The basic interest rate in Brazil, the Selic rate, has proven itself effective in controlling inflation, and the Central Bank should raise it soon.
The first COPOM (the Brazilian monetary policy committee) meeting under a PT’s (Workers’ Party) administration, back in January 2003, raised the Selic rate by 50bps, from 25% to 25.5%. In the following meeting, in February 2003, it acted again, raising the Selic to 26.5%. These monetary policy actions were crucial to tame inflation expectations, which have increased substantially, due to the huge exchange rate depreciation during the 2002 confidence crisis.
The 2002 sudden stop was the most severe crisis that Brazil faced since hyperinflation was conquered, with the Real Plan, in July 1994. The country risk, measured by the EMBI+Brazil, exceeded 2400bps. At the time, the Central Bank had less than 10% of the current war chest of foreign reserves to fight the intense capital flight. The exchange rate, currently hovering around .5 USD/BRL, dropped to mere 25 cents, sparking expectations of high pass-through to inflation.
Showing right from the start that it meant business was crucial for the Central Bank to rein in inflation. Together with other policy measures, such as the increase in the primary surplus target, the success of inflation targeting paved the way for economic growth in the following years, granting Brazil investment grade status, and also allowing the PT to win two additional presidential terms.
The chart illustrates well how the tightening cycles in monetary policy were successful to deter inflation scares. It is undeniable that Brazilian interest rates have always been too high, but they have been showing a long term declining trend, a process that has sped up considerably since September 2011.
Today, however, it is crystal clear that the current Selic rate, 7.25%, is not enough to bring inflation back to target, 4.5%. The 12-month-accumulated inflation already breached the upper limit of the band, 6.5%, and the Central Bank’s own forecasts (Inflation Report, March 2013) show that inflation will not converge to 4.5%, even considering moderate rate hikes anticipated by the financial market. It is necessary and beneficial that the Central Bank begins a tightening cycle, as already signaled by the COPOM members and by Central Bank documents.
Doubts cast on the Central Bank’s autonomy (or lack thereof) are only evidence of the government’s own mistakes. Several government officials have repeatedly advertised the “irreversible” fall in interest rates as an undertaking of the current administration, not as simply the proper management of the interest rate by an autonomous central bank with an inflation target mandate, as it should be. One must bear in mind that the Brazilian Central Bank does not have formal independence to conduct monetary policy; all COPOM members may be fired at the government’s will. In the recent past, however, the Central Bank used to have much greater autonomy, as the president, the finance minister and other government officials did not manifest themselves so often about the “desirable” path of interest rates.
If the government truly wishes to reinstate the Central Bank de facto autonomy, as it has been the successful experience since the Real Plan, monetary policy decisions should be addressed only by the Central Bank. The strong and negative repercussion of the unfortunate statement by president Dilma Roussef emphasizes the point: “I do not believe in anti-inflation policies that hurt economic growth” (Valor Econômico, 3/27/2013).
The disappointing GDP growth record of the Dilma administration (2.7% in 2011, and 0.9% in 2012) is due to well known, but never duly addressed, structural problems of the Brazilian economy. Until 2005, some efforts were made to tackle those issues. After 2005, when finance minister Palocci was ousted in the wake of a corruption scandal, Brazilian economic policy, with very few exceptions, just surfed the long wave of high commodities prices. As long as the government keeps the current policy, high and sustained growth will not resume. Letting inflation rise will not speed growth. Raising interest rates is not a pleasant task, but the Central Bank should be allowed to do its job.
Selic basic interest rate and inflation