Many economic analysts tend to praise the present Brazilian macroeconomic policy with floating exchange rates, government primary surpluses and inflation targeting. Only a few dedicate their time to call attention to the serious problems and risks, which are building themselves precisely because of this “triple” approach to economic policy.
The economic statistics indicate that such policies are simply destroying exports of manufactured and semi-manufactured goods as well as almost doubling in a 12-month period the amount of imports of goods (80% growth in contrast to 8% GDP growth). Furthermore, nominal and real interest rates are excessively high: the record levels for real interest rates as a matter of fact produce further exchange rate appreciation.
Even worse, on the fiscal side, the surpluses are being generated by one of the highest tax burdens in the world which are being wasted with current government expenditures leaving minimal amounts for public investments.
We can project a major balance-of-payments crisis in 2011. In spite of a high level of international reserves, they may disappear very quickly to the extent that they were fed and built by short-term speculative capital flows related to high interest rates and growing stock market prices, which are typical of bubbles.
One can also project that – in order to avoid government fiscal surpluses being transformed into deficits – the size of government will continue to increase through taxation, which will be necessary to finance government personnel expenses rather than public investments.
In other words, even if the ratio Government debt/GDP is kept at reasonable levels, this will be hiding unsustainable growth in other important ratios relating taxes and personnel public spending to GDP.
In consequence of balance-of-payments restrictions and negative consequences generated by loose fiscal policy (as defined in the previous paragraph), the very rapid growth of the economy in 2010 will not be sustainable.
As a matter of fact, Brazil is growing at 8% this year simply because this represents a recovery from huge previous output gaps provoked by very low growth rates since at least 1999.
Even the relatively low inflation rate of 5% expected for 2010 (considering previous Brazilian patterns) should not be repeated in 2011 and 2012 because the reality of the balance-of-payment numbers will require devaluations of the exchange rate.
One should not count out a change in exchange rate policies – independent of the newly elected president in October/November 2010. In our view, the old arguments made by Robert Mundell (Nobel Prize) against floating exchange rates will come back for discussion.
The thinness of foreign exchange markets suggests that China is being more realistic than Brazil in this field: more intervention is necessary, in order to avoid bubbles in the exchange rate market in Brazil. The country cannot afford further exchange rate appreciations.
Targets for the exchange rate and for fiscal variables may very well replace the existing “triple” macroeconomic system. Inflation targeting and free floating rates will not guarantee that the “miracle” of 2010 may be repeated.
On the contrary, without exchange rate targets and without fiscal targets (such as strict requirements for declines in the rations between taxes and current government spending with respect to GDP), Brazil will repeat once more the disappointment of the “day after,” which happened after the so-called Brazilian “miracles” of the last twentieth century – particularly the period of 1968-1973, when Brazil grew for six years at 10% per year on the average.
Rather than exchange rate and fiscal populism, the country needs exchange rate and fiscal realism. It is possible to do this. Long term Brazilian growth requires a different exchange rate and a government much smaller in size. Without this, the external accounts will tend to explode in the next few years and growth will decelerate.
It is true that many analysts will argue that such economic policy changes might lead to an acceleration of inflation in the next few years. We tend to agree. However, we are confident that such acceleration will occur anyway: the inflation targeting system is doomed because it is not compatible with Brazilian fiscal policy of the last few years.