Economy & Trade, Headlines, Latin America & the Caribbean

ECONOMY-BRAZIL: High Interest Rates a Deadly Trap, Say Experts

Mario Osava

RIO DE JANEIRO, Feb 11 2005 (IPS) - Ten years after taming hyperinflation, the Brazilian economy is facing a new demon: the high interest rates that are crimping economic growth and heightening the country’s already drastic inequalities.

Brazil’s Central Bank has "fallen into a trap" by setting an overly ambitious goal of 5.1 percent inflation for the coming year, Carlos Tadheu de Freitas, a professor of economy and business administration at the private Brazilian Institute of Capital Markets (IBMEC), told IPS.

This "impossible" goal is being pursued through overly high interest rates that hurt the entire economy, discourage productive investment and dangerously increase the public debt, warned Freitas, who is also a former director of the Central Bank.

Economists, politicians and members of the business community have been protesting even more vocally since the Central Bank decided to raise the Selic benchmark interest rate for the fifth month in a row on Jan. 19. Since last September, when it stood at 16 percent, it has now risen to 18.25 percent.

According to experts, an increase of 0.5 percent in the Selic rate represents close to 2.5 billion reals (some 950 million dollars) in state spending, which means that keeping interest rates high significantly adds to the public debt.

Last year, high interests rates drained 128.3 billion reals (49 billion dollars) in public funds. In the meantime, Brazil’s primary fiscal surplus (which excludes interest payments on its debt) exceeded the target set by 50 points, reaching 4.6 percent of gross domestic product (GDP).

This surplus has been achieved by reducing public spending and increasing taxes, which are now among the highest in Latin America, leading to growing protests from business. It is more advantageous today to buy public debt bonds and earn 12 percent annual returns, in real terms, than to invest in production, economists point out.

High interest rates imply a significant transfer of income to banks and investors, thus accentuating already deep economic inequalities. Banks have made record profits over the last few years.

According to Fernando Cardim de Carvalho, a professor at the Federal University of Rio de Janeiro, the current government of leftist President Luiz Inácio Lula da Silva – a former trade union leader – missed a major opportunity to lower interest rates in 2003, when the newly elected leader enjoyed sky-high popularity ratings, a source of tremendous "political capital".

Lula’s rise to power led creditors to fear far more drastic measures, like a moratorium, and would have actually been relieved by a mere reduction in their profits, Cardim told IPS.

Moreover, there were no inflationary pressures at the time, since the economic recession translated into low levels of demand, he added, concurring with former Planning Minister Joao Sayad.

In 1999, Brazil adopted the inflation targeting policy that led to the current "trap", as interest became the only weapon used to fight inflation.

The Central Bank is merely pursuing the targets set by the country’s economic authorities, say those who defend its actions. Moreover, as the economic officials and their supporters argue, last year’s high basic interest rates of between 16.5 and 17.75 percent did not stop the Brazilian economy from growing by close to five percent.

But critics say that raising interest rates can do nothing to control prices that are adjusted automatically, such as energy and telecommunications fees, which are indexed to past inflation rates. Because the official inflation rate for 2004 was 7.6 percent, prices in these sectors will increase by that amount this year.

There are also prices set by the international market, like oil and steel, which had a significant influence on last year’s inflation rates. As a result, interest rates only affect free-floating prices, demanding an even more concerted effort to control inflation.

A recent communiqué issued by the Central Bank to explain the reasons behind the new basic inflation rate hike commented on the likelihood of further increases, reflecting what some refer to as "terrorism" on the part of the country’s monetary authorities.

The market no longer pays any attention to these "threats", since transactions on the futures market do not take them into account, said Freitas. He predicted that in April or May, the Central Bank itself will admit that this year’s inflation target is unfeasible, readjusting it to 5.6 or 5.7 percent and subsequently lowering interest rates.

Owing to the missed opportunities to lower it in the past, the basic interest rate is dangerously high today, which means the Central Bank has "less ammunition" in the event of future turmoil, since raising it to 20 percent or more would send the public debt through the roof and plunge the country into bankruptcy, Freitas said.

High interest rates also contribute to the current overvaluation of the real, a source of concern for exporters and economists who believe a large trade surplus is crucial to reducing the vulnerability of the Brazilian economy.

The current exchange rate is 2.61 reals to the dollar, as compared to 3.20 last May. Among all the world’s well-known currencies, Brazil’s has risen in value against the dollar more than any other, exporters warn.

January’s exports do not reflect any detrimental effects of this unfavourable exchange rate. The momentum achieved last year has been maintained, with a trade surplus of 2.18 billion dollars recorded in January, a fact that would seem to support Brazil’s current monetary policy.

But according to Freitas, the warning signs will only become apparent when performance in trade begins to flag, "and by then it might be too late," he concluded.