In the blog just prior to this, Roberto Rigobon stated his view that external factors (“luck”) have accounted for recent Brazilian higher rates of growth: “It seems that policy has not made the economy better, but just get by”. Let me argue otherwise.
Rigobon gives credit to the external environment as the major factor behind the recent fall in Brazilian real interest rates: “This reduction in real rates has happened to all countries in the emerging world. The risk premium in international financial markets has plummeted and all developing countries – irrespectively of how badly or well managed they have been – have experienced drops in real rates of about 4 percent. Hence, as to all those countries, I assign a lot of this reduction to external factors (luck) and not good internal policy.” I believe he underestimates the weight of the following factors: (1) The Brazilian EMBI+ has dropped substantially more than the index associated to all emerging markets since 2003. For the first time since that index started to be collected, Brazil’s risk premium has been fluctuating at levels below the average. To the extent that the EMBI+ effectively captures the risk premium associated to the corresponding debt securities, one cannot explain the Brazilian evolution simply by resorting to the general movement. (2) For risk-management reasons – as I approached in a previous blog – basic (policy) real interest rates in Brazil have been higher than the ones derived from risk-adjusted interest rate parities or other types of estimation of “normal rates”. I recommend reading a recent paper by Bacha, Holland and Gonçalves in which the authors present an estimation of a comprehensive empirical model of determination of real domestic-currency interest rates in emerging markets – taking into account dollarization, price-dillution risks, risk ratings, etc. – and at which they conclude that, “since the adoption in 1999 of inflation targeting and floating exchange rates, Brazil’s real interest rates are [only] slowly converging to [their] model’s predicted values”. In fact, instead of having domestic nominal interest rates trailing any sums of risk premia and foreign interest rates, the exchange rate has played the role of adjustment variable in the equation, with policy interest rates being determined in a strongly exogenous manner in accordance with what the Central Bank has thought to be appropriate to reach inflation targets. Only now, after so many years, inflation and monetary policy are approaching “normal life” in Brazil and that explains the consensus about the presence of some ground for additional reductions in the basic real rates in the near future, despite the rising mood in many quarters abroad. Thus, there seems to be some space for lowering real interest rates even further, rather than the straitjacket – temporarily loosened with the “luck” from abroad – that Rigobon sees on Brazil’s monetary policy. (3) Contrary to Rigobon’s remarks, fiscal policy has been at the core of risk improvements. Both GDP growth rates and real interest rates have not been friendly to the debt dynamics and the shift of direction downwards in the debt trajectory since 2003 cannot be explained without taking account the primary surpluses systematically obtained since the end of the 1990s. Of course, the quality of the fiscal adjustment – tax-based rather than from compression of expenditures – is object of strong appropriate critiques, but these should not be confounded with any denial that the fiscal landscape improved remarkably in the last few years and that this fact has been crucial to better growth prospects. External Accounts
Successes in both monetary policy and fiscal management would not have been the same without the sea change that occurred in Brazil’s external accounts. And in this regard, Rigobon concludes after examining a specific US-based data set that “all the [Brazilian] export improvement is explained by price increases”. The investment-grade-like state of arts of Brazil’s current external indicators would thus be reversible, as soon as the current phase of “luck” is followed by a cyclical downturn. However: (A) Once a broader geographical base is taken as a reference, the rates of growth of Brazilian export quantities exhibit brighter figures. A simulation presented by UBS in its “Latin American Economic Perspectives” (10-11-2006) shows that, even in the hypothesis of a return to the lowest quantities and prices of exports found in 2003-2006, the trade balance would still be black (US$ 24.8 billions). Such a reversal does not seem likely to undo the dramatic shrinkage of foreign liabilities vis-à-vis reserves and exports that has happened since the beginning of the decade. (B) The export increases of basic goods and semi-manufactured goods would not have been achieved without the technological advance in frontier agricultural areas. (C) The balance-of-payments has not been dissociated of policy measures. The adoption of a floating exchange-rate regime has privatized exchange-rate risks and this has affected the investment behavior of private agents, leading them to hedge their portfolios by developing production capacity in tradable goods. This push factor on exports and on import substitution has been present independently of prevailing levels of exchange rates. Bottomline
If one uses as a benchmark what would Brazil’s growth be if a more appropriate fiscal policy were in place, there is certainly underperformance. But it is not accurate to say that the current better growth prospects have only to do with “good luck” and not with a somewhat improved domestic policy framework.