Download Ulrika Wienecke - Banco Central do Brasil

Preliminary
Inflation targeting in Brazil: Lessons from the first year
Claes Berg
Chief Economist
Sveriges Riksbank
2000-06-24
I would like to thank you for inviting me to this conference evaluating the first year of
inflation targeting in Brazil. As inflation targeting is becoming increasingly popular in
emerging market economies, it is important to take stock of the experiences so far in order to
come up with concrete improvements and useful policy advice for the future. Brazil has
introduced a framework for inflation targeting, similar to that in UK, Sweden and other
industrial countries and thus has the potential of providing a suitable model for other
developing countries, not least with regard to quantitative modelling and transparency.
As I understand, the decision to eventually implement inflation targeting in Brazil was
brought about by a confidence crisis related to the global financial crisis 1997-1999. The
confidence crisis generated capital flight from emerging markets. In Brazil, fiscal and balance
of payments weaknesses were already apparent at the time of Russia´s debt default in August
1998: the consolidated fiscal position showed a primary deficit (i.e. before interest payments),
the bulk of government domestic debt consisted of short-term financing and the current
account deficit was approaching 5 percent of GDP. Brazil had to let its currency – the real –
float on January 15, 1999. In February, the real plummeted to 2,15 to the dollar, from 1,20 at
the beginning of the year (see Figure 1). In the new, highly unstable, environment, the
authorities had to find a new nominal anchor for monetary policy, which involved a stronger
and more transparent commitment. In this context, inflation targeting emerged as an
appropriate regime to achieve price stability.
On March 8, the Brazilian government and the IMF jointly announced a new economic
programme for 1999. The programme aimed at minimising the passthrough of the devaluation
on inflation, while allowing for some nominal appreciation of the exchange rate. As a first
move, Banco Central do Brasil raised interest rates from 39 percent – the level they had
reached before the float – to 45 percent. In order to further calm markets and reduce inflation
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expectations, an interest-rate-bias concept was introduced, which meant that the Bank could
lower rates between meetings without calling for a new vote by COPOM (the Monetary
Policy Committee).
All in all, Brazilian monetary policy performs well in the area of transparency and
accountability. The main tools in this regard are the official inflation targets and the quarterly
Inflation Report. Given that the January devaluation represented a once-and-for-all change in
the price level, with no further upward pressure, the authorities decided to opt for successively
declining inflation targets: 8 percent in 1999, 6 percent in 2000 and 4 percent in 2001, all with
a tolerance range of +/- 2 percentage points. So far, the inflation target has been met, and
actual inflation figures and market expectations are converging. The Broad Consumer Price
Index, IPCA, was chosen for the purpose of gauging inflation targets (see Figure 2). The
index covers a sample of families with personal income between 1 and 40 minimum wages
and has a broad geographical basis.
The first Inflation Report was published in June 1999. The Reports are both detailed and
technically advanced, including fan charts of inflation and GDP growth which reflect the
varying degrees of uncertainty surrounding the central tendency measures of forecasts over
the medium term. The analysis assumes a constant interest rate and the time horizon spans
from six months to two years. The central bank bases its forecasts on a range of indicators
including surveys of market expectations, short-term forecasting models and structural
econometric models of the transmission mechanisms of monetary policy. Naturally,
assessments of prospects for relevant economic variables such as the exchange rate, the fiscal
policy stance and aggregate demand and supply are also included in the analysis.
Moreover, in order to promote transparency, edited notes of COPOM meetings are released
and published on the web with a one-week lag (until a few months ago, there was a two-week
lag). These minutes, which are about five pages long, contain information on the Committee’s
discussion and assessments of aggregate demand and supply conditions, the international
environment, prices, the money market, open market operations and, most importantly,
inflation prospects and monetary policy guidelines. Importantly, the forward-looking bias
(downward, upward or neutral) is always mentioned in COPOM minutes, which increases
predictability and openness with regard to policy decisions.
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During its first year of inflation targeting, the central bank has successively lowered interest
rates from 45 percent in early March 1999 to 19,5 per cent in July 1999 and 18,5 per cent
today (cf. Figure 3). Thus, interest rate policy has been prudently cautious over the past year,
making sure that expected inflation is well within the target band for end-2000 before further
monetary easing is pursued. Indeed, with a floating currency regime and less reliance on
short-term capital flows, rates are now not only lower, but also more stable than before. Along
with the improving trend of the fiscal and external accounts, the successful interest rate policy
has contributed to the strengthening of the exchange rate.
Despite a nearly 50 percent nominal depreciation of the real, the occurrence of supply chocks
such as drought as well as substantial adjustments in domestic oil product prices and other
administered prices, inflation for 1999 was within the Bank’s tolerance range of 6-10
percentage points. During the autumn, inflation picked up somewhat, mainly due to the
impact of higher oil prices, tax increases and a weaker currency. However, during the last
three months, inflation has been on a downward trend - supported by the appreciation of the
real and sluggish domestic demand – and reached 6,5 percent (y/y) in May. Thus, the Bank’s
target of 6 percent (+/- 2 percentage points) for 2000 looks safely within reach.
Similarly, inflation expectations have come down as the performance and credibility of
inflation targeting has gained momentum. In May 2000, they reached approximately 6,1
percent for 2000 and 4,5 percent for 2001. Thus, market expectations have gradually
converged to the official targets and private actors are increasingly adapting to a flexible
exchange rate system. In fact, market forecasts on the day of COPOM meetings are highly
correlated with actual rate decisions as a result of the flexible arrangement with forwardlooking biases. In this way, monetary policy is predictable and paves the way for an
increasingly stable political and economic environment.
In spite of inflation targeting, exchange rate developments still play a vital role for the
Brazilian economy, which remains quite vulnerable to the external environment due to big
shares of assets and liabilities denominated in dollars and the dependency on capital inflows1.
Indeed, inflation performance is still to a large extent influenced by developments in the
currency markets, which has been very apparent over the past year (cf. Figure 1). Moreover,
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However, the dependency on capital inflows is much less pronounced with the new exchange rate regime.
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the central bank has occasionally, as provided for in the IMF agreement, been intervening in
foreign exchange markets in order to boost the value of the real.
All in all, the Brazilian economy has performed remarkably well over the past year.
Despite pessimistic growth forecasts in the beginning of the 1999, ranging between –3 and –6
percent, GDP eventually turned out positive at 0,8 percent. This was due to the very strong
fourth quarter GDP figure of 3,8 percent, driven by investment, industrial production and net
exports (see Figure 4). Growth was somewhat slower in the beginning of 2000, reflecting still
sluggish domestic demand after the severe fiscal tightening during the previous year, but is
nevertheless expected to reach a healthy 3,5-4,0 percent this year.
In order to come to terms with deep-rooted fiscal weaknesses, a comprehensive three-year
programme was worked out with the IMF in September 1998. The objective of the
programme was to achieve high and rising primary surpluses in order to stabilise the debt-toGDP ratio and put it on a declining path. Progress has been quite remarkable: ever since the
announcement of the targets, Brazil has fulfilled them by a comfortable margin. The primary
surplus for the central government is forecasted at 2,6 percent for 2000. Moreover, the current
account deficit is projected to decline to about 3,5 percent of GDP (US$23 billion), which will
be more than fully financed by net FDI. Another encouraging development was Brazil’s
decision in early April to pay back the IMF emergency assistance, which signals the
authorities’ confidence about the prospects for capital flows and the broad external accounts.
In conclusion, the implementation of inflation targeting in Brazil is off to a very promising
start. However, I would nevertheless like to take this opportunity to deliver a few words of
caution. With such a short period of success, credibility is still fragile. The perhaps most
difficult issues lie ahead and are related to other areas than monetary policy: further
adjustments in the fiscal deficit, a comprehensive tax reform and reforms in the pension,
health and education systems. However, as the new monetary policy regime provides for
continuous adjustments of the interest rate in light of inflation prospects, imbalances in the
economy can now be prevented in a much better way than before. With its technically
sophisticated framework for inflation targeting, promising track record of transparency and
crucial contribution to Brazil’s remarkable economic performance during the past year, the
central bank sets a good example for other emerging markets to learn from and follow.
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Before ending I will pose some questions. Is it true that the market therefore focuses
primarily on the minutes, rather than on the Inflation Report, when analysing the future
direction of policy. It would be interesting if someone in the COPOM would like to comment
on this. I would also like to know how you arrive at a certain inflation forecast in the inflation
report: what are the respective roles of the staff and the members of the COPOM in writing
the report? Which were the main considerations when the COPOM decided to cut interest
rates? Was actual inflation figures more important than the forecast for future inflation? Was
a stable real a prerequisite for rate cuts?
Figure 1. Brazil Exchange rate and CPI, 1997-2000
2,1
9
2,0
8
1,9
7
1,8
6
1,7
5
1,6
4
Percent
10
USD/BRL
2,2
1,5
3
1,4
2
1,3
1
1,2
0
1,1
-1
1,0
-2
AprJul Oct 98 AprJul Oct 99 AprJul Oct 00 AprJulOct
Brazil Exchange rate USD/BRL, clos e daily (lef t scale)
Brazil CPI total (right scale)
[c .o.p 262]
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gure 2. Brazil IPCA index, monthly change, 1998-2
1,25
1,00
0,75
0,50
Percent
0,25
0,00
-0,25
-0,50
-0,75
J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND
98
99
00
Brazil W ider consumer price index monthly change (I PCA)
gure 3. Brazil 1 Month CD-rate, close daily, 1998-2
50
45
40
Percent
35
30
25
20
15
Mar May J ul SepNov 99 Mar May J ul SepNov 00 MarMay
Brazil 1 Month CD-rate, c los e daily
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e 4. Brazil Gross domestic product, Volume, sa, 199
10,0
7,5
5,0
Percent
2,5
0,0
-2,5
-5,0
-7,5
90
91
92
93
94
95
96
97
98
Brazil Gross domestic produc t, Volume, sa
99
00
[c .o.p 4]
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