Brazil is right to be cautious. But it should not lose its sense of directions
That’s a U-turn by any standard. Today’s announcement that Brazil would cut its petrol tax, on top of its surprise interest rate cut earlier this month, is the clearest indicator yet that it is shifting gears towards expansionary policy.
Up to very recently, the finance ministry had a different road map for macroeconomic stability. It was primarily concerned about a politically dangerous, stubborn inflation, and using increasingly daring weaponry to contain the pressure: the highest real interest rates in the world, taxes on consumer credit, and a more flexible approach to currency appreciation. Nothing really worked, but the persisting memories of hyperinflation in the 90s meant that, with unwavering resolution, economic policy would continue to target rising prices.
But this week-end Brazil’s ministers freaked out. They came back utterly shocked from Washington, where the IMF explained that the global economy was entering a much more ‘dangerous phase’ than originally thought. Worse, despite the sense of alarm permeating the meeting, they witnessed a tragic absence of global consensus for decisive action.
It didn’t take long for them to decide they had to hit the road and forge their own riposte to the international crisis. Soon they were enacting the petrol tax cut, pledging further interest rates slashes, and promising more fiscal support. Their plan was coming together, wrapped in a terminology full of ‘economic defence’, ‘expansionist policy’ and ‘growth-enhancing measures’.
If it does everything it says, however, the government will soon find itself down a tricky route. First because the timing of the Central Bank’s reversal, along with broader concerns over the global economy, has sent the real down a cliff (it’s now down 16 per cent against the dollar since August). The Bank’s intervention last Thursday prevented further collapse - but more interest cuts will probably see the real plunge again.
In itself, a weaker real is not a bad thing: Brazil has repeatedly complained that its overvalued currency was hurting its export-led industries. Only a few weeks ago it was even implementing a series of capital controls, including taxes on currency derivatives, to make this happen. But too weak a real is no good either. Many exporters are also borrowers in foreign currency, and due to the recent tax on derivatives their position are not securely hedged. The real, at R$1.80 to the dollar and up, is already above what analysts see as a sustainable R$1.70-R$1.75 unofficial target.
But then inflation has not gone away, and will probably constrain any future shift in macroeconomic policy. Aggravating global turmoils will bring less relief than hoped: long-term bottle necks, caused by a tight labour market and a cumbersome fiscal system, continue to feed in higher prices. A weaker currency will not necessarily help either, as it will make imports more expensive. This will add to the already pessimistic inflation expectations - at 6.53 per cent for the whole of 2011 they’re already blowing the target ceiling.
The official response is not up to the task. Pressured to choose between two evils, the government seems to be looking for directions: Guido Mantega, finance minister, has approved the Central Bank’s intervention to stop the real’s free fall; yet he is unwilling to dismantle the capital controls implemented when the currency was too strong. Dilma Rousseff, president, has pledged expansionary policy to assuage the cooling effects of the international crisis; but she also says rising prices remain a prime concern. Alexandre Tombini, central banker in chief, says he is personally accountable for keeping inflation within target this year; yet he is the one to kick it up the ladder by slashing interest rates.
Brazil’s inflation/currency problem has no easy solution. But it’s no wise thing to pull the brakes one minute and push the accelerator the next, as its politicians seem inclined to do. What Brazil really needs is a better road map: economists have long argued for structural reforms, such as a simplification of the tax system and a long-term plan to boost productivity. For the moment, sadly, that seems well off the radar.