Someone said that history is a prophet with its eyes turned toward the past. For this reason, I feel that an evaluation of what has been achieved so far in the Brazilian economy by the first year of the Lula administration can be very useful to understand the state we are in now and the prospects for the future.
The Lula administration has shown an unequivocal commitment to the responsible construction of the future, proving that it is possible to pursue both sustained growth and social justice based on the fundamental prerequisites of monetary stability and fiscal responsibility.
At the turn of 2003, the Brazilian economy suffered an enormous crisis of confidence. The country lost approximately $28bn – almost 6% of GDP – in 2002 in capital inflows. Coupled with growing global risk aversion, the internal crisis had significant impacts on the economy. Brazil risk moved up beyond 2,400 points in September 2002. The difficulties faced by the country were reflected in both the exchange rate market, which moved up to around R$4 per dollar, and the inflation expectations.
In the final quarter of 2002, monthly consumer price inflation moved beyond an annualised rate of 40%. Forecasts of inflation in 2003 were revised upward to more than 12.5% in the beginning of the year.
Gloomy forecasts
Hasty observers proclaimed the return of chronic inflation to Brazil. According to them, classic monetary policy instruments would never work well in Brazil for being ineffective against inertial inflation or inflation caused by backward-looking regulated prices. These sombre forecasts were not fulfilled. The new administration managed to overcome the crisis and the threat of a new inflationary spiral. Confidence was restored through a sound process of adjustment based upon macroeconomic stability (with inflation targeting and floating exchange rate) and upon fiscal responsibility (with the adoption of a fiscal surplus target of 4.25% of GDP for 2003 and the following years).
In recent decades, central bankers have learned that the force of gravity is not sufficient to bring inflation down. Once economic agents incorporate higher inflation into their expectations, this will become the threshold of the new inflation rate. In this case, inflation can be curbed exclusively through application of monetary policy instruments – both controlling aggregate demand and effectively coordinating expectations of lower inflation. And this is precisely what has been done in Brazil.
The success of the monetary policy is undeniable. In less than a year, the Central Bank has managed to ward off the threat of a new inflationary spiral. After peaking at an annualised rate of 29% in the last quarter of 2002, inflation shifted into a downward curve and has returned to the median level of developing countries. In the third quarter of 2003, our Consumer Price Index increased by 0.29%, corresponding to an annualised inflation of 3.5%. Markets expect the Central Bank to meet the 2004 inflation target, established at 5.5% (with tolerance intervals of plus/minus 2.5%).
The 2002 crisis provoked an inflationary surge without precedent in Brazilian history. In less than six months, the level of inflation increased by a factor of five. This reality demonstrates the precise dimension of the success achieved by monetary policy in combating the threat of renewed inflation.
Brazil is experiencing a solid process of public accounts adjustment. This is a new phenomenon in our country, which only in the last quarter of 1998 shifted into a sustained trajectory of primary surpluses. This is now being consolidated by the Lula administration.
As a result of this process, the country will be steadily reducing the public debt/GDP ratio, which is expected to close the current decade at around the 40% level; in 2002, this ratio passed the 60% mark.
The country’s external accounts are also being subjected to a vigorous and permanent adjustment. An important component of the external adjustment is the structural change in the trade balance. The solid trade balance surpluses have, to a great extent, been a consequence of productivity and efficiency gains derived from permanent structural changes. On a 12-month accumulated basis, in November 2003 the Brazilian trade balance registered a surplus of almost $24bn; in early 1998, the trade balance had a deficit of more than $6bn.
The increase in exports is based on a significant diversification of markets and of exported goods. The country pursued a consistent policy of marketing new countries and exporting non-traditional goods that produced clear results in 2003: China is now the second largest importer from Brazil, increasing its imports by almost 90% in 2003.
Surplus registered
The excellent trade performance sustains a higher than $23bn trade surplus market forecast for 2003. From January to October 2003, the balance of payments current account registered a surplus of $3.9bn, and for the first time in a decade, Brazil was expected to end the year with a current account surplus. In 1998, the current account deficit came to more than $33bn.
The evolution of the exchange rate, which floats freely, is a fundamental element of the external adjustment process. In recent months, exchange rate volatility has diminished significantly, being no longer a source of inflationary pressures or of uncertainty to economic agents.
The adoption of solid fiscal and monetary policies capable of ensuring the sustainability of internal and external accounts has provoked an accentuated fall in Brazil risk. Compared to the 2,400 points registered in 2002, the risk index stood below 500 points in December 2003, the lowest level since May 1998.
Another clear sign that international confidence is being regained is shown in the recovery of foreign direct investment. In the five months to November 2003, FDI averaged around $950m per month. Following a downward trend generated by the 2002 crisis, these figures reflect a strong upturn in foreign investment inflows. For 2004, we forecast a total of $13bn in FDI.
Under the concept of international liquidity, Brazilian reserves totalled $54bn, a level consistent with a floating exchange rate system. Besides, a new precautionary $14bn agreement with the IMF was concluded at the end of 2003.
Another significant factor in the process of regaining confidence was the adoption of a policy of lengthening the public debt profile and reducing the public debt indexed to the exchange rate. A sharp reduction (from almost 40% to 24%) in debt indexed to the exchange rate was obtained through reducing the rolling over of securities and swap operations offered to the market in moments of increased uncertainty.
Brazil lost approximately $28bn in capital inflows in 2002. Countries forced to adopt similar adjustments in their current accounts underwent reductions of 7% to 15% in their national products. Despite the exceptional dimension of its crisis, Brazil was expected to register positive growth in 2003. The conditions for recovery are already set and the country is on the path to growth. The economy has sound fundamentals; for the first time in decades, Brazil has all the conditions required for a process of sustained growth, without generating either external accounts imbalances or inflationary pressures.
Sustained development, however, still requires elimination of the bottlenecks that have hindered expansion of the productive capacity of the Brazilian economy. The attainment of these goals will also demand complementary measures such as social security and tax reforms, both of which were approved in the Lower House in a record five months and are now under deliberation by the Senate.
Infrastructure plan
The government is also finalising the Multiyear Plan, targeted at making significant investments in infrastructure. Priority will be given to investments in highways, railways, ports and energy. Part of these investments will be financed through partnerships with the private sector. Definition of regulatory benchmarks for key infrastructure sectors is now nearing conclusion and should result in an additional incentive to investments.
Building the future is a highly complex process. The future of a country is determined by the present size of its ambitions and challenges. Sustained growth depends in part on planning and correct policies by the government. But it also depends on the investment decisions taken by innumerable economic agents. In Brazil, we have no fear of removing the obstacles that still stand in the path of sustained growth. I am strongly confident that Brazil is about to take this path for good, and I would like to invite you all to join us in this effort.
Henrique de Campos Meirelles is the governor of the Central Bank of Brazil
