GUIDO MANTEGA: The cost of war

17/03/2012 | Guido Mantega

The economic competitiveness of emerging economies must not become a casualty of the West’s crisis response

In the second half of 2011, the world economy entered a new phase of severe difficulties. This manifested itself primarily in an even greater slowdown, with a risk of recession in the developed countries and the loss of dynamism in a large number of emerging economies. The impact of this current crisis, which originated in the financial cataclysm of late 2008, is already visible in the latest economic data.

But this scenario has taken on aspects that are all the more worrying because of the economic policies adopted by developed countries to combat the crisis. Europe, the United States and Japan have only made use of highly expansionary monetary policies in their attempts to overcome the adverse situation.

Monetary policy is not sufficient to promote the recovery of economic growth, despite its contribution to calming market fears and avoiding a fresh disaster in the world economy. Fiscal policies are needed to stimulate investment and strengthen demand.

Aside from its limited impact on economic growth, the approach developed nations have adopted has caused collateral damage in emerging countries: a genuine “currency tsunami”, with an impact on foreign exchange rates and the creation of financial bubbles.

A large part of the liquidity injected into the European, American and Japanese banks is destined for the financial market of solid and safe economies such as Brazil’s. Investors take advantage of the tremendous financial opportunities, above all in the interest rate differential, to conduct arbitrage and speculative operations. They also bet on the currency valuation in an attempt to increase their gains with interest rate arbitrage.

The result is a trend to value the real at a level that is unhealthy for our economy. Up to the beginning of March, the Brazilian currency gained 11% year on year, ahead of the Mexican peso, which gained 8.9%; the New Zealand dollar, with 8.5%; and 8% for the South African rand. Only the yen lost to the US dollar: 4.3%. With the measures Brazil recently adopted to deal with the problem, we eliminated a degree of the variation in the currency’s valuation, and the real moved to levels that are less damaging to the industrial sector.

An overvalued real is harmful to the Brazilian economy, especially to the manufacturing sector, which loses competitiveness with countries that have currencies that are artificially devalued.

The Brazilian government will not stand idly by in this currency war. We have an arsenal of measures which we are ready to use that are capable of stopping or neutralizing the overvaluation of our currency and stemming the excess inflows of foreign capital into the country.

Since 2009, when we noted an upturn in the flow of foreign capital, the government has been successfully adopting measures to combat a rise in the real. That year, for example, we established a 2% IOF (Tax on Financial Operations), levied on the entry of foreign capital applied in fixed and variable income assets in.

Last year, we applied a 1% IOF tax on operations carried out on the derivatives market on contracts that result in an increased currency exposure from the sales.

In 2012, we attacked again. In March, we extended to five years the period for charging the 6% IOF levied on loans taken out by Brazilian banks and companies. Until February, the taxable period was two years.

On another front, the Central Bank has expanded its activities in the foreign exchange market. With high international reserves, the monetary authority can intervene in the foreign exchange market at any moment, whether in the cash market through daily spot auctions, or in the fixed term and futures markets(through swap contracts).

Besides this, the Central Bank reduced to 360 days the period for operations categorized as advance payments on exports. In January and February, there was a 46% increase in the influx of dollars through this method. Last year, the annual total was US$ 54.4 billion.

The numbers show that the measures the Brazilian government has adopted to contain the excessive inflows of foreign capital have been effective over time. Without those actions, the dollar would certainly have fallen below R$ 1.40.

Brazil’s stance has been smoothed by the backing of multilateral bodies, including the International Monetary Fund (IMF), which recently recognized as legitimate the actions of emerging countries to control the flow of foreign capital and protect their economies in the face of foreign exchange rate fluctuations that deviate from an equilibrium over the medium-term.

It is important to reiterate that the Brazilian government does not work with an ideal exchange rate or with exchange rate bands. We have a floating exchange rate regime and it is beneficial to us that it remains that way.

But the government of Brazil, faced with a situation of excess global liquidity, cannot accept capital flows which have nothing to do with economic fundamentals and which are prejudicial to our industry.

Guido Mantega is Brazil’s Minister of Finance

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