Brasil’s Interest Rate Anomaly
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Brasil’s Interest Rate Anomaly

Some of the policies implemented as part of the much heralded Plano Real in the 1990s are to the detriment of Brasil's economy 20 years later.
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One of the most negative results of Brasil’s much heralded Real Plan, implemented during the Itamar Franco presidency, was the establishment of some of the world’s highest interest rates. Although they were lowered to some extent during the Lula and Dilma presidencies, they remain higher than any other nation in the G20 with the exception of Argentina. In this, the fourth instalment of our partnership with Le Monde Diplomatique Brasil, Silvio Caccia Bava interviews Amir Khair  about the last 20 years of Brazilian political economy, Dilma Rousseff’s fiscal austerity adjustments and the base interest rate.

Silvio Caccia Bava: Was the fiscal austerity adjustment necessary? We are talking about billions of reais in public spending cuts this year – cuts in retirement pensions, health and education. Are these the only public spending cuts we need?

Amir Khair:  The objective is to create better economic equilibrium and not to increase the gross debt because Brasil, unlike other countries, has an interest rate over this debt that transforms it into expenditure.

When people talk about the adjustments, they only consider reducing federal government spending, which is where the cuts are made, and reducing the federal taxes. This is the primary budget surplus. They ignore the issue of interest rates.

In 2005 we had the greatest budget surplus in history, reaching 3.9% of the GDP, but we also had a very high interest rate and the result was a 3.2% GDP deficit.

What is the primary outcome?

You calculate all the federal, state and county tax collection in the public sector, look at the costs and sum everything up. If you exclude the financial costs, which are the interest payments and financial revenue, you have the primary outcome. When you add  the costs of interest payments and financial revenue you have the final, or nominal outcome of the public accounts. This is the main indicator observed around the world by all the institutions, the risk classification agencies,the IMF, World Bank, Inter-American Development Bank, etc. The primary outcome isn’t as important as the final outcome and its twin, which is the gross debt in relation to the GDP.

With a very weak primary outcome – as we saw in 2005 – but lower interest rates, the result was a 2.4% GDP deficit this year, which was better than 2005. It doesn’t make sense to talk about public finances looking exclusively at the primary result, it is important to consider the primary outcome together with the interest payments, which is the final outcome. This is what alters the relationship between the debt and GDP- not the primary surplus or the interest payments alone.

The issue of interest is buried in the debate over fiscal issues in Brasil. It is hard to see any press venue outside of specialised magazines, even by people who are considered experts in the field, to talk about interest. They keep their distance because the big banks make the commands on fiscal issues.

OK, but you haven’t said if you think the adjustments are needed…

I think that a certain equilibrium between receipts and spending is important for a simple reason. Every time it spends more than it earns, the government issues bonds to cover the difference. When it does that it increases its spending on interest, and that is what has been happening.

Now, with the so-called adjustment underway, for which the government is struggling to reach a primary surplus of 1.2% of the GDP, the bill for interest payments will reach 7.5% of the GDP, because the Central Bank keeps raising the Selic rate, raising the interest rates that relate to the debt.

Will these spending cuts, along with the increase in the Selic and interest rates, resolve the issue of equilibrium between receipts and public spending?

No. There will be an easy to predict budget overrun even if they reach their goal of 1.2% of the GDP with their adjustments. We have a lot of debt above this. A simple calculation can show it. If the payment of the interest on the debt is 7.5% of the GDP – and this is what we expect- and the primary surplus is 1.2%, this will cause a deficit of at least 6.3%. A deficit of 6.3% increases the relationship between gross debt- to GDP by 5 points and this is the indicator that everyone analyses.

I think that they chose a difficult path politically, because there are two types of cuts. The first is in spending that falls on the backs of the workers, reducing some of their rights.  There may be abuses, but you are reducing people’s rights.  The second is and cuts in benefits such as tax exemptions for businesses. Revoking these tax exemptions provokes strong resistance among powerful people who have influence over the Congress.. Many of the businessmen who finance election campaigns and put congressmen in power to defend their interests benefit from these exemptions.

There are estimates that these tax exemptions cost around R$100 Billion last year.

Yes, it’s possible. I don’t know the exact number, but it is a large amount, very large. This was made in a confusing form and the bill for these exemptions fell on the shoulders of the public retirement pension fund. It is an employers’ contribution of  20% of the payroll that was eliminated and replaced with tax of 1 and 2% of their revenue. Those sectors that have a greater payroll than revenue benefited greatly, because they didn’t pass their savings on to the consumer through lower prices, they just increased their margins. If the government’s goal was to strengthen these companies it worked, without a doubt, but it was the price paid to maintain an artificial exchange rate.

What does the exchange rate have to do with this?

These companies don’t just compete with other Brazilian companies but with all of the others around the world and there has been a terrible price war underway since 2008. Companies from the US, Europe and Japan came in strongly in the international product placement dispute and are invading everywhere. When you have an exchange rate that is is out of place like Brasil has had since the Fernando Henrique Cardoso era and the Real Plan, you create a  difficult situation for national companies to compete both internally here in Brasil and especially in the export market.

Does the government control the exchange rate?

The government controls the exchange rate. It is incorrect to say that the exchange rate is floating, alas, the exchange rates in the entire world are much more managed than floating. With the increase in the Selic rate the government attracts dollars and their abundance drives prices down. Today Brazil is flooded with dollars. There are around $300 billion applied in short term investments here. During the last 13-14 months the Central Bank issued around $114 billion in exchange swaps to maintain the value of the Real because, according to its vision, it should only control inflation by means of the exchange rate, which facilitates the penetration of foreign products.

What is the part that that rich and the big companies are paying in the current fiscal adjustment?

There hasn’t been one charge made on these large companies. They continue to receive financing through the BNDES (Brazilian National Social and Economic Development Bank) with  interest rates that are subsidised by the population at large and they haven’t had their exemptions reversed. But these large groups have everything to lose with the economy moving slowly. This decreases their income. The current counterpart is that  these large companies, in general, have fantastic cashflow generation and large financial reserves held for interesting investment opportunities. Since the investment is paralysed because there isn’t a future perspective of increased consumption, they invest in the financial market, applying their reserves in bonds and sometimes these large corporations make most of their profits from the financial sector.

Are there other strategies to confront this need to reduce public spending?

They exist but they are politically difficult.

As we all know, the communications sector here in Brasil is tied to the financial markets. It is very hard to find any criticism of the financial markets in the media.

If you work with the largest interest rates on consumption, you paralyse the country because it doubles the price of products that are bought on credit.  I don’t see much possibility to move forwards and take advantage of  the potential for consumption unless this anomaly of the basic interest rates isn’t changed. This affects the exchange rate and the public finances. It affects the  working capital for companies that get financial bailouts from the banks and sacrifices the consumer. There are alternatives, but I am talking about another strategy.

I think that it would be intelligent to contain spending as long as you propose to work will all expense items, including interest rates. But, if you bring this to the table you will make allies and enemies.

Who would the allies for a policy that would change the interest rates be? In the first place, the labour union federations. Secondly a portion of the big companies that lose more in income than they gain in finance because they want a market for their products. Third, those companies that export, in general the large companies that traditionally export to Europe, the US, South America, etc. This group wants to see consumption. It feed on consumption and anything that strengthens it to compete abroad. This group does not want artificial exchange rates and it is clear to everyone that the current rate is artificial because of distortions caused by the Selic rate.

If the Selic rate is lowered, how high could the dollar go?

I can’t say for sure, but I estimate that it would be between R$4-R$5.  I have followed this issue since 1980 and analysis shows that we are still at the bottom of the well with the current exchange rate of R$3. The historic average is above R$4.

If the Central Bank stops intervening in the exchange rate it will rise to between R$4 and R$5. With this, imported products will be more expensive and the Brazilian consumer will buy more locally manufactured goods. Companies that have more tradition with international markets will be able to reactivate their exports.

You learn a lot when reactivating exports because it is a difficult dispute. So, technology will improve, productivity will improve, innovation will improve, all through the external challenges where the fight is more complicated.

When the crisis started in 2008, the US, Japan, Europe, and China depreciated their currencies and injected money into the economy. Brasil did the opposite. It retreated. Why? Because the great mantra of the Brazilian system is the ghost of inflation. Any time a leader tries to take any other measure automatically a large racket begins, led by the banks, that says it will generate inflation.

And you can see that there are other ways of fighting inflation without increasing the Selic rate. Eighty percent of Brazilian inflation has nothing to do with the Selic. Trying to control inflation by exclusive actions of the Central Bank is a basic error of an economy in which the fiscal and monetary policies are not integrated.

I am skeptical about the possibility of lowering the interest rates, but this does not invalidate the need to start working in the social area, mainly on the impact that these interest rates have on the lives of the Brasilian people.  To do this you have to increase support for society as a whole. The government never mobilised for this. It doesn’t have any strategy to confront the anomaly of the Brasilian financial market.

The current crisis is threatening productive chains such as oil and gas. Is this a passing crisis?  Will we continue to develop these internal productive chains?

The policies that started during the beginning of Rousseff’s government tried to use Petrobras  and Electrobras as a screen against inflation and this created a complicated financial situation for these companies, both of which had  strategic plans that involved large investments that they no longer have resources to fund. Today Petrobras is behind on its payments. This effects other companies as they are forced to lay off workers and no longer see any perspective in the investments that were planned and canceled. Petrobras is straying from its large scale investments to cover its interest payments and foreign debt without the minimum need to do so.

It was a policy error to subsidise gasoline prices through Petrobras instead of the national treasury.

You said that the big fear used to justify all these cuts is inflation. Are there other ways to fight inflation other than the ones that are being used?

Brazilian inflation can be broken down into three factors, which make up the IPCA, the official indicator that measures inflation. One group is the prices that are called free, within which you have the food and beverage industry, which contributes to 25% of the IPCA. So, if you have inflation, for example, of 10% in one month in the beverage industry, it will increase the IPCA by 2.5% that month.

Another item is the service sector, which makes up nearly 70% of the GDP. This is made up by millions of companies and people, kitchen maids, drivers, manicurists, hair stylists, restaurants and so on. The service sector is strong and commerce is heavily tied to it. Services are tied to the law of supply and demand because it is a competitive market with millions of consumers and millions of service providers.

In my opinion, Lula’s greatest legacy was the entrance of between 30-40 million people into the middle class. This group wants cellphones, TVs, cars, and an enormous variety of things. It wants services, a lot of services that it didn’t have before. 40 million new service consumers created  imbalance between supply and demand. This created an inflation of demand that averaged 8.5% per year, never dropping below 8%. Since services are weighted at 35%, if you do the math 35% at 8% contributes 2.8 points to the IPCA.

These prices are not controlled by the Central Bank. Service prices are set by the market and those of the food industry are controlled mainly by climactic conditions.

Finally the third group is based on the monitored prices, that is, prices that depend on government decisions at the federal, state and municipal level.  What is this? Electrical energy and fuel prices are controlled by the federal government; water and sanitation prices are controlled by the state governments; and collective transportation prices are mainly controlled by the municipal governments.

Differently than the Lula and Fernando Henrique Cardoso governments, Rousseff’s government suffered from four years of punishment from the food sector. Few people talk about this. She had to deal with an inflation in food prices that didn’t depend on her and compensate for this by holding down the monitored fuel and electricity prices. Now we are seeing the results of this problem.

This years’ inflation comes mainly from these monitored prices that are returning to the rates they had before they were held down.

There is a fourth group which runs outside, that is called the commercial goods. They are goods that are subject to international competition. If a company wants to increase the price of olive oil produced here, there will be oils produced in Spain, Portugal, Italy, wherever, that will compete with them. The head of household will go to the supermarket, look at the display and if there is a price increase, will experiment with another product. In this sector therefore the competition is closely tied to external factors.

Now,  you don’t fight monitored prices with the Selic rate, you don’t fight service price increases with the Selic rate and you don’t control food prices with the Selic. They have nothing to do with each other and this is 80% of inflation. You only fight 20% of inflationary forces with the exchange rate and this is what the Central Bank does,  playing hard with an elevated Selic rate, which attracts speculative dollars.

If you have a lot of dollars flooding in here, your currency gets stronger and this is the suicidal policy that has been in place since the beginning of the Real Plan in Brasil.

When there have been more costs than revenue in the entire context of public finance, including interest payments, what Brasil has done is simply issue public debt bonds. The Central Bank is prohibited from issuing bonds, but the National Treasury isn’t. So, the Central Bank requests the Treasury to issue them. If the Treasury were fiscally responsible, it wouldn’t do it. There has to be a limit for the federal debt. The Law of Fiscal Responsibility attempted to set mandatory limits on the state, municipal and federal governments, but neither Fernando Henrique Cardoso , nor Rousseff or Lula wanted to regulate and approve the part related to federal government spending in Congress.  They wanted the freedom to increase the debt and they all defined the interest rates over these debts.  If you regulate this part of the Fiscal Responsibility Law, this group will think twice whether it will issue bonds or not.

Another way to finance debt is to issue money. The government injects resources into the economy but automatically those who are against it will say that it will generate inflation because it puts more money in circulation.  If it really worked that way, there would be huge amounts of inflation in the US, which nearly tripled its monetary base since the 2008 crisis. Europe, China and Japan did the same thing. Nevertheless, they are all afraid of deflation at the moment.

The monetary base of Brasil is around 4-5% of the GDP. In the world, it is over 30-40% of the GDP. With the current policy, the Brazilian government secures the economy by all possible measures and passes a huge fiscal cost onto the public sector in the order of 7-8% of the GDP, when in the rest of the world this fiscal cost of the debt is around 1-2% of the GDP.

Why don’t we do what the other countries do?

Because the government as well as the opposition and the analysts speak in the language of the financial markets, and this is what dominates in the Brazilian economy.  It is rare to see an analyst make a broader level, more complete or more systematic criticism of the Brazilian economy.

Looking forwards, considering the situation that we are in, how can we get out of this downward spiral that the fiscal adjustments are inducing?

Sometimes I think that the crisis itself will show us the way. If we insist on the current path, we will finish the year with a 2% decrease in GDP. This hasn’t happened in decades and next year the estimate is for between 0-1% growth.  What will be the repercussions of this be in social terms? Unemployment will increase. There will be social tension, people will react cautiously- they won’t want to buy and this will have repercussions in business profits. The social and economic situation affecting the country will worsen and could reach a point of a near rupture. We are not at this point yet because there is a little hope in the so-called fiscal adjustments.

You cannot sit calmly with the understanding that this will worsen. You have to be alert and start looking for allies in this process, and put your mouth on the trombone.

Looking for allies implies that they will be put together to deliver a minimum agenda. What is this agenda and who are the allies?

Speaking in terms of the working class, the biggest alliance is the one made to defend employment and, in second place, for improvements in salaries and benefits. With the business class, you have allies among companies trying to increase earnings. Every company wants to increase its earnings, improve its competitive position, and this improvement is tied to economic growth. This is another important ally. And finally, one ally that is rising up now with great force is civil society, the population itself that is organising and complaining about what it receives from the public sector. This group is still amorphous from the point of view of its proposals, etc, but it is a group that yells and bothers. You have to speak for this group too, which can be a marvellous ally; not a group that speaks in terms of impeachment or not, of return to the military dictatorship, but one that will toughly hold the government to task and if it tries to respond with more taxes.

In the case of Curitiba at the moment, it’s the teachers.

This is one of the strong examples. It’s very moving. This group has straight relations with the government and depends on it as salaried public workers and they vote, make noise  and the social networks multiply their clamour and power. When you start having concrete things… For example, Mais Medicos is an excellent government program which has started placing doctors in places that never had them before. In this way you create a favourable public opinion and the group that is against it begins to lose power. There have been a lot of experiences already made, its now a question of really putting this all into practice.

Amir Khair was the Former Finance Secretary during the Luiza Erundina Mayoral Administration in São Paulo (1989-1992). Tax, finance and budget consultant who’s clients have included the BNDES, the São Paulo state government and the Salvador, Belo Horizonte and Goiania mayoral administrations.