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BRAZIL’S CURRENT MONETARY
POLICY DILEMMAS
Edmar L. Bacha
Bank of Israel
April 14, 2011
April 2011
1
Edmar L. Bacha
SUMMARY
• Brazil’s macroeconomic policy framework
• Central Bank status and functions
• Economic policy performance
• Current economic conditions
• Monetary policy objectives and dilemmas with use of
overnight interest rate and FX spot market intervention
• Search for ‘unorthodox’ policy instruments: credit
restrictions, capital controls, and more diversified FX
intervention
• Evaluation of current ‘unorthodox’ policies
April 2011
2
Edmar L. Bacha
Macroeconomic policy framework
since Jan’ 1999
• Inflation targeting (currently, 4.5% ± 2.0%)
• Floating exchange rates (w/regular CB FX intervention)
• Primary (ex-interest) public sector surplus
(2011 target, 3% GDP)
April 2011
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Edmar L. Bacha
Digression on Central Bank’s status
•
The CB is an autarky linked to the Ministry of Finance. But the CB Governor is
a cabinet level position since 2004, and, thus, responds directly to the
President of the Republic. His appointment is approved by the Senate
•
CB directors (7 to 8) are normally selected by the CB Governor in agreement
with the Finance Minister. Subsequently, they are appointed by the President of
the Republic, once approved by the Senate. CB Governor and directors can be
freely dismissed by the President of the Republic
•
Currently, the CB Governor and all directors are career civil servants. In
previous years, at least some of them were selected in the local financial
market or academia
•
The yearly inflation target range is set for two years ahead by the Monetary
Council, composed by the Finance Minister, the Planning Minister, and the CB
Governor
•
The CB’s Monetary Committee (≈ CB board) is responsible to maintain inflation
on target. It meets every 45 days to set the SELIC (overnight) interest rate
target for the subsequent period
•
The CB operates in the FX market through electronic auctions open to
authorized bank dealers
April 2011
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Edmar L. Bacha
Economic policy performance
• Inflation: target range and actual 12mo inflation
• Wages and Unemployment
• Exchange rate (BR$/USD) and CB foreign exchange market
interventions
• Current account deficit, capital inflows and international
reserve accumulation
• CB international reserves
• Primary public sector surplus
• Public sector debt/GDP
April 2011
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Edmar L. Bacha
Inflation
IPCA inflation vs Central Bank target
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: IBGE
April 2011
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Edmar L. Bacha
Wages and Unemployment
Real Wage Bill Index – Mar-02=100 - SA
Unemployment rate and NAIRU - % - SA
140
14
135
Brazil’s NAIRU ( non-accelerating
inflation rate of unemployment) at
close to 7.5%
13
130
12
125
11
120
10
115
9
110
8
105
100
7
95
6
90
5
7.5
6.3
2002
2004
2006
2008
2010
2002
2004
2006
2008
2010
Source: IBGE; Itaú
April 2011
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Edmar L. Bacha
Exchange rate and CB intervention
BCB’s Intervention in the FX market
1300
3.8
Daily average US$ mn
800
3.5
3.3
-200
3.0
-700
2.8
-1200
2.5
-1700
BRL / USD
(-) liquidity injection / (+) liquidity draining
300
2.3
-2200
-2700
-3200
FX swap
Foreign currency loans
Spot intervention (including fowards, since Jan-11)
Redemptions of the dollar-linked debt
Average exchange rate (RHS)
2.0
1.8
Source: BCB; Itaú
April 2011
1.5
jan/03
mar/03
mai/03
jul/03
set/03
nov/03
jan/04
mar/04
mai/04
jul/04
set/04
nov/04
jan/05
mar/05
mai/05
jul/05
set/05
nov/05
jan/06
mar/06
mai/06
jul/06
set/06
nov/06
jan/07
mar/07
mai/07
jul/07
set/07
nov/07
jan/08
mar/08
mai/08
jul/08
set/08
nov/08
jan/09
mar/09
mai/09
jul/09
set/09
nov/09
jan/10
mar/10
mai/10
jul/10
set/10
nov/10
Jan-11
-3700
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Edmar L. Bacha
Balance of Payments (US$ bn)
120
96.6
100
85.9
87.5
80
71.0
60
49.1
46.7
40
22.0
20
3.3
31.2
30.6
26.5
8.5
7.9
4.3
0.3 4.2
16.9
13.6
14.0
11.7
4.3
2.2
3.0
1.6
0
-2.3
-7.6
-9.4
-20
-24.2
-9.7
-23.2
-28.2
-40
-24.3
-47.5
-60
2000
2001
2002
2003
Current Account
2004
2005
Capital Inf lows
2006
2007
2008
2009
2010
International Reserves Accumulation
Source: BCB
April 2011
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Edmar L. Bacha
International Reserves
350
2.0
316
1.8
300
1.63
1.6
250
1.4
200
1.2
150
1.0
100
0.8
50
0.6
0
0.4
2001
2003
2005
2007
International Reserves (USD Bn - Right)
2009
2011
Reserves/Imports Ratio (Lef t)
Source: BCB
April 2011
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Edmar L. Bacha
Public sector primary surplus
4.5%
% GDP
3.5%
2.8%
2.5%
1.6%
1.5%
0.5%
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Recurring Primary Fiscal Balance
Jan-09
Jan-10
Jan-11
Central Bank's Primary Fiscal Balance
Source: National Treasury, Itaú
April 2011
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Edmar L. Bacha
Public sector debt/GDP
Total Public Debt: Net and Gross (% GDP)
70
65
60
55.9
55
50
45
40
40.6
35
2006
2007
2008
Net Debt
2009
2010
Gross Debt
Source: BCB, Itaú
April 2011
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Edmar L. Bacha
Current economic conditions
• Overheated economy
• Inflation rate: high and rising
• Very high real interest rates
• Very appreciated currency
• Dependence on commodity-related exports
• Rising current account deficit
April 2011
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Edmar L. Bacha
Overheated economy (growth of
domestic demand)
Domestic Demand (12 Months)
10%
8.7%
8%
7.8%
6%
5.4%
4.3%
4%
3.7%
2%
0%
-2%
2000
2002
2004
2006
2008
2010
2012
Source: IBGE, Itaú
April 2011
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Edmar L. Bacha
...backed by strong growth of government
spending and public banks’ credit expansion
Outstanding Loans (YoY)
Total Government Expenses (inflation adj. 3-month YoY %)
60%
20
16
Public Banks
40%
12
20%
\
8
7.4
Private Banks
0%
4
-20%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
2004
2005
2006
2007
2008
2009
2010
Source: BCB, Itaú
April 2011
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Edmar L. Bacha
Inflation rate: high and rising
(headline and ex-food and beverages)
IPCA Index (12 Months)
Itaú Forecast
20%
18%
17.2%
16%
14%
12%
10%
8%
5.9%
6%
6.3%
5.0%
4%
2%
0%
2002
2003
2004
2005
2006
2007
2008
IPCA ex- f ood and beverages
2009
2010
2011
2012
IPCA
Source: IBGE, Itaú
April 2011
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Edmar L. Bacha
April 2011
17
4T-10
4T-09
2T-10
4T-08
2T-09
4T-07
2T-08
4T-06
2T-07
4T-05
2T-06
4T-04
2T-05
4T-03
2T-04
4T-02
2T-03
4T-01
2T-02
4T-00
2T-01
4T-99
2T-00
4T-98
2T-99
4T-97
2T-98
4T-96
2T-97
2T-96
High real interest rates (Brazil’s and
World’s, since 1996)
50
40
30
20
Brazil
10
0
World
-10
Source: Itaú
Edmar L. Bacha
Very appreciated currency (Big Mac X-rates)
Big Mac
Index 2010
Difference to the US Big Mac (USD)
Country
Switzerland
Brazil
Euro Area
Canada
Israel
Japan
United States
Britain
Singapore
South Korea
South Af rica
Mexico
Thailand
Russia
Malaysia
China
-2
-1
0
1
2
3
4
Switzerland
Brazil
Euro Area
Canada
Israel
Japan
United States
Britain
Singapore
South Korea
South Africa
Mexico
Thailand
Russia
Malaysia
China
Dollars
6.78
5.26
4.79
4.18
4.17
3.91
3.71
3.63
3.46
3.03
2.79
2.58
2.44
2.39
2.25
2.18
Source: The economist
April 2011
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Edmar L. Bacha
Dependence on commodity-related exports
Exports (USD bn – 12M)
Main Brazilian Exports - 2010
160
149
Other
Iron Ore & Metals
140
Commodities
20.1%
Meat
21.7%
120
100
6.6%
Sugar
6.8%
and Ethanol
18.0%
Oil, Fuel and
Chemicals
76
80
70
61
7.5%
Machines, Equip.
Incl. Electrical
128
60
8.5%
49
10.8%
Transport Equip.
40
Non-commodities
Soya Complex
20
0
1999
2001
2003
2005
2007
2009
Source: MDIC
April 2011
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Edmar L. Bacha
Rising current account deficit
4.0
Forecasts
% GDP
3.5
3.5
Current Account Deficit (12M)
3.0
2.7
2.3
2.5
2.3
2.0
2.4
2.5
Foreign Direct Investment (12M)
1.5
1.0
0.5
0.0
2008
2009
2010
2011
2012
Source: BCB; Itaú
April 2011
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Edmar L. Bacha
Current monetary policy objectives and
dilemmas in the use of the Selic interest rate
• Main current policy objective is to cool off the
economy to bring inflation back to target
• Problem is that fiscal stance and public banks’ credit
expansion provide little help to the CB
• Raising an interest rate that is already very high is
costly and induces further exchange rate
appreciation
• CB as a consequence is following a gradual path of
interest rate tightening, hoping to bring inflation to
target by 2012
April 2011
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Edmar L. Bacha
Gradual monetary tightening
Selic Target Rate
Itaú Forecast
28
26
24
22
20
18
16
14
12.25%
11.25%
12
11.50%
10
8
2000
2002
2004
2006
2008
2010
2012
Source: BCB; Itaú
April 2011
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Edmar L. Bacha
Current monetary policy objectives and dilemmas in
the use of FX spot market intervention
•
Second objective is to prevent FX volatility resulting from ‘speculative’
capital flows – while supposedly not intervening to avoid FX
fluctuations related to ‘fundamentals’
•
(Regressions of the BRL/USD on the CRB commodity price index, the
10y Brazil’s CDS spread over Libor, the DXY index of the dollar against
major currencies, and the lagged BRL/USD, yields good statistical
results)
•
This is the FX intervention objective as seen from the CB’s
perspective. The Finance Ministry is also concerned with the negative
impact on manufacturing of ‘fundamental’ X-rate appreciation (
because of ‘deindustrialization’)
•
Problem is that sterilized intervention in the FX market is very costly
(because of very high domestic interest rates)
April 2011
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Edmar L. Bacha
Current search for ‘unorthodox’
monetary policy interventions-I
• Control of domestic demand through restrictions on domestic
credit expansion, introduced as ‘macroprudential measures’
(Dec’03, 2010)
• Higher reserve requirements on bank deposits (from 23% to
32% on CDs, and from 51% to 55% on demand deposits)
• Higher capital charges on banks’ consumer credit w/maturity
over 2 years
April 2011
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Edmar L. Bacha
Current search for ‘unorthodox’
monetary policy interventions-II
•
Fighting FX appreciation through capital controls and more diversified FX
market intervention
•
Tax on ‘speculative’ capital inflows (Oct’4 2010: IOF tax up to 4% on fixed
income flows from 2% previously; Oct’18, 2010: IOF tax up to 6%, including
margin on derivatives)
•
Restrictions on local banks short spot FX positions (Jan’6, 2011: max
exposure, $3 bn)
•
Intervention in the future FX market (reverse swaps reinitiated on Jan’ 13, 2011)
•
Intervention in the forward FX market (starting from Jan’25, 2011)
•
CB FX acquisition for the Treasury (Oct’5, 2011: extension of foreign debt
prepayment coverage to 4y from 2y previously) and for the Sovereign Fund
(not yet activated)
April 2011
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Edmar L. Bacha
Interventions had little effect...
April 2011
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Edmar L. Bacha
...or did they have some?
Extended UIP
2.6
2.4
2.2
2.0
1.8
1.6
1.4
2006
2007
BRL
2008
Dynamic Forecast
2009
2010
Static Forecast
2011
Source: BCB; Itaú
April 2011
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Edmar L. Bacha
Evaluation of current ‘unorthodox’
monetary policy stance on demand control
•
Gradualism in interest rate tightening prolongs inflationary spell and
reinforces semi-dormant indexation mechanisms
•
Restrictions on credit expansion should be designed to ensure
financial stability, nor to control domestic demand, as they result in
higher distorting bank spreads
•
It’d be much better to give the monetary authorities power to control
the expansion of subsidized credit expansion by the public banks
(30% of total)
•
Economic policy requirements for a lower real ‘equilibrium’ interest
rate remain a highly contested academic topic. But a lower public debt
and a longer-term commitment to low inflation (as signaled by a more
independent CB) would help
April 2011
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Edmar L. Bacha
Evaluation of current ‘unorthodox’
monetary policy stance: X-rate policy
•
Preventing FX appreciation is self-defeating because it gives speculators a
‘one side bet’, induces Brazilian firms to borrow abroad, and dampens the FXchannel of inflation control
•
Interventions in the spot market are very costly to have effective FX impact.
Marginal gains of operating futures and forwards seem limited
•
‘Soft’ capital controls tend to be by-passed in Brazil’s highly sophisticated
financial market
•
‘Hard’ capital controls seem inconsistent with Brazil’s increased openness and
need for foreign capital
•
“Leaning against the wind" (not fixing) may be a good reason to intervene, if
there is uncertainty on the future course of ‘fundamentals’ (like commodity
prices). Except for this, it seems better to let the X-change appreciate /fluctuate
freely to contain speculation, foreign borrowing, and inflation
•
Abundant international reserves may later be used to smooth the required Xrate devaluation, when-and-if a sudden stop of capital inflows occur
April 2011
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Edmar L. Bacha
Thanks for helpful discussions to Darwin Dib, Marcio Garcia, Sergio Goldenstein, Ilan
Goldfajn, Eduardo Loyo, Alkimar Moura, and Livio Ribeiro. Thanks to Natasha Daher and
Italo Franca for research assistance. Graphs 5-12, 14-20 and 26 prepared by the economic
team of Banco Itaú Unibanco. Graph 25 prepared by the economic team of Banco BTG
Pactual.
TODAH RABBAH
April 2011
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Edmar L. Bacha