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CHALLENGES 2005-2006: Brazil's Economic Policy under Fire
By Mario Osava
RIO DE JANEIRO, Dec 23, 2005 (IPS) - From an economic standpoint, this year in
Brazil has ended in disillusionment, with widespread criticism of the
performance of Finance Minister Antonio Palocci and particularly the Central
Bank, accused of maintaining exaggeratedly high interest rates.
The 1.2 percent drop in gross domestic product in the third quarter of this
year as compared with the previous quarter was essentially the final straw
for economists who formerly supported the government's policy of setting
inflation targets, but have now joined the side of its critics.
While the inflation targeting policy was initially adopted by the previous
administration, it has been taken to extremes by President Luiz Inácio Lula
da Silva's economic team since he took office in 2003, say his critics.
The current state of economic stagnation is reflected by the fact that the
unemployment rate has stubbornly remained at 9.6 percent over the last three
months, without the seasonal decline usually brought about by increased
year-end consumption.
Economic growth for the year as a whole will amount to a mere 2.5 percent in
2005 and only slightly higher in 2006, according to most estimates.
Long-time critics like Fernando de Carvalho, a professor at the Federal
University of Rio de Janeiro, have consistently condemned the adoption of an
economic policy centred on inflation targets as a "trap" that has hindered
sound economic growth for many years.
This approach has given the Central Bank de facto autonomy in guiding the
country's monetary policy, as if raising interest rates was merely a
"technical decision" aimed at curbing inflation, while in reality it also
destroys jobs, and "it is tragic that Palocci and Lula seem to ignore this
fact," de Carvalho told IPS.
But at least the government has given up on a proposal to officially
establish the independence of the Central Bank through law, an initiative
that "won't come up again for a good long time," he added.
During the last two and a half years, the Monetary Policy Committee made up
of the president and seven directors of the Central Bank has been an endless
source of frustration for the productive sector by fixing higher than
expected interest rates month after month, thereby hindering investments
that could boost economic activity.
The current management of the Central Bank started out in early 2003 by
raising the Selic benchmark interest rate to 26.5 percent annually, as a
means of fighting rising inflation that had reached 12.5 percent in 2002 and
the economic turbulence caused by the election of a left-wing national
government for the first time ever in Brazil.
The bank did not begin easing back on interest rates until June 2003,
despite an economic recession that eliminated the danger of a new surge in
inflation from an increase in demand. According to Joao Sayad, who served as
minister of planning in the 1980s, this meant the loss of an ideal
opportunity to further reduce interest rates and boost the economy.
The Selic rate continued to decline gradually until reaching 16 percent the
following year, but rose again to a high of 19.75 percent last May. Thanks
largely to this rise and fall of interest rates, GDP grew by a mere 0.5
percent in 2003, and although 4.9 percent growth was achieved in 2004, this
year has seen the return of mediocre economic performance.
In the meantime, inflation fell from 9.3 percent in 2003 to 7.6 percent the
following year. Although this year's target was to limit inflation to 5.1
percent, it is estimated that it will end up being closer to 5.7 percent.
In addition, high interest rates contribute to the overvaluation of the
Brazilian currency, the real, against the U.S. dollar, which causes
difficulties for the export sector, despite a hefty trade surplus expected
to reach 44 billion dollars this year. In southern Brazil, a large footwear
factory was forced to shut down, while agricultural output has fallen in
relation to previous years.
This was an "absolutely tragic" year according to Antonio de Salvo,
president of the Brazilian Confederation of Agriculture and Livestock (CNA).
Agricultural GDP will have fallen 3.4 percent by the end of the year, owing
to high interest rates, unfavourable exchange rates and insufficient credits
for farmers, in addition to the severe drought in southern Brazil, he said.
"Today the nearly universal assessment is that the Central Bank went beyond
what would have been prudent," and that it should quickly begin to reduce
its interest rate, although that was not the only factor responsible for the
low rate of growth, said Flavio Castelo Branco, an economist with the
National Confederation of Industry business chamber.
The problem is the government's economic policies, whose various instruments
are inconsistent among themselves, and which curb the reduction in interest
rates, he told IPS. Brazil has, for example, a bulky short-term public debt
which requires constant restructuring, and a state with excess current
expenses, he added.
To defend the value of the local currency and fight inflation, the only
instrument available to the Central Bank is its control of interest rates;
"It can't do anything else," said Castelo Branco. Inflation in Brazil is
still higher than the global average, he pointed out.
But the economist said the Central Bank has turned a deaf ear to the demands
and analyses of the productive sector, allowing its policies to be guided by
a "very closed" circle of financial market advisers. "That increases the
risk of mistakes, by delaying the perception of tendencies and errors," he
added.
Another problem, he said, is that when it feels pressured to lower interest
rates, the Central Bank reacts by doing just the opposite.
Castelo Branco said the Bank refuses to admit its own errors, in order to
avoid losing credibility, acting like a father who, after realising that he
punished his child too severely, does not back down because he believes he
will lose authority.
That seems to be the mechanism that prompted the Monetary Policy Committee
last week to adopt the decision to lower the interest rate only slightly,
from 18.5 to 18 percent, when even conservative economists and bankers
recommended a much larger reduction.
Strong economic performance is essential to President Lula's hopes for
reelection in October 2006, now that his Workers Party (PT) has lost its
claim on ethics as a result of the ongoing corruption scandals that broke
out in May.
The scandals brought down the PT leadership as well as around 70 government
officials and employees of state enterprises, and two legislators who had
previously provided important support to the government.
With an "isolated" Central Bank, which has lost the confidence of broad
sectors of the economy, and a finance minister who is also weakened by
corruption allegations, Lula has been left with very little maneuvering room
on the economic front, said de Carvalho.
The adoption of measures that would provide a rapid boost to the economy
would be labeled as "populist" and could cause instability by making the
financial market nervous, he explained.
But with a stagnant economy, Lula would face almost certain defeat.
The problem is the inflation targeting policy itself, not an "excess of
conservatism" in managing that strategy, as the "new critics" argue, said de
Carvalho. With that same policy, the previous government only obtained
mediocre results, he maintained.
(END)
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