Finance minister of the year: Staying tough in a crisis
Armínio Fraga Neto is famous for being parachuted into Brazil at the time of the currency crisis, for getting quickly to grips with urgent policy decisions and for soothing investors' nerves with his market-friendly language. With Brazil now in a much better macroeconomic position than was expected six months ago, these are all good reasons for making Fraga Euromoney's central bank governor of the year.
But Fraga also deserves the award for the revolution in Brazilian finance that is taking place under his direction. The changes encompass everything from removing capital controls to overhauling the payments system to improving bank supervision.
Among the great assets that Fraga brings to the job are his strong working relationships with president Fernando Henrique Cardoso and finance minister Pedro Malan - Fraga is an old student of Malan's - and his long experience in the private sector. He came to the post from Soros Fund Management in New York, an association that did not amuse some sections of the Brazilian press. To them George Soros is a speculator who has little regard for national sovereignty. Fraga, as one of his henchmen, was viewed as "poacher turned gamekeeper".
In fact, Fraga's varied career has taken him across the public/private sector dividing line before and another move back to government was not a radical departure. Only the timing was dramatic. Fraga served as director for international affairs at the central bank in the early 1990s and worked with Malan during complex negotiations over Brazil's external debt. Says William Rhodes, vice-chairman of Citigroup, who was on the other side of the table: "Fraga showed then how open-minded he is. During the debt negotiations he was always open and transparent in all his dealings. He has a lot of energy and is always easy to get in contact with."
These were qualities that Fraga would need in abundance on returning to the central bank when not only Brazil but emerging markets everywhere were in crisis. Fraga knew the situation intimately. "I don't know of a bank on the planet that wants to increase its exposure to anything, let alone emerging markets," he had told the Economist some months earlier while still with Soros Fund Management.
With the Brazilian real in free fall, one of Fraga's first tasks at the central bank (he worked as an adviser to Malan before his confirmation as governor) was to convince those very same banks to maintain Brazilian credit lines. To this effect he was soon on the road to major financial capitals where he calmed investors with his clear espousal of policies fit for a world of international capital flows. A particular high point was his showing at the Inter-American Development Bank (IDB) meeting in Paris in March.
"One of the lessons learned from the Mexican peso crisis is that you have to keep up a dialogue with the investment community both internally and externally," says Rhodes. "Fraga speedily did this. When you get into a crisis you have to move quickly because the clock is running against you."
Francisco Gros, his former boss at the central bank and now at Morgan Stanley Dean Witter, says of Fraga: "He has a Princeton PhD, he is a guy who has worked in the markets. It is not all theory, he has a lot of practical experience." Included in Fraga's practical-experience portfolio is a spell as a Salomon Brothers vice-president in New York and in the mid-1980s he was chief economist at Garantia - now CSFB Garantia - the Brazilian investment bank noted for its ability to outrun central bank rules.
On the policy front Fraga describes putting things together as a two-step decision. The first is to decide the kind of exchange-rate regime required - fixed or floating. Then, if floating is picked, the next choice is how monetary policy will be run whether by targeting monetary aggregates, by targeting inflation or what Fraga calls the "just do it approach" where you have no anchor and just do it.
With the real having bust out of its exchange-rate peg, in place since 1994 and credited with curing Brazil's hyperinflation, there were calls for a currency board to be established along the lines of Argentina's. But the Brazilian team went in the other direction - free floating backed by inflation targeting.
"Inflation targeting to me is the superior method [of monetary policy] because it's very focused while at the same time allowing some room for discretion because you need it in this very creative world we live in," said Fraga at a press conference in London earlier this year.
Fraga is also attempting to bring Brazilian financial markets up to world standards. "It might sound a bit pompous but this is a process of institutional change," says Fraga. This involves removing financial taxes and directed credit and Fraga is known not to be a fan of the CPMF tax on financial transactions which was reinstated in June as part of government revenue-raising measures.
Fraga is instinctively against capital controls and says, "we think it's time to go the last mile" on removing Brazilian capital controls. Brazil's two-tier exchange rate was unified in January before Fraga arrived and while taxes on short-term flows remain, they are set at zero. Fraga says this mechanism will be kept in some fashion with the aim of using it to ward off inflows in exceptional and temporary circumstances only.
Banking supervision is following the international trend of using the market and the banks themselves to assume a lot of the responsibilities; an overhaul of the payments system is underway; money markets were updated a few months ago; bank privatization remains a policy aim even, controversially, for the Banco do Brasil where a strategic investor may be sought.
"This process of eliminating financial repression and taking away capital controls must be matched by proper banking supervision," says Fraga.