Henrique Meirelles on his six years as president of Brazil's Central Bank, the current crisis and Brazil's outlook.
BY JOHN FITZPATRICK
Foreign investors are not attracted to Brazil by high interest rates but because the economy has sound fundamentals, is well diversified and has a large and expanding consumer market. That's the view of is, Henrique Meirelles, the president of the Brazilian Central Bank who has been steering the monetary authority during President Luis Inácio Lula da Silva's two terms in office. In this interview, Meirelles – who is expected to leave the Central Bank in the near future and stand for the governorship of his native state of Goiás next year - explains why he has no doubt that Brazil will emerge from the current crisis in better shape than it was when the crisis broke out.
This is the last part of the Lula term and of your administration of the Central Bank of Brazil. Is it possible to identify the best and worst moments of your time in command of the monetary authority?
Henrique Meirelles: That is a difficult question to answer. There have been many challenges, difficulties, but also positive moments. In the current crisis there have been some difficult moments, especially because the crisis came from abroad and through several channels. However, without any doubt, the worst point was at the beginning of my term in January 2003, when annual inflation exceeded 20 percent, our reserves were less than US$20 billion, the country was on the brink of insolvency, and economic activity was contracting. Raising interest rates was the right choice under the circumstances, but it was a very hard decision. At a certain point, the Central Bank had to decide against selling more international reserves, hoping that investors would have confidence in the measures adopted by the government. That was particularly difficult. The most gratifying event occurred in December 2006, when President Lula paid tribute to me in his year-end speech of thanks to his ministers. Another very gratifying moment was the day Brazil received the investment grade rating from a very respected foreign rating agency.
You often state that Brazil has become more resilient to international shocks over the past few years. What are the signs of this resilience almost a year since the onset of the international subprime crisis?
Meirelles: Let me emphasize that there are two very different stages to the current international crisis. The first phase started after the collapse of the subprime market in the US, in mid-2007; it mainly hit the developed countries and was characterized by correction of the excesses of the so-called “great moderation” period, with low real interest rates, excessive credit growth and leverage of the banking system, and asset prices inflation. This correction process triggered a severe loss of capital from American and European financial institutions; otherwise, there were no major ruptures in the system.
The second stage of the international crisis started in September 2008, prompted by the bankruptcy of Lehman Brothers. That paralyzed credit around the world and affected economic activity in countries everywhere, including countries that, like Brazil, had been spared up to that point. The scarcity of international credit was the main channel of contagion, compounded by the contraction of international trade and the waning of confidence in both the business community and consumers. So the crisis struck Brazil in its second global phase. Now, returning to the issue of Brazil’s resilience to external shocks, let us compare the situation today with previous crises that hit the country. Unfortunately, Brazil has had to face rather frequent external crises over the past 15 years — Mexico in 1995, Asia in 1997, Russia in 1998, and Argentina in 2001 — and in all of them the pattern of adjustment was similar: a massive loss of reserves, higher interest rates, and fiscal tightening.
Today, the circumstances are different. We have reserves, and the Central Bank can offset insufficient foreign credit by extending credit lines to exporters and by implementing anti-cyclical monetary policy. We have conquered room to maneuver to address the crisis. The crisis is serious, but it will be overcome, and Brazil will be in better shape than it was when the crisis broke out.
Are you satisfied with the results produced by the measures introduced to improve the availability of credit and stimulate the economy in general? Are there further measures that could be envisaged for the short and medium term?
Meirelles: The Central Bank continuously monitors credit and the economy in general. This is not the time to anticipate new measures. Our assessment is that the measures introduced since last September have been successful, and indeed authorities around the world have acknowledged their timeliness and precision. We have acted with determination to provide liquidity to the credit market using a variety of mechanisms, particularly the reduction of bank reserve requirements, which in Brazil are a prudential instrument to ensure liquidity, as well as incentives to transfer portfolios out of institutions with liquidity problems. Incidentally, no bank has had to resort to the discount window, demonstrating that these initiatives were quite effective. More recently, we have extended deposit insurance for time deposits, a measure that has been crucial for normalizing the credit supply of small and medium-size banks.
Brazil’s high foreign reserves have functioned as a sort of insurance against the crisis. Because the Central Bank continues to intervene in the exchange market, reserves are increasing. For what purpose?
Meirelles: In fact, foreign reserves have been an important defense against the turmoil, and their pre-crisis level seems to be just right. In the past, some analysts who tried to determine the optimal level of reserves often reached the conclusion that Brazil had already exceeded it. Today, the same analysts recognize that they were mistaken. Since the beginning of May the Central Bank has once more acquired dollars in the market, taking advantage of the favorable circumstances of foreign inflows into Brazil. It should be noted that the objective of acquisitions of foreign currency by the monetary authority is to take advantage of opportunities; the intervention does not intend to influence the exchange rate but simply to reduce its volatility. That said, the level of reserves today is higher than before the crisis. That is not a consequence of the Central Bank policy of sales and purchases but is rather the result of investments in assets that in the past few months have appreciated significantly.
The productive sector continues to criticize the government’s monetary policy, suggesting that the Central Bank policy rate could be pushed down further. When President Lula’s mandate comes to an end in December 2010, the policy rate will be comparatively lower than it was a few years ago, yet it remains one of the highest in the world. Would it be possible to change this before December 2010?
Meirelles: What is decisive for economic activity is not the policy rate but the longer-term market rates, particularly the 360-day term negotiated at the BM&F (the Brazilian Securities, Commodities and Futures Exchange). If we analyze the correlation with economic activity, we see that market rates are much more significant than the Central Bank policy rate. It is also important to recognize that the market rates are not fully linked to the policy rate—they also anticipate monetary policy decisions and the behavior of future inflation. As a matter of fact, if we compare the 360-day rate to inflation expectations, we see that both track each other very closely. Thus, it is not the policy rate but rather expectations about inflation that orient market rates. It is clear that lowering the policy rate by decree is pointless unless expectations about inflation warrant it. Any attempt to manipulate the policy rate would push up market rates and would translate into costs to economic activity, as has happened in Brazil in the past. On the other hand, when we analyze the evolution of interest rates over the past few years — both policy and market rates — we see an indisputable declining trend. For instance, at the end of the 1990s, the policy rate exceeded 40 percent; at the June Monetary Policy Committee (Copom) meeting it was set at 9.25 percent. In other words, we can observe a significant structural adjustment over time. The real interest rate shows this declining trend as well; today it is the lowest in the country’s recent history.
As interest rates continue to fall, will Brazil still be attractive to foreign capital?
Meirelles: Our economy has sound fundamentals, is well-diversified, and has a large and expanding consumer market. These — not interest rates — are what attracts the foreign investor. Data from both before the crisis and now clearly indicate that most capital inflows are being invested in productive capacity and in the stock market, which is a way to finance Brazilian corporations. In other words, what is motivating capital inflows are the opportunities in the real economy. The short-term moves of interest rates are far less important.
In 2002 you were elected to be federal representative for the state of Goiás with an impressive vote count. Do you still consider the idea of running for a political office? Rumors say that you would like to be governor of Goiás.
At the moment, I am totally concentrated on my work at the Central Bank. My priority is to work to help Brazil out of the crisis as swiftly as possible. There will be plenty of time to think about the future later.
Note: This is an abridged version of an interview which appears in the current issue of The Brazilian Economy, a publication of the Getulio Vargas Foundation and George Washington University. We are grateful for permission to publish it.
© John Fitzpatrick/FGV 2009