Statistics show that Brazil’s economy grew only 0.3 percent in the first quarter of 2005. (1) The economy will continue to grow slowly as long as interest rates are high.
For nine months straight, interest rates in Brazil have risen, to the current 19.75 percent rate today. (2) Today, Brazil has the highest interest rates in the world!
It is a country with the highest debt among developing nations. The central bank defends the hikes in interest rates by claiming it is essential to contain Brazil’s inflation rate.
This policy has failed since interest rates have been in the rise since late 2004. The inflation estimates for this year have continuously risen due mainly to excessive public charges that distort inflation.
While the battle to tame inflation seems to be the central bank’s explanation there seems to be other reasons for the continued practice of high interests that has blocked the Brazilian economy from growing as rapidly as Russia, India and China.
Brazil’s short-term federal debt is extremely hefty. The total federal debt is approximately US$ 360 billion (873.83 billion reais) of which 42.85 percent is owed in the next twelve months.
This means that the federal government will need to refinance roughly US$ 154 billion (374.40 billion reais), which is about equal to the yearly federal revenue. (3)
The government does not posses the necessary funds to sustain such short-term debt while servicing the other nearly 500 billion reais (US$ 206) in debt.
Now, many industrialized countries have much larger debt levels than Brazil but the difference is that Brazil has an exceptionally bloated short-term debt that is forcing the government to keep elevating interest rates.
Higher interest rates are the only way to keep creditors interested in loaning the government the money it needs to sustain its debt obligations.
Other countries with significantly more debt do not suffer from extremely high interest rate because they have decades to pay-off their debt.
Italy, for example, owes 100 percent of its debt in 40 years and the United States must pay back 80 percent of its debt in 30 years. (4)
Now, the government is dependent on domestic and international creditors to provide the necessary financial resources to sustain its overwhelming debt. In order to keep the interest of domestic and international creditors it is essential that interest rates do not fall too much.
Domestic banks lend the savings of Brazilians to the government to finance the perpetual need to make the payments of its astronomical debt.
If interest rates were lower it is likely that banks would make more long-term investments that leave the government without the funds for its short-term debt.
It is clear that the government desires to avoid any default on its debt because of the devastating consequences to its domestic economy and it could even affect the international economy since many foreign banks hold Brazilian debt.
Brazil’s federal government has very few economic options. It could try to continue the present course of high taxes or have cuts in spending in an attempt to somehow gain control of the government’s debt.
This route is unlikely to succeed since the sheer amount of debt continues to rise as the interest rates go up even though they are needed to sustain the profit margins and interests of creditors.
The escalating interest rates for example, have increased the federal debt in April alone byÂ US$ 11.64 billion (28.22 billion reais). In the first quarter of this year the total federal debt has gone up US$ 26.12 billion (63.35 billion reais). (5)
The higher debt is due mostly to the higher interest and has spilled over to increases in spending towards debt servicing. The government is predicting that by the end of 2005, Brazil’s total debt will rise by US$ 54 billion, to more than US$ 388 billion. (6)
This administration or future administrations may be forced to one day restructure its debt payments. This does not mean defaulting on such debt. In fact, it seems possible to prolong Brazil’s debt while balancing fiscal prudence.
Ciro Gomes, the current Integration Minister writes that asset liability management would basically, “prolong Brazil debt in a voluntary manner, would break no obligation and would be gradual.” (7)
It is doubtful that such a plan is easy to implement considering that the capital might leave the market if any government unwisely restructures Brazil’s debt. The fear, is that the investors will feel uncertain whether the government will stop paying its debt.
Such fears must be stemmed by reassurance that it is voluntary and that no default will occur. In a last resort measure the government might consider introducing temporary capital controls to restrict detrimental economic fluctuations.
If the government could extend its debt obligation, it could then prosper today by adopting a more pro-growth economic strategy.
The origins of this debt are still debated in the political arena. Brazil’s ex-President, Fernando Henrique Cardoso (1995-2002) of the PSDB (Social Democratic Party) says the debt comes from the massive deficit the pension system, the court rulings against the government due to failed economic plans and continued federal spending.
The progressive left-wing political parties blame Cardoso’s Real Plan, introduced in 1994 to eliminate inflation. They say that it used astronomical interest rates to maintain an artificial value equal to the dollar.
Such unbalances in the economy led to speculative loaning that has caused the explosion in federal debt since 1994. The truth seems to be a combination of factors, but it is without doubt that the interest rates was the single most important factor in contributing to the accumulation of such debt in such a short period of time.
If Brazil successfully restructures it debt, interest rates could fall to normal levels. The need to finance Brazil’s short-term debt would no longer be so strenuous.
Lower interest rates have two immediate benefits to the Brazilian economy: more economic growth and lower debt levels. In fact, higher levels of economic growth and less debt from lower interest rates will have major impacts on the federal budget.
Also, investors would likely stop making short-term loans to Brazil and make productive long-term investments that are badly needed. The budget deficit would fall sharply as the economy generated more revenue while the payments made to sustain the countries debt would eventually decline.
The president and congress have a duty to balance the budget and require a budget surplus that would then be used to repay the countries debt.
Tax revenue would be maintained while a curbing of the abuses and privileges that plague the pension system and reducing the payments towards debt servicing would go a long way in sustaining any surplus revenue in the budget.
Higher growth rates would increase incomes while contributing to job creation. Much lower interest rates will also likely depreciate the currency but the benefits of any controlled devaluation will benefit the competitive Brazilian exports helping inoculate it from international crisis.
A larger trade surplus helps the country maintain the necessary revenue to sustain the rest of its debt payments. In the end, strong fiscal discipline and more sane interest rates will allow the Brazilian economy to develop on a path of sustainability.
Fixing the macroeconomic imbalances that the Brazilian economy faces is only one part of a larger struggle to improve the overall economy. Recently reports have written that 98 percent of all small businesses are part of the informal sector. (8)
This shows that future governments must focus their attention in the informality of the small businesses in order to greatly expand economic prosperity.
In order to accomplish this goal, these small businesses need favorable tax incentives, lessening of the tax and regulatory burden and less bureaucratic hurdles, which make joining the formal sector worthwhile.
Attempting to formalize the informal sector will not be easy but it is needed in order to build a larger middle-class, create more jobs and reduce overall poverty and inequality.
The plan to incorporate the informal sector of small businesses must also extend to other areas of the economy, including providing property rights to those who live in the favelas.
The working-poor who live in such conditions have more wealth than they are given. They lack the property rights of the federal land their favela is situated in and they usually work long hours in either the informal and sometimes formal sector earning very low wages.
As Hernando de Soto writes, “Thirty years ago, more than two-thirds of housing construction was for rent; today rentals constitute scarcely 3 percent of Brazil’s construction. Most of that market has moved to the informal parts of Brazilian cities – the favelas.” (9)
De Soto acknowledges that, “there are no rent controls in the favelas; rents are paid in US dollars, and renters who do not pay are rapidly evacuated.” (10)
The right to property must be extended to ownership of farmland. According to the group Friend of the Land, about 10 percent of the land in the Amazon jungle is protected under property rights. (11)
Brazil is a country where almost three percent of the population controls roughly half of all the arable land. The country is in need of land reform.
After WWII, the American military conducted land reform as one essential economic measure needed to rebuild Japan. The American government was also committed to land reform under the 1862 Homestead Act where large estates where distributed to poor peasants throughout the United States. (12)
If the Brazilian government conducted land reform it would stimulate economic development, especially in the arid Northeast. This could even subdue or reverse the mass migration from the Northeast region to Brazil’s overcrowding cities and promote economic prosperity in a region seeking economic revival.
Greater ownership of property rights can empower those poorer individuals towards greater economic prosperity. The federal government can also implement a tax policy that promotes economic prosperity and equality.
For example, the federal government could push a simple tax reform measure that eliminates the state sales tax ICMS, in exchange for providing the states with the revenue from the CPMF, the financial transaction tax.
Currently, the CPMF is charged at 0.38 percent of all the financial transactions providing the federal government with about 23.9 billion reais (US$ 9.7 billion) in revenues per year. (13)
If the government increased the rate it charges of the CPMF, to about 2 percent it could easily compensate state governments revenue lost in the elimination of the sales tax (ICMS).
This would eliminate one of Brazil’s indirect consumption tax that tends to favor those who are wealthy since the poor pay a higher proportion of their income under this tax.
Now under a permanent CPMF, transaction tax, it will mostly exclude 60 percent of the population who does not have a bank account. (14)
Brazil’s 27 governors would have a better chance to support such a measure if they were constitutionally guaranteed more revenue under the reformed tax code than under the current tax.
In order to compensate for the federal government’s revenue loss, Congress could eliminate the deductions in the federal income tax, which Finance Minister Palocci says only affects 7.5 percent of the economically active people. (15)
Higher revenue from the federal income tax is needed. Deductions only benefit a small percentage of the population that is wealthy enough to pay income tax. Once again, higher income tax revenue on a direct tax such as income can promotes more income equality.
Also, a larger ITR, the rural land tax, rate can bring more revenue, which today brings in only about 292 million reais (US$ 118 million) a year. (16)
Many experts praise the farming sector as a rapidly expanding industry that is helping Brazil export billions throughout the world. If this is true then they have a responsibility to pay more tax revenue as their sector continues to grow.
Also, higher federal taxes on inheritance can contribute to the billions of reais lost in any tax reform. Of course, large taxes on salaries, income and land run the risk of higher fraud than under the current indirect consumption taxes but this must not deter the government from trying to enforce a better tax code.
Another tax reform plan drafted by former Congressman, Marcos Cintro calls for the elimination of all taxes in Brazil replacing it with the CPMF contribution (called IMF, financial transaction tax) and another tax, which will share revenue with all the levels of government.
With Congress unwilling to accept such a radical but necessary transformation, a new tax reform measure exists in the cabinet halls of Brasília that would eliminate all federal taxes replacing it with the CPMF tax. This tax unfortunately has gone nowhere because of the lack of political will.
A fairer and more equitable tax would give the government the revenue it seeks while stimulating production and productive investment that generate economic growth leading to job creation and income growth. (17)
If Brazil did not have the ICMS sales tax, prices for domestic good would rapidly fall. Falling prices lowers inflation thus giving the central bank more room to cut interest rates to further stimulate economic growth and lower the debt.
Also, state governments would no longer lure companies to their state with tax incentives, known today as the “fiscal wars” between states. Another tax reform plan would exempt many federal taxes for the construction industry.
This would assist in the hiring of construction workers who tend to be from the poorer working-class. This would also help the industry grow rapidly, helping to create millions of direct and indirect jobs.
The creation of a stronger property rights and a more just tax system can assist in eradicating extreme poverty and perverse income equality. But a more vibrant society needs investments in better public services.
But investing in federal funds in improving basic public education, basic health care and sanitation can reduce long-term poverty, strengthen the middle-class and reduce income inequality.
Also, giving more money under the Bolsa Familia, that unified income transfer programs which includes Bolsa Escola program (a stipend to pay parents to send their school) can contribute to higher levels of education among the poor and provide dividends in the future for Brazil.
Future hikes in the minimum wage can alleviate poverty for some but eradicating extreme poverty involves helping those Brazilians in the informal sector who might in fact earn less than a minimum and have no guaranteed protection.
Clearly, these are only a few ideas on how to improve the situation in Brazil and other programs not mentioned are needed. Brazilian politicians have the right ideas but the backroom deals and the inability to find a strong political leader willing to push a favorable agenda is lacking.
Slowly, Brazil’s leaders will resolve its economic troubles, reform the political rules to build a vibrant economy and contribute to its democracy where today governments can be replaced every 4 years by the will of the people through the democratic means of elections.
(1) Recondo, Felipe. CNI atribuiu baixo crescimento ao juro e reduz estimativa para PIB. Folha Online. 31/05/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u96792.shtml
(2) Alencar, Kennedy. Lula, de novo, espera fim de alta de juros. 4 June 2005. Folha de S. Paulo. http://www1.folha.uol.com.br/folha/dinheiro/ult91u96959.shtml
(3) Folha: Juro eleva divida federal em R$ 9,5 bi em abril. PPS-Partido Popular Socialist-23. 5/18/2005. http://www.pps.org.br/index.asp?opcao=noticias&id=22871.
(4) Gomes, Ciro. Um desafio chamado Brasil. Civilização Brasileira: Rio de Janeiro, 2002. pg. 293
(5) Ribeiro, Ana Paula. Dívida do governo em títulos sobe R$ 28 bilhões em apenas um mês. 21 April 2005. Folha Online. 5/19/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u95512.shtml
(6) Ribeiro, Ana Paula. Dívida pública interna deve crescer R$ 130 bi em 2005. 23 Feb. 2005. Folha Online. 03/19/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u93730.shtml
(7) Gomes, Ciro. Um desafio chamado Brasil. Civilização Brasileira: Rio de Janeiro, 2002. pg. 293
(8) Sabrae quer políticas públicas que incentivem a formalização de empresas. Folha Online. 05/15/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u96488.shtml
(9) De Soto, Hernando. The Mystery of Capital: Why Capitalism Triumphs In The West and Fails Everywhere Else. Basic Books: New-York, 2000. pg. 85
(10) Ibid pg. 21
(11) Ibid pg. 85
(12) Nery, Sebastião. A reforma agrária de Lincoln.. 2/17/2005. http://www.espacpacademico.com.br/021/21res_benyon.htm
(13) Salomon, Marta. Incentivos dão “perdas” de R$ 35 bilhões. 8 June 2003. Folha de S. Paulo. 05/27/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u68357.shtml
(14) Brazilian Economic Crisis. Oxfam Organization. 05/25/2005. http://www.oxfam.org.uk/what_we_do/issues/trade/brazil_econcrisissumm.htm
(15) Ribeiro, Ana Paula. Palocci diz que Imposto de Renda brasileiro “não é alto”. 7 December 2004. Folha Online. 05/28/2005. http://www1.folha.uol.com.br/folha/dinheiro/ult91u91457.shtml
(16) Deputados criticam MP 232. 4 April 2005. PDT-Partido Democratico Trabalhista. 5/19/2005. http://www.pdt.org.br/partido/discurso_mp.asp
(17) Imposto íšnico Federal. 05/20/2005. www.marcoscintra.org/iut/iuf/index.asp
Daniel Torres is a political science and economics major at the University of Massachusetts. Comments welcome at email@example.com.