as domestic demand was already rising strongly at
the time. The central bank eventually slashed its benchmark
Selic rate by 500bp between January and July to 8.75%
its lowest level ever.
They may not have cut interest rates immediately, but
what they tried to do is to settle down the foreign sector
first, says Welch. They were able to show that some
normality was underway in the foreign exchange rate market, and
this opened the path for the central bank to cut interest rates
The new dynamism
Mantega is adamant that orthodoxy is not enough to explain
why Brazil stomached the global recession better than previous
crises. The difference is not only the product of
macroeconomic stability the three pillars of inflation
targeting, floating exchange rate and fiscal stability,
If it were only for that, Brazil would not have
reacted so well to the crisis. Brazil has benefited from a new
dynamism thanks to state policies to promote
Tax breaks boosted domestic car sales as well as those of
other durable consumer goods, such as domestic appliances.
Meanwhile, public-sector banks were sent to the front
line to address the widespread credit crunch. They were
able to respond more strongly than private banks, which have
been more cautious and conservative, says Mantega.
They increased credit, especially BNDES [the state-owned
national development bank]. The result is that we are getting
used to the quick action of the state in counter-cyclical
Along the way, BNDES received a 100 billion real ($55
billion) funding boost from the Treasury, including 25 billion
reais to support investment in the oil industry.
Lula sacked the president of Banco do Brasil, the largest
state-owned bank, in April because its spreads were still
considered too high. In Lulas view, institutions like
Banco do Brasil have to lead the crusade for lower bank
spreads. By July, Banco do Brasil had regained its position as
Brazils largest bank in terms of assets, which it had
lost last year to Itau Unibanco.
As a result, the domestic credit market has kept expanding,
albeit at a lesser rate than before the crisis. The credit to
GDP ratio, which was barely around 20% of GDP five years ago,
reached 45% this July. State-owned banks account for nearly 40%
of outstanding loans, according to central bank records.
The very fact that state-owned banks took greater
risks just when the financial system needed credit was
interesting, says William Eid, a financial academic from
the Getulio Vargas Foundation. The government gambled on
state-owned banks, forced them to supply credit, and it can
celebrate a decision that proved correct.
Nevertheless, some private-sector banks, such as Itau
Unibanco, have argued that the trend was not sustainable.
Non-performing loans have also been increasing payment
arrears of more than 90 days rose to 5.9% this July, compared
to 4% before the crisis impacted Brazil which has forced
banks to raise the level of provisions and curb their
Meirelles, meanwhile, warns against excess optimism but says
that, although confidence is rebounding, euphoria is unlikely
to accompany it. Markets are more cautious and more
realistic than in the past. Hedge funds and investors are more
cautious on carry trades; they are not betting on movements
only in a single direction, and that is positive.
Investments in the stock market are already back to
pre-crisis levels but on a much more sober basis than before.
We are calling peoples attention to keep it that way and
not to risk too much volatility, as we had in the