Brazil’s macro economy, past and present
In this Economic Report we take a look at Brazil’s turbulent macroeconomic history and discuss the main characteristics of Brazil’s current macroeconomic policy mix. Brazil has experienced many economic crises. In the past its dependence on commodity exports proved a major vulnerability. Meanwhile, in the eighties the government had to reschedule its foreign debt and as recently as the early nineties, the country suffered from hyperinflation. However, since the launch of the Plano Real in 1994, Brazil’s macroeconomic environment has become increasingly stable and in the past decade, Brazil started to benefit from the commodity boom. However, more recently growth has disappointed.
A turbulent past
Brazil’s economic history is characterized by economic volatility. South America’s largest country experienced many huge booms that were followed by periods of economic stagnation and decline. In the 16th century, Brazil became the world’s main sugar producer, but in the late 17th century the sugar industry suffered heavily from the rise of the Caribbean as a sugar producer. At the turn of the 18th century, there was a gold boom after a major discovery in Minas Gerais, but the resulting upswing for the Brazilian economy proved only temporary.
The mother of all Brazilian booms was the coffee boom which started in the 19th century. Brazil benefitted from the rapid growth of coffee consumption in the late 19th century, with the country producing almost 75% of all coffee produced globally around the turn of the century. It made the country very reliant on this sector. It is estimated that coffee exports were equal to more than 10% of Brazil’s GDP. However, due to overproduction and a fall in demand due to the global recession, the coffee price fell 50% between September 1929 and January 1930. As Brazil tried to maintain the gold standard, to which it had returned in 1926, this resulted in the depletion of Brazil’s foreign exchange reserves and in 1930 the country abandoned the gold standard. The economy 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 wanted to become less dependent on commodity exports. Especially during the 1970s, the country enjoyed very high rates of economic growth and made large scale investments in infrastructure and industry. This helped to establish 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 already been high thanks to a history of concentrated landownership and slavery, grew rapidly, making Brazil one of the most unequal societies of the world.
Meanwhile, the first oil shock in 1973 led to a strong deterioration of Brazil’s terms of trade. As Brazil at that time imported 80% of its oil consumption, its total import bill more than doubled from USD 6.2bn in 1973 to USD 12.6bn in 1974 . Brazil accommodated this shock by borrowing large amounts of cheap petrodollars The boom thus continued for some time, but when global interest rates were raised strongly and lenders became less willing to lend to Latin American countries in the early eighties, this reliance on foreign lending led to huge economic problems. Debt service was equal to 83% of export earnings in 1982. The country struggled to finance its external indebtedness and growth came to a halt. In 1987, the government was not able to pay the interest on its foreign debt and Brazil’s public debt had to be rescheduled.
These economic problems were accompanied by political turbulence. The military dictatorship that had ruled Brazil 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 military rule, which had focused on maximizing growth without much attention for Brazil’s extremely high social inequalities.
The first democratic government after military rule had limited means to resist spending pressure from congress. As a result, inflation, which had already been high for some decades (see figure 2) thanks to the decades old practice of monetary financing of budget deficits, frequent devaluations and indexation (automatic correction of prices, interest rates and wages according to past inflation), ran totally out of control. In the late eighties and early nineties several attempts were made to end high inflation, some primarily based on wage and price freezes, and one on a deposit freeze, but all failed. Instead, Brazil experienced Weimar Republic style hyperinflation, with inflation peaking at 2,950 percent in 1990. Hyperinflation made all economic activities extremely short-term oriented and was most detrimental to the poor, who were not able to protect themselves against inflation.
A new start
The launch of the Plano Real in 1994 would prove to be the turning point. This plan, designed by Henrique Cardoso, who would later become Brazil’s president, envisaged the introduction of a new currency, put constraints on public spending and ended the indexation of the economy The new currency, the real, had a crawling 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 nineties also embarked on large scale trade liberalization and privatization.
The Plano Real was very successful in exterminating hyperinflation, with inflation falling from 2,477% in late 1993 to 9.5% in late 1996. Although it was thus a big step forward, the Plano Real did not mean an immediate end 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 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 foreign capital.
In 1999, Brazil was therefore forced to make major policy changes. The real was floated and instead of an exchange rate targeting regime the country adopted an inflation targeting regime. Monetary policy was tightened and fiscal policy as well. The introduction of a Fiscal Responsibility Law in 2000 thereby helped to control public spending. To stave off a default, Brazil also got an IMF loan package. The election of Lula da Silva in 2002 led to new economic tensions, as foreign investors suddenly shunned the country fearing president Lula would default on Brazil’s debt, as his Workers Party had very radical roots and Lula had been very critical about the Plano Real during the nineties. However, once in office, Lula chose to maintain Brazil’s macroeconomic policies.
Brazil as a BRIC
Meanwhile, the outside environment became much friendlier for Brazil. High growth in China and other Emerging Markets fuelled the demand for many different types of commodities. As a prime producer of iron ore, sugar, coffee, meat, soy and many other commodities, Brazil was very well placed to benefit from this trend. At the same time, the domestic economy also became more dynamic. Cash transfers, a higher minimum wage and credit growth resulted in a strong growth of consumption. The good years were also used to build a large stock of foreign reserves, while the government maintained a large primary surplus, which, coupled with higher growth, led to a fall of the public debt/GDP ratio. Early in 2008, the rating agencies recognized that the macro economy had stabilized by granting the country an investment grade rating.
Brazil’s resilience was demonstrated when the 2008 global financial crisis struck. The country suffered from the quick fall of commodity prices and the strain on financial markets. For the first time in its history, Brazil was able to enact countercyclical policies during a (global) crisis. Instead of having to tighten fiscal and monetary policies, which was necessary in the past to preserve confidence, Brazil had enough buffers to counter the crisis by 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 Brazilian economy 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 already experienced a strong growth of oil production in the first decade of the 21st century, could become a major oil producer, with partially state owned Petrobras playing a central role. In 2010, Petrobras raised USD 70bn in the world’s biggest IPO ever. However, growth fell disappointingly to 2.7% in 2011 0.9% in 2012.
Thanks to the hyperinflation history, support for anti-inflation policies has been strong in Brazil. The central bank has an inflation target of 4.5%, whereby inflation should not fall or rise more than 200 basis points above or below the target. Although inflation increased temporarily above the target in 2011 and in early 2013, the central bank has been successful in keeping inflation in check, especially when Brazil’s dismal track record before 1994 is taken into account. The central bank is fairly independent, although the influence of the government over monetary policy increased somewhat in the past years. It seems that the central bank in practice no longer aims for 4.5% inflation, but instead wants inflation to be between 4.5% and 6.5%.
Brazil’s real interest rates used to be high, but have declined for many years. During 2012, the policy interest rate reached a historic low, after the central bank had cut the SELIC rate, its main policy rate, by 525 basis points in one year. In April 2013, the started a new tightening cycle and the central bank seems intent on regaining its credibility that had been somewhat weakened by the earlier unprecedented easing of policy. In the past years, the central bank has also increasingly resorted to macro prudential rules as complementary tools for monetary policy. In practice, this has meant that the central bank tries to influence credit growth by increasing or lowering capital and reserve requirements for banks, and not through monetary policy, as the latter could make it more difficult to control the exchange rate.
Figure 3: Foreign reserves
Exchange rate policy
Brazil has had a managed floating exchange rate system since its ended the real’s peg to the US dollar in 1998. In the past few years, the ultra-loose monetary policies in the western world and high commodity prices resulted in strong upward pressure on the exchange rate. To protect the competitiveness of domestic producers, the government went to great lengths to limit the appreciation of the real, thus making the real a heavily 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 depreciation of the real after the financial markets started to anticipate a tapering of the monetary stimulus by the US Federal Reserve. In the past decade, the central bank has built up a large stock foreign reserves. In August 2013 this stock was USD 367bn, which is equal to roughly 14 months of imports and almost all of Brazil’s foreign debt. Nowadays, the central bank primarily intervenes in the currency markets with swaps.
Brazil’s fiscal policies have improved markedly in the past decades. Control over public spending has increased strongly, with the already mentioned Fiscal Responsibility law playing an important role. This allowed the government to achieve its target of running sizeable primary surpluses. Even in 2009, when the government took to significant fiscal stimulus, the government had a 2% of GDP primary surplus. However, Brazil’s sizeable public 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 2012 primary surplus target, despite the fact that it used several accounting tricks. Thanks to the reserves build-up and the fact that almost all government debt is now local currency debt, the government has become a net external creditor. With total government revenue accounting for 36.2% of GDP in 2011, against a 26.3% average for emerging markets, the public sector is relatively big in Brazil.
Conclusion and outlook
Brazil’s macroeconomic situation has become much more stable in the past decades. In the past years, the macroeconomic policies became somewhat less orthodox. The exchange rate has become more heavily managed and the central bank seems to aim for a slightly higher inflation target. This increases the risk of inflation overshooting the target range, which would force the central bank to raise rates aggressively, and may thus lead to slightly more volatility. Recently, the central bank seems to be trying to regain its credibility, while controls on capital inflows were abolished, after the strong upward pressure on the real eased.
- Werner Baer, The Brazilian economy : growth and development, 6th edition, 2008
- Thomas E. Skidmore, Five Centuries of Change, 2nd edition, 2009