Q: What actions did you take to equip Brazil to deal with the global economic crisis?
A: Brazil learned from the past crises and addressed its most important vulnerabilities. They were concentrated on the fiscal area; not only municipal state, but also federal government. Brazil always used a managed or pegged exchange rate. Normally, the currency was capped in order to help control inflation. The past vulnerabilities led to bouts of inflation and also to current account/balance of payments crises. This normally led to a pro-cyclical action on the part of the central bank. In order to curb domestic demand and generate surpluses, the central bank raised rates. So we had a tightening of rates at a time when the economy was contracting. That led to volatility in output, volatility in the inflation rate and volatility in the interest rate. It also led to instability in the financial system.
Q: What is different now?
A: Brazil tackled all these problems by initially adopting very strict prudential rules for the financial system as a result of the banking crisis in the 1990s. Brazil also adopted a very austere fiscal responsibility law that became part of the constitution. That enabled Brazil to target a primary surplus for the budget. This has been met for the past 10 years and those targets were increased in 2003.
Q: What actions did your office take when you became central bank governor?
A: When I took over in 2003, the sovereign debt-to-gross domestic product (GDP) ratio was close to 60%. Brazil at that time also adopted a very hawkish approach to monetary policy in order to bring inflation down to our target in a short period of time, which did happen. With all of that together, the inflation risk premium and the balance of payments premium came down steadily and that led to a decrease in real interest rates in the market, which helped to bring the sovereign debt-to-GDP ratio down to 40% [at the outset of the crisis].
Q: And what about the inflation rate in Brazil today?
A: Inflation rates have been at target for the past few years and our free-floating currency regime enabled Brazil to generate trade surpluses, enabling the central bank to accumulate almost $200bn of international reserves. Equally important, today the treasury is a net creditor in foreign currency by a large margin. In the past, more than 50% of sovereign debt was dollarised.
Q: So how did this help to keep the crisis at bay?
A: There was a different dynamic as we approached this crisis, when compared with previous crises. When risk aversion went up in the markets and the real depreciated, the reserve value in dollars went up and as a result of that, the net debt-to-GDP ratio went down, and that worked as an automatic stabiliser. During the crisis, the total net sovereign debt-to-GDP ratio fell from 40% to 36%. Brazil also had foreign exchange reserves, which enabled the central bank to act pre-emptively during the crisis and to replace the lack of cross-border [credit] lines, which had been restricted as a result of the post-Lehman changed credit circumstances.
Q: What else did the central bank do to protect Brazil's financial system?
A: The bank imposed two buffers to the financial system. First, the capital buffer - the capital adequacy ratio - was twice the Basel-recommended level. Second, about 20% of the deposits in the banking system were placed at the central bank as compulsory liquidity reserves.
Q: How did these actions help?
A: It enabled the central bank to release real reserves into the system in order to tackle the tightening of liquidity due to the international situation. That allowed the monetary authority to act on the direct causes of the crisis and the moment that liquidity was restored, the financial system could quickly get back to normal. We also managed to restrict job losses, in particular in the export-related sectors. As a result of that, when the industrial sector began to recover, industrial output - after a sharp drop in the last quarter of last year - began to recover and we are now in the ninth month of industrial output growth.
Q: What is the current unemployment rate?
A: This year, Brazil has already created 1 million new jobs, which more that offset the job losses brought about as a result of the downturn. The unemployment rate for the month of September is the same as last year, which was the lowest ever [for September].
Q: What was the thinking behind the recent 2% tax on foreign portfolio investments?
A: The action was taken in order to mitigate some of the euphoria, which could have led to market exuberance. The idea was to avoid a bubble being created.
Q: Is there a danger of a BRIC [Brazil, Russia, India and China] bubble?
A: The most problematic bubbles are the ones that are credit driven. With credit bubbles you have two components: you have the monetary component and you have the prudential one. On both fronts, Brazil took some very important steps in the past few years. Brazil has the most severe prudential regimes in the world and we keep improving it so as not to risk a credit bubble.
Q: How does this policy manifest itself?
A: To give you some idea: the leverage ratio in Brazil is much lower than international standards these days. Capital adequacy ratios in Brazil are much higher than the global average and liquidity is still kept at a reasonable level. All financial institutions are regulated and under supervision, regardless of systemic importance.
Since our strategy from the beginning did not just rely only on the base rates but on addressing the transmission channels of the crisis, the monetary steps were measured. This means that the base rate of Brazil is 8.75%, for an inflation forecast this year of 4.2%. That means that we are watching carefully in order to avoid a credit bubble in Brazil.
Q: A senior figure in Brazil's private bank market recently criticised the actions of Brazil's public banks for offering lower rates during the crisis and therefore taking market share unfairly. What is your take on this?
A: The private banks were more cautious. They built up liquidity, collected loans and were conservative because they were not sure whether Brazil would be able to weather the crisis. The public banks, by definition, had the treasury guarantee. As a result, they could act in a counter-cyclical way - extending credit during the crisis and bringing the spreads back to pre-crisis levels sooner rather than later. As it ended up - the public banks took more market share and better customers.
Q: Is this unsustainable or, indeed, fair?
A: I think now we are at a time when the private banks are catching up and are basically trying to get market share back.
Q: Looking ahead into 2010: what threats do you see to the recovery in Brazil?
A: The key threat to the economy will be too much euphoria and too much exuberance; in other words, bubble building. The challenge is to keep a responsible monetary and fiscal policy.
Q: What more needs to be done to improve Brazil's infrastructure?
A: Transportation is the most important area, plus the ongoing projects in energy should be kept on track - in particular hydroelectric.
Q: And what about the fiscal side of the equation?
A: Our [recession] exit strategy has to be managed well to bring the primary surplus back to its target and bring the debt-to-GDP level to pre-crisis levels. And last but not least, the new wealth that will be created by the oil fields offshore will need to be managed well.
Q: What are the dangers of mismanagement of oil revenues for Brazil?
A: It's always a challenge, as we have seen in many other countries that have oil reserves. It's very important that it's managed publicly. The plan for Brazil is that we spend only the return on the investment and not the principal.
Q: What are your political ambitions?
A: There were conversations about my political ambitions because I became a member of a political party and many saw that as a political move, which was not the case. It was simply a result of Brazilian law requiring that one is a member of a political party at least one year before an election in order to run for office. I simply decided to keep that option open in order for me to take a decision by April 2010 on whether I stay on as governor or whether I would seek some electoral position.
