Raising Interest Rates Is Not Working in Brazil

In May and in an effort to contain inflationary pressures for the ninth time running Brazil’s Central Bank raised the minimum interest rate or Selic, which now stands at 19,75% and is described as a world record.

But the situation has led some economists and think tanks to doubt the effectiveness of monetary orthodoxy which seems to have become inefficient, particularly when one third of the inflation index components are basic services such as telephones, electricity and energy and are subject to government controlled rates.


“No matter how much interest rates are hiked, services’ costs remain unchanged”, according to economist Mario Mesquita who says the solution is reducing government expenditure. However this would have a high political cost and there would be no – autonomous – Central Bank to blame.


After long episodes of hyper inflation Brazil since 1994 has managed to keep prices under control when the stabilization program and the new currency Real were introduced. Since then inflation has dropped from 2,477% a year to just 8% currently although the Central Bank target is 5.1%.


Since 1999 Brazil has appealed to inflation targets as its monetary policy with the Central Bank fixing interest rates to achieve the goals. However prices remain stubbornly high and the Central Bank has kept pushing rates up.


“Taking into account the latest Central Bank hike and inflation projection, the basic real interest rate in Brazil stands at 13.6%, which is one of the highest in the world”, said CRG Visão, a São Paulo financial consultant.


The catch is, according to a growing number of economists, that strict interest rates do not necessarily apply to public utilities since energy and telecommunications companies are entitled, according to contract, to increase rates, and these are conditioned to the evolution of the US dollar.


Particularly the 2002 US dollar that was significantly strong at the time compared to other hard currencies.


“A government decreed increase in electricity rates should not be the cause by itself of a monetary adjustment”, writes José Alexandre Scheinkman a Brazilian economy professor lecturing in Princeton University.


Furthermore the Brazilian economy is relatively closed to imports and therefore does not benefit from cheap merchandise coming in from China, argues economist Mesquita, and since the Central Bank is not entirely autonomous, it’s exposed to political pressure.


Faced with this situation a growing number of economists believe Brazil must adjust its inflationary targets and have a tighter control over government spending.


In 2004, Brazil’s primary budget surplus was 4.6% of GDP, but the real balance was a 2.6% GDP deficit given the size of its foreign debt.


Hiking interest rates has an additional problem: each time the Central Bank increases one point the basic rate, the country’s debt of 350 billion US dollars increases 2.7 billion US dollars, according to economist Alex Agostini.


But cutting government expenditure is politically complicated. Excluding interest payments, 90% of all government outlays directly benefit highly sensitive political areas, explains Mr. Agostini.


This article appeared originally in Mercopress – www.mercopress.com.

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