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AmericasOctober 5 2003

Evolution is the aim

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Brazil’s finance minister, Antônio Palocci, tells The Banker that the government’s attention is not just on economic policy but on social evolution.

Last year, the Partido dos Trabalhadores [Workers’ Party] promised Brazil a “spectacle of growth” if it were elected. When will that happen?

Last year, we had a strong currency crisis and we made this year a year of economic adjustments. This has allowed a substantial reduction in interest rates so that the country can return to growth. Growth this year will be slow. Because of the crisis last year, growth this year has been compromised.

But what is important is that the macroeconomic adjustments should allow growth to begin now and be sustained into the future. With effective control of inflation, real incomes will increase. And with lower interest rates, investment is coming back. Plus, there is spare capacity for growth. Today Brazil could grow by 3.5% a year with no new investment.

How much space will the government have for more investment this year and next?

In this year’s budget there is very little room for spending. We are not going to give way on our target of a 4.25% budget surplus. Some people have commented on the possibility of cuts because the tax take fell in August, so there was a worry that this could lead to cuts. The tax take has already recovered in September, so we do not see the need for any further cuts, but nor do we see room for increased spending this year.

Next year, in the social area we are increasing funds for income transfer from R$4.3bn [$1.5bn] to R$5.3bn. The focus is on health, food and education. Today Brazil has hundreds of programmes, some federal, various state and municipal ones, and President Lula is unifying all these programmes in a single income transfer programme.

In the tax reform, how much has been left for a later stage?

It is still going through Congress, so it can change. But what is most important is that it encourages economic growth in that it removes taxes on exports, which was a shortcoming of Brazilian law. We will also exempt spending on capital goods and reduce the number of cascading taxes in the economy.

The ICMS, the sales tax levied by the states, is governed by 27 different laws, 27 different regulations and 44 different rates. It is complex and encourages evasion. That is being changed to a single, simplified law. The benefit to the economy is that there will be a more correct and just tax system. The aim is to improve the quality of our taxes. As that leads to a higher take, it will allow a reduction in rates.

There has been some deterioration in the ratio of debt to GDP. What is the outlook?

As we have had a year of strong adjustments, the relationship of debt to GDP is unlikely to improve significantly this year, but it is stable. The plan is at least to stabilise the ratio and keep up the fiscal effort during the coming years to achieve a reduction in time. At the beginning of the year, the amount coming due in less than 12 months was 40%; now it is close to 30%. Dollarised debt was 47%; now it is 28%. At the beginning of the year, we were working with interest rates of about 33%; now they are about 20%, 21%. The situation is much better.

What has been done specifically to reduce the risk from external shocks?

The main way to reduce vulnerability from external shocks is to lengthen the debt profile and convert more debt to local currency. The biggest problem in any shock is its impact on dollarised debt. And the government’s commitment to a consistent, long-term primary budget surplus creates a stable environment.

We are also focusing on the question of income distribution. Countries with poor income distribution suffer more from external shocks. The stronger sectors of the economy are better protected than the weaker. In Brazil, the richest 1% of the population has 10% of the income and the poorest 50% also has 10% of the income – and that has not changed for decades. The poorest sectors of the population pay much more in taxes proportionally than the richest. Looking at the distribution of government resources, the return of taxes in the form of spending, it is inversely proportional to the needs of the population. When you unify poverty relief programmes and reform the pensions system, you go in the direction of a better distribution pattern.

Has the current agreement with the IMF been worthwhile and will Brazil seek another?

The accord is a good one. It was not actually used because the funds are in our reserves, and the reserves have not been spent. We have drawn down $22.4bn and the money is still there and does not depend on a new agreement. It will be repaid according to plan until 2007. In October, we will discuss whether or not we should seek another agreement.

When the agreement was reached in August-September last year, a big crisis was looming. Today, predictions are of economic growth. So an agreement reached on the eve of a crisis and an agreement reached on the brink of sustained economic growth have to be different.

But that does not mean relaxing, in terms of maintaining control of the country’s fiscal balance. What it does mean is that can work with lower interest rates, a lighter monetary policy, with economic growth and stronger social targets.

There has been a lot of talk about social targets in a new IMF agreement but what does that mean? Why should the IMF impose social targets on the Brazilian government?

When we talk about social targets we do not mean targets to be controlled by the IMF. We are talking about a programme with targets for the primary budget surplus, for debt and so on, but which is a complete programme with social targets and targets for growth.

Does that include making commitments to spending in social areas?

We have not got that far. But the point is that an accord reached now would have to be reached under a different point of view from the current one. We want the IMF to receive a new agreement in a different set of circumstances, so that in the future the Fund can see these programmes as an essential part of the programme.

When you make a fiscal adjustment that demands that a country produce bigger budget surpluses, and that country has a problem of hunger, this has to be taken into consideration. That is what we want to introduce into the debate. If we do or do not reach a new agreement, we want the Fund to perceive the question of its fiscal support, which is important, as something that supports a programme developed by the country, rather than the Fund presenting the country with a purely fiscal programme.

Has there been a change in emphasis from the Fund and other international institutions? Is there a move towards relaxing strict inflation targeting?

Well, countries that have used inflation targeting have achieved extraordinary results. Inflation targeting has proved to be a better instrument than the ones that came before.

But I do think there has been an evolution among international institutions. For example, we proposed a challenge to the IMF last year before we took office. We said: “Look, the agreement is very important but we want to devise our own economic policies, we don’t want to follow the exact steps that are in the programme. But we’re going to follow austere policies.” And the IMF agreed; it did not make any great demands on the government, it followed things closely but it did not keep inspecting us step by step. So I think this has been positive.

The IMF needs to insist that a country has an effective economic programme, not necessarily the Fund’s programme. The Fund nowadays is seeing that in each situation it needs to watch the precise situation of the country in question. In a crisis, you need to make big changes in macroeconomic policies but if you do not do it step by step, you will not arrive at the objective; you take the risk of running an unrealistic programme. And then either the country pretends to fulfil the programme to get the support of the Fund or it does not manage to fulfil it. I am not saying that the Fund should accept lenient programmes in terms of inflation targets and so on but it should put more value on the ownership of the programme.

Given that inflation seems to be under control, why have interest rates in Brazil not fallen more quickly?

What monetary theory shows is that the best way to fight inflation is by raising interest rates when it is high and then bringing them down slowly. You need to look at the real interest rates in use in the economy. In January, when the overnight rate was 25.5%, the effective rate in the economy was 33%. Today, with 22% overnight rate, the practical rate is 18%. So our policies have taken the rate from 33% to 18%, not from 25.5 to 22%. This is the real benefit of our fiscal policies for the economy: a substantial fall in interest rates. But we can continue.

At some moment, the overnight rate will reach a point at which it becomes more advantageous for banks to lend to the productive economy than to the government, which will be an important moment for growth. Why not cut rates immediately to that level?

That is exactly what we are working towards: a time when it becomes interesting to invest in production. And I have never seen another country bring interest rates down so quickly over such a short period as we have in Brazil.

And is the target purely inflation or does it include the exchange rate, too?

No, we have no exchange rate target. Interest rates affect the exchange rate and the exchange rate has an impact on inflation, but we do not target the exchange rate. And if the exchange rate should change as a result of what we are doing, that is not a problem.

What makes this government different from the previous one? A lot of what we have been talking about is basically along the same lines. After the period of adjustment, will the Lula government become more interventionist, for example?

I would not see the Lula government as more interventionist, I would see it as more concerned and more focused on economic development and social policies. The previous government believed that, given stability, social and economic consequences would follow of their own accord. And it was not just the Brazilian government, the Washington consensus said this. Today, we say that we have to have stability, although not as an end in itself but as a precondition for effective social and economic growth. For me, this is the biggest difference between the Lula government and the previous one; this government will manage to achieve economic stability along with economic and social development.

What does that mean in practice?

I think that by next year we will have growth along with the right programmes for income distribution, more effective social inclusion, and with health and education programmes showing better results. I think that these will be the elements of a system of sustainable development, that is not made up of constant advances and retreats but is balanced and viable in the long term.

Under the previous government, even with economic advances, some social indicators improved but others, such as crime, worsened. Why should things be different now?

Not just social indicators, some economic indicators got worse as well. The ratio of debt to GDP went from 30% to 60% after eight years of adjustments.

But things will improve as long as we have policies for economic growth along with clear policies for social inclusion. That is why we are unifying the social programmes, and that is why President Lula has always said to the government and to the population that we have to fight hunger, that we have to have well-defined employment policies.

In other words, the government has its attention on economic policy but, more importantly, on the country as a whole and on its social evolution. And this can indeed lead to lower levels of crime and produce real results in terms of education.

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