Brazil’s Macro Economy, Past and Present

In this Economic Report we take a look at Brazils turbulent macroeconomic history and discuss the maincharacteristics of Brazils current macroeconomic policy mix. Brazil has experienced many economic crises. Inthe past its dependence on commodity exports proved a major vulnerability. Meanwhile, in the eighties thegovernment had to reschedule its foreign debt and as recently as the early nineties, the country suffered fromhyperinflation. However, since the launch of the Plano Real in 1994, Brazils macroeconomic environment hasbecome increasingly stable and in the past decade, Brazil started to benefit from the commodity boom.However, more recently growth has disappointed.

A turbulent pastBrazils economic history is characterized by economic volatility. South Americas largest country experiencedmany huge booms that were followed by periods of economic stagnation and decline. In the 16th century,Brazil became the worlds main sugar producer, but in the late 17th century the sugar industry suffered heavilyfrom the rise of the Caribbean as a sugar producer. At the turn of the 18th century, there was a gold boomafter a major discovery in Minas Gerais, but the resulting upswing for the Brazilian economy proved onlytemporary.

The mother of all Brazilian booms was the coffee boom which started in the 19th century. Brazil benefittedfrom the rapid growth of coffee consumption in the late 19th century, with the country producing almost 75% ofall coffee produced globally around the turn of the century. It made the country very reliant on this sector. It isestimated that coffee exports were equal to more than 10% of Brazils GDP. However, due to overproductionand a fall in demand due to the global recession, the coffee price fell 50% between September 1929 andJanuary 1930. As Brazil tried to maintain the gold standard, to which it had returned in 1926, this resulted inthe depletion of Brazils foreign exchange reserves and in 1930 the country abandoned the gold standard. Theeconomy contracted strongly in 1930 and 1931, but recovered quite vigorously in the following years.

After World War II, Brazil implemented a policy of import substituting industrialization, as the country wantedto become less dependent on commodity exports. Especially during the 1970s, the country enjoyed very highrates of economic growth and made large scale investments in infrastructure and industry. This helped toestablish new industries and to diversify the economy. People started to talk about the Brazilian miracle.However, at the same time, a large part of the population was left behind and inequality, which had alreadybeen high thanks to a history of concentrated landownership and slavery, grew rapidly, making Brazil one of themost unequal societies of the world.

Brazils macro economy, past andpresent

Economic Report Herwin Loman

January 09, 2014 | Rabobank | Economic Research Department

https://economics.rabobank.com/publications/2014/january/brazils%2Dmacro%2Deconomy%2Dpast%2Dand%2Dpresent/

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Figure 1: Economic growth Brazil

Source: World Bank

Figure 2: Inflation Brazil

Source: World Bank

Meanwhile, the first oil shock in 1973 led to a strong deterioration of Brazils terms of trade. As Brazil at thattime imported 80% of its oil consumption, its total import bill more than doubled from USD 6.2bn in 1973 toUSD 12.6bn in 1974 . Brazil accommodated this shock by borrowing large amounts of cheap petrodollars Theboom thus continued for some time, but when global interest rates were raised strongly and lenders becameless willing to lend to Latin American countries in the early eighties, this reliance on foreign lending led to hugeeconomic problems. Debt service was equal to 83% of export earnings in 1982. The country struggled to financeits external indebtedness and growth came to a halt. In 1987, the government was not able to pay the intereston its foreign debt and Brazils public debt had to be rescheduled.

These economic problems were accompanied by political turbulence. The military dictatorship that had ruledBrazil since 1964 lost support and was forced to step down in 1985, which resulted in the return of democracy .Thanks to democratization, social inclusion became a new priority, which marked a big departure from militaryrule, which had focused on maximizing growth without much attention for Brazils extremely high socialinequalities.

The first democratic government after military rule had limited means to resist spending pressure fromcongress. As a result, inflation, which had already been high for some decades (see figure 2) thanks to thedecades old practice of monetary financing of budget deficits, frequent devaluations and indexation (automaticcorrection of prices, interest rates and wages according to past inflation), ran totally out of control. In the lateeighties and early nineties several attempts were made to end high inflation, some primarily based on wageand price freezes, and one on a deposit freeze, but all failed. Instead, Brazil experienced Weimar Republicstyle hyperinflation, with inflation peaking at 2,950 percent in 1990. Hyperinflation made all economicactivities extremely shortterm oriented and was most detrimental to the poor, who were not able to protectthemselves against inflation.

A new startThe launch of the Plano Real in 1994 would prove to be the turning point. This plan, designed by HenriqueCardoso, who would later become Brazils president, envisaged the introduction of a new currency, putconstraints on public spending and ended the indexation of the economy The new currency, the real, had acrawling peg against the dollar as a nominal anchor and was somewhat overvalued, which made imports cheap,thus limiting the room for domestic producers to raise prices. Meanwhile, Brazil in the late eighties and ninetiesalso embarked on large scale trade liberalization and privatization.

The Plano Real was very successful in exterminating hyperinflation, with inflation falling from 2,477% in late1993 to 9.5% in late 1996. Although it was thus a big step forward, the Plano Real did not mean an immediateend to economic volatility. Partially thanks to the overvaluation of the real, the current account deteriorated,which made Brazil reliant on a continuous inflow of foreign capital. Brazil needed high interest rates to



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suppress inflation and attract capital, but those high rates contributed to a deterioration of the fiscal accounts.This became problematic when financial crises in Asia and Russia greatly reduced the availability of foreigncapital.

In 1999, Brazil was therefore forced to make major policy changes. The real was floated and instead of anexchange rate targeting regime the country adopted an inflation targeting regime. Monetary policy wastightened and fiscal policy as well. The introduction of a Fiscal Responsibility Law in 2000 thereby helped tocontrol public spending. To stave off a default, Brazil also got an IMF loan package. The election of Lula daSilva in 2002 led to new economic tensions, as foreign investors suddenly shunned the country fearing presidentLula would default on Brazils debt, as his Workers Party had very radical roots and Lula had been very criticalabout the Plano Real during the nineties. However, once in office, Lula chose to maintain Brazilsmacroeconomic policies.

Brazil as a BRICMeanwhile, the outside environment became much friendlier for Brazil. High growth in China and otherEmerging Markets fuelled the demand for many different types of commodities. As a prime producer of ironore, sugar, coffee, meat, soy and many other commodities, Brazil was very well placed to benefit from thistrend. At the same time, the domestic economy also became more dynamic. Cash transfers, a higher minimumwage and credit growth resulted in a strong growth of consumption. The good years were also used to build alarge stock of foreign reserves, while the government maintained a large primary surplus, which, coupled withhigher growth, led to a fall of the public debt/GDP ratio. Early in 2008, the rating agencies recognized that themacro economy had stabilized by granting the country an investment grade rating.

Brazils resilience was demonstrated when the 2008 global financial crisis struck. The country suffered from thequick fall of commodity prices and the strain on financial markets. For the first time in its history, Brazil wasable to enact countercyclical policies during a (global) crisis. Instead of having to tighten fiscal and monetarypolicies, which was necessary in the past to preserve confidence, Brazil had enough buffers to counter the crisisby increasing public spending and lowering interest rates.

As a result of these stimulus measures, and also due to a strong recovery of commodity prices, the Brazilianeconomy recovered vigorously in 2010, with GDP growth swinging from minus 0.9% in 2009 to 7.5% in 2010.Meanwhile, large oil reserves were found in the Atlantic Ocean. This meant that Brazil, which had alreadyexperienced a strong growth of oil production in the first decade of the 21st century, could become a major oilproducer, with partially state owned Petrobras playing a central role. In 2010, Petrobras raised USD 70bn in theworlds biggest IPO ever. However, growth fell disappointingly to 2.7% in 2011 0.9% in 2012.

Present situationMonetary policyThanks to the hyperinflation history, support for antiinflation policies has been strong in Brazil. The centralbank has an inflation target of 4.5%, whereby inflation should not fall or rise more than 200 basis points aboveor below the target. Although inflation increased temporarily above the target in 2011 and in early 2013, thecentral bank has been successful in keeping inflation in check, especially when Brazils dismal track recordbefore 1994 is taken into account. The central bank is fairly independent, although the influence of thegovernment over monetary policy increased somewhat in the past years. It seems that the central bank inpractice no longer aims for 4.5% inflation, but instead wants inflation to be between 4.5% and 6.5%.

Brazils real interest rates used to be high, but have declined for many years. During 2012, the policy interestrate reached a historic low, after the central bank had cut the SELIC rate, its main policy rate, by 525 basispoints in one year. In April 2013, the started a new tightening cycle and the central bank seems intent on



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regaining its credibility that had been somewhat weakened by the earlier unprecedented easing of policy. Inthe past years, the central bank has also increasingly resorted to macro prudential rules as complementarytools for monetary policy. In practice, this has meant that the central bank tries to influence credit growth byincreasing or lowering capital and reserve requirements for banks, and not through monetary policy, as thelatter could make it more difficult to control the exchange rate.

Figure 3: Foreign reserves

Source: EIU

Exchange rate policyBrazil has had a managed floating exchange rate system since its ended the reals peg to the US dollar in 1998.In the past few years, the ultraloose monetary policies in the western world and high commodity pricesresulted in strong upward pressure on the exchange rate. To protect the competitiveness of domesticproducers, the government went to great lengths to limit the appreciation of the real, thus making the real aheavily managed currency. It not only used foreign exchange interventions to influence exchange rate policy,but also imposed several capital controls, such as taxes on portfolio inflows, to limit capital inflows.

Recently, the government has removed those restrictions, as it became concerned about the strong depreciationof the real after the financial markets started to anticipate a tapering of the monetary stimulus by the USFederal Reserve. In the past decade, the central bank has built up a large stock foreign reserves. In August2013 this stock was USD 367bn, which is equal to roughly 14 months of imports and almost all of Brazilsforeign debt. Nowadays, the central bank primarily intervenes in the currency markets with swaps.

Fiscal policyBrazils fiscal policies have improved markedly in the past decades. Control over public spending has increasedstrongly, with the already mentioned Fiscal Responsibility law playing an important role. This allowed thegovernment to achieve its target of running sizeable primary surpluses. Even in 2009, when the governmenttook to significant fiscal stimulus, the government had a 2% of GDP primary surplus. However, Brazils sizeablepublic debt and the high interest rates require a relatively high primary surplus. Thanks to economic growth,moderate inflation and budget deficits, public debt fell as percentage of GDP from 77% in 2002 to 54% in 2011,but increased afterwards to 58% of GDP in 2012. Furthermore, the government missed its 3.1% of GDP 2012primary surplus target, despite the fact that it used several accounting tricks. Thanks to the reserves buildupand the fact that almost all government debt is now local currency debt, the government has become a netexternal creditor. With total government revenue accounting for 36.2% of GDP in 2011, against a 26.3% averagefor emerging markets, the public sector is relatively big in Brazil.

Conclusion and outlookBrazils macroeconomic situation has become much more stable in the past decades. In the past years, themacroeconomic policies became somewhat less orthodox. The exchange rate has become more heavily managed



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and the central bank seems to aim for a slightly higher inflation target. This increases the risk of inflationovershooting the target range, which would force the central bank to raise rates aggressively, and may thuslead to slightly more volatility. Recently, the central bank seems to be trying to regain its credibility, whilecontrols on capital inflows were abolished, after the strong upward pressure on the real eased.

Sources

Werner Baer, The Brazilian economy : growth and development, 6 edition, 2008Thomas E. Skidmore, Five Centuries of Change, 2 edition, 2009

Author(s)

International Research (IR)

+31 30 21 [email protected]

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Herwin Loman



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Brazils macro economy, past and presentA turbulent pastA new startBrazil as a BRICPresent situationMonetary policyExchange rate policyFiscal policy

Conclusion and outlook

Documents

Brazil’s Macro Economy, Past and Present