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Analyzed by: Group 1

Alekhya Chakrabarty 08FT-002 Ankit Goel


08FT-006
P Randheer 08FT-026 Raviraj Kurdekar 08FT-
036
Rohit Kumar 08FT-038 Vikas Gupta 08FT-059
Brazil - Statistics
 GDP: US$ 1.994 trillion (2008*)
 Currency: Brazilian Real
 GDP Per Capita: US$ 10.551 (2008)
 Inflation (CPI): 4.46% (2007)
 Population below poverty line: 14% (2008)
 Labour force: 101.77 million (2008)
 Unemployment: 7.6% (2008)
 Exchange Rate: 2.50 per $
 Exports: US$ 218.6 billions (2008)
 Imports: US$ 145.7 billion (2008)
 Public finances: Public debt US$ 103.2 billion; 6.4% of
GDP (2008)
 Credit rating: BBB-
 Reserves: US$ 219,4 billion (2008)
Brazilian Economy

 Largest economy in Latin America


 Tenth in world at market exchange rates
 Ninth largest in terms of PPP
 Regarded as one of the group of four
emerging economies called BRIC
 Booming exports
Objective of the Study

To understand the macroeconomic


policies and study their implication
on the Brazilian economy in light of
the various internal as well external
crises that were faced by the country
in the post war period
Post-war Period, 1945-64

 Favourable condition post World War II


 Exports increased sharply, though constraints on
imports
 Allied victory discredited fascism and encouraged
constitutional system
 Half billion dollars in reserves, constraint on import
capacity eliminated
 Fixed nominal exchange rate resulted in
overvaluation and worsened trade balance
Post-war Period, 1945-64

 Overvaluation and increased imports worsened


current accounts
 Reinstituted exchange controls rather than
confronting the overvaluation directly.
 Development programs financed through
extending monetary base
 The trade balance and the balance of
payments worsened, first inflationary surge
Post-war Period, 1945-
64
Post-war Period, 1945-64

 Accelerating inflation
 Slowdown in GDP growth
 Severe foreign exchange shortage
 Affected production especially in
industrial sectors
Stabilization and Reform,
1964-67
 On March 31, 1964, military coup occurred and
Army Marshal Humberto Castelo Branco
became the first President of the Military regime
 Economist Roberto Campos was appointed
planning minister.
 Immediate economic concerns:
 Rising inflation
 Worsening external payments position
 Stabilization program included,
 Strict control of public debt
 Restrictions on credit and wages
Stabilization and Reform,
1964-67
 Fiscal strategy consisted of:
 increase in direct and indirect taxes
 Reduction of subsidies through realistic pricing of
public utility services
 Increased tax revenues through the indexing of
tax rates
 Financing of government debt through the sale of
bonds.
 The authorities established monetary growth rates of
70 percent for 1964. 30 for 1965, and 15 for 1966.
Stabilization and Reform,
1964-67
 Credit expansion during the 1964-66 period was 18.5
percent below the mean for the 1960-62 period.
 But an increase in net foreign borrowing and foreign direct
investment, and the fixed nominal exchange rate resulted
in an unintended monetary expansion.
 Under a law passed in 1965, nominal wage adjustments
could only be made at twelve-month intervals and had to
take into account the official inflation forecast, the
average real wage of the preceding twenty-four months,
and an officially mandated "productivity gain.“
Stabilization and Reform, 1964-67
Short Term Effects
 Inflation fell from an annual rate of 90 percent in 1964 to
about 25 percent in 1967.
 The federal deficit fell from 4.2 percent of GDP in 1963 to
1.1 percent of GDP in 1966
 Monetary financing of the deficit fell from about 85
percent in 1963 to about 13 percent in 1966
 Foreign payments arrears of $300 million in 1963 were
replaced by reserves of about $400 million by 1966.
 The real GDP growth rate increased from 1.6 percent in
1963 to 5.1 percent in 1966 and 4.8 percent in 1967.
Stabilization and Reform, 1964-67
Long Term Effects
 The economy's allocation mechanisms were
deeply compromised
 In principle, the government's strategy was an
economic democratization carried out under
government supervision.
 The government would use its policy instruments
to allocate resources according to its own
predetermined objectives and the demands of
those interest groups that were still allowed a
voice by the government.
 In reality, government supervision did not end.
Instead, it multiplied.
Stabilization and Reform, 1964-67
Long Term Effects
 The government increasingly disregarded
price mechanisms to allocate resources.
 The efficacy of price mechanisms was
further compromised by Indexation.
 Indexation sped the transmission of
shocks to other sectors of the economy
and increased the variance of the rate of
inflation.
Brazil: 1964 -1967

 The post-1964 regime has often been characterized as one in


which the private sector was given much freer rein than it
had previously enjoyed.

 Foreign trade remained subject to a variety of administrative


controls, and commercial policy was relatively protectionist .

 The prices of numerous goods and services were subject to


government control throughout the period, and foreign
exchange controls remained in effect.

 Despite the development of financial markets after 1964,


government intervention in these markets resulted in wide
variations in interest rates
Positives and Negatives
Positive side:
Intervention in key industrial sectors produced a
more diversified industrial base than might
otherwise have developed.

Negative side:
 The government’s lack of concern about
allocative efficiency suggests that intervention
exacted a high price in welfare terms.
 No institutional checks and balances
 Increased degree of uncertainty surrounding
economic decisions.
Inflation and Indexation
The root of Brazilian inflation :
Monetization of part of the government's
deficit.
Inflation took its first substantial leap in
the period after World War 11.
Reaction to Inflation:
 Tightened fiscal policy, increased
prices for
public services to levels that would
cover costs, and reduced the growth
of government services. in order to
reduce the deficit that underlay
money supply increases
Extensive system of indexation, or
"monetary correction."

Brazilian inflation was both a cause and


an effect of the extensive indexation that
developed after 1964.
In October 1989 price inflation was running at
Inflation and Indexation
 Cornerstone of this policy was Law 4357, which legalized the revision of nominal
financial values to reflect inflation, in effect permitting financial contracts to be made
in real terms
 Government sold indexed government obligations to the public. Private sector
absorption of the debt, which had been negligible before 1964, was large enough by
the late 1960s
 The shift from monetization to public debt financing in the decade after 1964 was
one of the reasons for the drop in inflation rates between 1964 and 1974.
 But the arbitrary nature of Government decisions about the price indices that
underlay the indexation system increased the uncertainty caused by inflation
 Monetary correction in the external sector also lagged behind financial market
indexation.
 Brazil adhered to a fixed nominal exchange rate policy until 1968
 Wage readjustment was less frequent and less automatic than was monetary correction.
Only in 1979, for example, was the adjustment in the minimum salary (saldrio mininio)
changed from an annual to a semiannual increase.
 Then, in August 1968, Brazil adopted a crawling peg or "minidevaluations“
(minidesvalorizaq6es). which in effect indexed the exchange rate.
ECONOMIC GROWTH IN THE MILAGRE
YEARS(1968-1973)

 Restraints of the 1964 stabilization program


began to weaken in 1967

 Centre of power in economic policy making


shifted to the Finance ministry headed by
Antonio Delfim
DELFIM’S ECONOMIC POLICY SHIFT
 Less orthodox & restrictive than Campos mainly due
to substantial decline in inflation rates produced by
the earlier regime
 Move to expansionary policy also facilitated by
considerable excess capacity in the economy mainly
in the industrial sector & by improvement in balance
of payments
 Main policy difference –diagnosis of inflation –
demand side to supply side
 Tolerate gradual slowing of inflation in exchange for
higher growth rate of real O/P & employment
DELFIM’S ECONOMIC POLICY SHIFT

 Most important strategy was monetary


policy
 Believed inflation in part due to high
interest rates by producers, hence
expanded the money supply rate
greater than the income based
monitory growth rate
 Maximize short run growth rate
preventing liquidity constraints in
private sector
 To implementcreated credit through
open market operations along with govt
control of interest rates
PRICE,WAGE & SECTORAL POLICIES UNDER DELFIM
 Created a price control agency

 Actual value of nominal wages in the


previous 12 month period was replaced by
a value that would have occurred if the
inflation rate was predicted correctly

 Crawling peg exchange rate policy

 Sought to improve agricultural productivity


through subsidies,greater
mechanisation,fertilizers but had limited
effect
MACROECONOMIC PERFORMANCE DURING THE
MILAGRE
 Performed brilliantly between 1968-1973
 Real O/P grew at an avg 10.8% a year,per capita
GDP grew to average 7.9%

 Annual inflation was held at avg of 20%,public


deficit fell from 1.2% of GDP in 1968 to 0.2% of GDP
in 1972

 Ratio between Net External debt & exports fell from


1.9 % in 1968 to 1.5 in 1972,situation under control

 High real income growth rate permitted the


increase in real money supply at an annual average
rate of 14% without corresponding increase in
inflation.
MACROECONOMIC PERFORMANCE DURING THE
MILAGRE
 Capacity utilization in manufacturing rose
to 90.5 %

 Industrial employment rose at slightly


less than 9% during 1968-1974

 Industrial output expanded at an annual


average rate of more than 11%

 Tightness of labor markets in the early


1970s was reflected by substantial gains
in real wages in industry & agriculture
The First Oil Shock,
1973
 Policy making from 1973-82 attempted to
prolong the boom of preceding years
 Steep rise in oil prices rose the import bill from
$6.2billion to $12.2 billion
 Only half of the increased prices were shifted to
consumers, rest absorbed by subsidies
 The growth rate slowed down in 1974-75, but
still high by world or Latin American standards
The First Oil Shock,
1973
 Aggregate demand remained
unbalanced
 External borrowing increased and
reserves decreased.
 Burden of external shocks heavier
than they had been dealt with
promptly
The First Oil Shock,
1973
 Aggregate demand remained
unbalanced
 External borrowing increased and
reserves decreased.
 Burden of external shocks heavier
than they had been dealt with
promptly
Growth After the Shock,
1974-79
 Long term investments in import
substitution and capital goods
encouraged
 Exports had grown rapidly during
Milagre period
 Reserves had grown from $650 million
to $6 billion
 Financing the current account deficit
through additional external borrowing
Growth After the Shock,
1974-79
 Inflation rate soared as monetary policy
became accommodative
 Stagnation in world economy slowed
exports growth
 Increase in domestic interest rates to
slow growth
 Output growth rate fell, internal supply
shock, 1978
 Increased imports and further inflation
After the Shock, 1974-79
External Shocks & Response,
1979-82
 Foreign interest rates increased sharply
 Second oil price shock
 Trade deteriorated
 Delfim’s policies
 Maintain high rate of growth
 Deal with high interest and inflation rates
 Agriculture and energy sectors encouraged
 Strict control to reduce nominal interest rate
 New wage policy to improve income distribution
External Shocks & Response,
1979-82
 Delfim’s policies
 Correct external imbalances
 30% devaluation of domestic currency
 New subsidies for exports, compulsory deposits on
imports, incentives to borrow abroad
 GDP increase of more than 7% in 1980
 Negative trends in all other measures
 Monetary authorities switched to targetting
money supply
External Shocks & Response,
1979-82
 Financing debt through sale of exchange
rate indexed-treasury bonds
 Ready market as real depreciation was
increasingly likely
 Real liquidity fell and domestic real
interest rates increased
 1981, GDP growth rate was negative for
the first time, output dropped by 10%
External Shocks & Response,
1979-82
 Inflation continued to be high
 Trade balance became positive due
to cuts in imports rather than
exports growth
 Net interest payments accounted for
70% of current account deficit
 Increase in domestic interest rates
encouraged foreign borrowing
 External debt increased
Collapse of Foreign
Lending, 1982-85
 Central bank reserves had fallen
sharply
 Brazil viewed as riskier borrower
following the collapse of Mexico
 Principal commercial lenders
suspended new and rollover of
expiring credits
 Brazil resisted turning to the IMF
Collapse of Foreign
Lending, 1982-85
 Central bank reserves had fallen
sharply
 Brazil viewed as riskier borrower
following the collapse of Mexico
 Principal commercial lenders
suspended new and rollover of
expiring credits
 Brazil resisted turning to the IMF
Milagre Oil Shocks Lending
Collapse
Heterodox Economic
Shocks
The efforts to stabilize the economy
saw three shocks:
 The Cruzado Plan (1985)
 The Bresser Plan (1987)
 The Summer Plan (1989)
The Cruzado Plan

 Price was freezed


 Wage readjustments and freeze
 Readjustment and freeze of rents
and mortgage
 Ban on indexation

Immediate results were


spectacular, inflation fell close
to zero, economic growth up
surged, foreign accounts were
The Cruzado Plan: In
Trouble
 With fixed price and growing
economy, real income increased
 Price fix was maintained for too long
 Demand increased

•Excess demand created inflationary


pressure
•Indexation was back to control
inflation
The Bresser Plan and
Summer Plan
 Both plan were introduced in 1987 and
1989 respectively
 Attempt to control inflation
 Introduced price freeze and banned
indexation
 Not able to address the public-sector
disequilibrium
•1980 ended with high and accelerating inflation
and a stagnant economy
•Public debt was enormous
•Govt. had to pay very high interest rate to ensure
public spending in govt. debt instruments
REAL PLAN

•In 1994 by Fernando Cardoso


•Introduction of a new
currency (The Real)
•Deindexation of the economy
•Initial freeze of public sector
prices
•Tightening of monetary policy
REAL PLAN

 Reduced tariffs(of 51 percent in 1988 to an


average of 14 percent in 1994)
 Liberalize foreign investment
 On the expenditure reduction in the funds
the states and municipalities.
 On the revenue side, federal income tax
rates were increased.
 Monetary policy was restrained gradually.
REAL PLAN
 Effects:
 Brought inflation down to under 2% per month
 food consumption rose
 30%, purchase of consumer goods increased
 imports increased,
 the economy grew 4-5% every year since 1993
 unemployment dropped to its lowest level and
 real wages grew from 5% in 1994 to 13% in 1995
 between 1994 and 1995 the income of the lowest 50%
of the workers grew by around 30% whereas the
income from the top group grew only 10%
 Economic crisis in Asia and Russia affected the
Brazilian recovery
1999 Crisis : Fiscal
Deficit
Persistent accumulation of these
deficits by a country that has a history
of debt defaults or moratoriums clearly
discomfited investors.
Financial crises in Asia and
subsequently in Russia.
Brazil responded to these crises by
raising interest rates in hopes of
maintaining its exchange rate and
holding foreign capital in the country
Led to drop in Brazil’s industrial
production index in second half of
1998
Forced up nominal fiscal deficits,
aggravating existing concerns over
sovereign default
1999 Crisis : Real
Devaluation
As problems became more acute in
1998
fiscal deficit a big issue , call for a
Brazilian devaluation
New budget plan intended to save $23
billion and $41.5 billion International
Monetary Fund
Devaluation postponed
December 1998, a deficit reduction bill
was voted down
Minas Gerais Governor Itamar Franco’s
announcement refused debt payment
six other governors followed suite
Capital outflow :$1 billion per day,
9 percent Devaluation in Dec 1998
Brazil declared floating exchange rate
at the end of Dec 1998
January 1999, when the exchange rate
Summary of the post 1994
Period
Strategy for Economic Growth :
Brazil
Analysis of the Past
And
Recommendations for Future
Macroeconomic framework of
countries with high
external indebtedness
Revisiting the Past
Revisiting the Past
• The 1999 switch from an exchange anchor to a floating
exchange rate regime plus an inflation target regime brought
no significant improvement in the macroeconomic variables.
• Balance of payments have improved their accounts in 2003-04
due mainly to the increase in the trade balance surplus.
 Average investment rate in the last fifteen years was insufficient to generate a robust
growth for the Brazilian economy.
 This behaviour of investment rate was mainly due to the “economic policy model”
adopted by Brazilian policy makers since the beginning of 1990´s.

(i) high nominal and real interest rates in order to achieve price stability;
(ii) growing liberalization of the capital account in order to integrate
Brazil to international capital markets;
(iii) overvaluation of domestic currency.
(iv) since 1999 an increasing primary fiscal surplus – generated mainly by
the reduction of public investment – in order to stabilize public
debt/GDP ratio.
Alternative economic policy model
 Adoption of a crawling-peg exchange rate regime in which
devaluation rate of domestic currency was set by the
Central Bank at a rate equal to the difference between a
target inflation rate and average inflation rate of Brazil’s
most important trade partners
 Adoption of market-based capital controls in order to
increase the autonomy of the Central Bank to set nominal
interest rates according to domestic objectives (mainly to
promote a robust growth)
 Reduction of nominal interest rate to a level compatible
with real interest rate
 Reduction of primary surplus from current 4.5% of GDP to
3.0% of GDP. These elements are fundamental for the
required increase in the investment rate of Brazilian
economy from current 20% of GDP to 27% of GDP needed
for a sustained growth of 5% per year.
1)The first principle of the “alternative economic policy model”
entails the abandonment of the current Inflation Targeting Regime
(hereafter ITR).
.... For the workings of this system, however, there must be a
floating exchange rate regime.
……Adoption of a crawling-peg exchange rate regime will reduce
the exchange rate risk.
•crawling-peg exchange rate regime is that it will serve as nominal
anchor for the Brazilian economy, substituting ITR as a device for
inflation control.

2). The adoption of capital controls. These controls are necessary for
two basic reasons.
a) Increase private investment b) Control over nominal exchange
rate.
• To reduce capital inflows, it is necessary the introduction of reserve
requirements over all capital inflows, except foreign direct
investment
Current challenges
 Brazil remains far from the full employment :8.2 percent
 Controlling inflation:6.4%(Present)-4.5 %(Target)-Food Prices
 Agricultural prices have risen substantially in the last few
months, a trend that may begin to be seen in other sectors,
given the huge increase in internal demand
 lack of technically qualified people to attend to certain sectors
 Insufficient electricity generation to support a lengthy period of
economic growth.
 The large trade surplus from agricultural and mineral
commodities, and the influx of speculative capital stimulated by
high interest rates, without neutralizing measures, causes
overvaluation of the real, which in turn undermines the
competitiveness of national industry, resulting in lower exports
and an invasion of cheaper imported goods.
Lesson’s from Brazil

 Monetary growth is an endogenous


process, driven by the need to
finance fiscal deficits
 Can be faced immediately,
postponed. But in the long run it
cannot be avoided
 Consequence of populist attempts to
ignore the fiscal disequilibrium :
Economic turmoil
Lesson’s from Brazil,
Contd.
 Large economies can also be vulnerable to
external shocks
 The large capital inflows of the 1970s ; a mixed
blessing, when real interest rates rose in world
markets, Brazil's terms of trade worsened, and
lenders declined to roll over maturing loans
 Despite its success in weathering the external
payments crisis, failure to increase domestic
savings imposed a high internal cost as
investment declined
Lesson’s from Brazil,
Contd.
 Long import substitution made the economy
more vulnerable to external shocks than more
open policies would have
 Trade restrictions permitted the delay of real
exchange rate adjustment which would have
reduced the effects of the oil shocks
 In the long run it encouraged rent-seeking and
undermined the competitiveness of a number
of sectors
Lesson’s from Brazil,
Contd.
 The greatest learning experience has been
with stabilization plans
 Price freezes without fiscal adjustment
waste valuable time and undermine
government credibility when they
eventually fail
 Markets respond more favorably to
sustained and consistent policies than to
quick fixes
 Extending price controls to trade (ie, by
fixing the nominal exchange rate) may
aggravate the situation further.
References

 Donald V. Coes (1995), “Macroeconomic


Crisis, Policies and Growth in Brazil,
1964-90”, World Bank ‘Comparative
Macroeconomic Studies’
 José Luís Oreiro and Luiz Fernando de
Paula(2005), “Strategy for Economic
Growth in Brazil”
 www.economist.com
 www.worldbank.com

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