Winning the currency war won’t solve the country’s problems
For Guido Mantega, Brazil’s finance minister, the end of the battle is in sight. His ‘currency war’ is going great guns: after 18 months spent talking down its currency, Brasilia can now boast a real at R$2 to the dollar, its weakest since 2009. But Mr Mantega would be wise to wait before claiming victory. Brazil’s economy is far from being back in top gear.
The finance minister has always had good reasons to fight for a weaker real. Loose monetary policy in the US and Europe over the past two years has unleashed significant capital inflows that have inflated the value of Brazil’s currency. This appreciation has rendered local industries uncompetitive, attracted cheap imports, and weighed on GDP growth. The economy slowed to a modest 2.7 per cent last year – a far cry from the 7.5 per cent peak of 2010.
But Mr Mantega’s battle has been skilfully fought. Helped by a deteriorating global outlook, the central bank has cut overnight interest rates by 350 points over the past eight months. It is expected to cut them again from 9 to 8.5 per cent this Wednesday, putting them at their lowest in 15 years. The government has also reduced guaranteed returns on a popular savings account, the poupança, effectively removing a floor under interest rates.
And yet Brazil’s currency plunge increasingly looks like a Pyrrhic victory. Despite a currency down 6 per cent since January, Brazil’s economic output shrank by 0.35 per cent in March. Credit growth is also slowing, with rising levels of household indebtedness dampening demand. And inflation, at 5.17 per cent, remains above the 4.5 per cent official target. Room for further monetary easing is shrinking fast.
President Rousseff now needs to get her priorities right. As many economists suggest, what is limiting the country’s potential growth rate is not an overvalued real, but a worsening lag in competitiveness and productivity. The government should therefore take aim at the right targets: chronic underinvestment in infrastructure and education, burdensome red tape, and an unwieldy tax system. Tackling these issues would ease inflationary pressures and allow for further reduction of Brazil’s high interest rates – thereby achieving two long-standing goals of the government.
None of this is new: academics have recognised the need for structural reforms for years. But Brasilia still seems to be missing the plot. Its recent embrace of protectionism, via the imposition of local content rules, is doing no good to its industrial output – as evidenced by the recent misfortunes of its automotive sector. Neither does its last stimulus package address the economy’s productivity problem, as it is mostly geared towards boosting domestic demand, already strong thanks to record-low unemployment.
Whatever path she chooses to take next, Ms Rousseff will have to keep on holding together a fractious ruling coalition. But she should see the current crisis as an opportunity to unite her partners, cement her leadership, and prepare the battlefield for real reforms.