| Arminio Fraga | ||||||
Euromoney caught up with Arminio Fraga in his hometown, Rio de Janeiro, where he spends his weekends. It was August – the middle of winter – but even so the breeze coming through the open windows from the Atlantic did little to cool his corner office at the central bank building. Come summertime, a lack of air conditioning is likely to be unbearable; in Brasilia, the capital, where the central bank is based, it will be even worse.
And Fraga is starting to feel the heat, as worries grow that Argentina’s problems may be transmitted to its northern neighbour. Weighed down by worries about the US and world economy, a growing regional crisis, a slowing domestic economy with electricity rationing and uncertainty over forthcoming elections, the Brazilian real is weakening and that has pushed up interest rates.
Even in rolled-up shirtsleeves, chinos and brown loafers, Fraga was much more the central banker than he was the former trader for Salomon Brothers and Soros Fund Management. The central bank building was busy, the lobby bustling with a broad cross-section of Rio de Janeiro society; Fraga had just come out of a union meeting, where he was presented with demands for wage increases.
Wages are one of the long-term issues facing Brazil. But average real wages haven’t really gone up, have they?
They’ve started. I’m quite positive on that. It’s one of the classic pudding proofs. If your development model is to work, it must deliver wage increases in a way that doesn’t jeopardize your macroeconomic environment: real wage increases that are driven by productivity.
A couple of things make me quite positive on that front: one is all the work and investment made in education here over the last seven, eight years. And then other factors seem to be pushing productivity gains up substantially here in Brazil over the past five to 10 years as well. We had negative total productivity changes in the 1980s, which is amazing for any country, but for a developing country is just unacceptable. But we had it, it was very chaotic here. In the 1990s, that terrible trend reversed itself, I think on the back of the opening of the economy, stabilization, all the work on education, foreign investment, privatization. And we saw that this total productivity number turned positive. In the 1990s it was about 1% a year, and we believe it’s now gone up since then. So I think we’re prepared to see the positive repercussions on wages, investment, and inflation.
Brazil might be improving in productivity and education, but the rest of the world is improving as well, and the gap seems to remain.
The US leads the global productivity frontier, and indeed has been showing very significant productivity gains over the last decade. I think this decade will show us catching up, which means I expect our productivity gains to be higher than theirs. It’s something reasonable to expect, in light of all the room for catching up that we have. It’s nothing to brag about, but it’s definitely something that we need to turn to our favour.
In any case, I wish the rest of the world well. If their productivity rates go up fast, it means ours will do the same, and it’s not a zero-sum game. So long as ours is going up substantially, we’ll be happy.
What about trade?
Trade is a classic non-zero-sum game. The only thing I can tell you on trade is that we’d like to do more of it, and we are working very hard with our partners to get engaged in a serious discussion about the issues that are important for us: agriculture, anti-dumping, things like that. We’re prepared to sit down and negotiate at the WTO level but also at a regional level.
Which regions?
We have ongoing dialogues with the EU and with the US. The US has the possibility of an FTAA. The presidents of Mercosur have discussed and support the idea of Mercosur negotiating as a bloc.
So Mercosur does have a role to play?
Without a doubt. I don’t think we should get caught in what is a difficult short-term situation. Which we’ll overcome. I’m not saying we’re happy to be where we are, but nevertheless the long-term views are definitely still there.
Over the long term, what would you like to see happen to Brazilian exports? At the moment they’re about 8% of GDP. Where do they need to be?
We believe we need to see exports growing faster than our GDP. Exports and imports should be growing. We believe it will benefit us to trade more. Export growth in our case would also help growth, and I think it is also a wonderful motivator for productivity. So all of that would be very helpful. At the moment, we’re seeing double-digit export growth here in Brazil. So if that continues for a while, it would certainly be a plus for us. It should continue.
What’s also likely to continue is the current-account deficit, isn’t it?
Well, some current account deficit makes sense for us. We’re a developing country, we have great investment opportunities here. So long as we’re borrowing or receiving foreign investment in a way that adds to our overall investment effort, we feel this is OK. So long, also, as the financing is appropriate: that is, not short-term financing of long-term development projects.
You would expect a current account deficit in a country like ours. The key issue is not that we have it, it’s that we have it and it’s well financed. Brazil has no short-term debt on the books other than trade finance, which is very stable. So I like the general way our balance of payments is shaping up. I do expect over a longer horizon that we’ll see a gradual slowdown in FDI, and we’ll see a gradual reduction in the current-account deficit. Those two will come.
But the reduction in FDI has already happened.
We were expecting a significant reduction this year. Part of it was due to lower privatization revenues in 2001; part of it now is probably due to the global slowdown and the regional slowdown as well. But we’re still looking at $20 billion in FDI, and with the current-account deficit at, call it $25 billion, it’s a very reasonable-looking balance of payments.
Now, the cost of that extra $5 billion is very high.
It could be, but a lot of it is trade finance as our trade is growing, and that doesn’t cost that much. Our foreign debt as a ratio of GDP is also nothing that worrisome, 35% of GDP. A lot of it is trade finance.
Overall we’re OK, it’s just the short-term environment of a global slowdown and a regional slowdown squeezes us a bit. But if you look beyond the near-term clouds, I don’t feel that anything is structurally out of line. In fact, if you think of countries that have had balance-of-payments problems over the years, and I’ve followed this very closely from way back, you find managed exchange rates, you find weak financial systems, you find a lot of short-term debt, you find fiscal deficits, none of which you see here. We’re making sure it stays this way, keeping an eye on the banking system, keeping an eye on the profile of our debt, making sure our fiscal policy is responsible and responsive to the needs of long-term stability and sustainability. I think it is important when looking at a country like ours to look back to where we came from, take into account the fact that right now there is some turbulence in the air, but that the long-term trends are quite encouraging.
What about this short-term turbulence, these clouds, one of the biggest of which is Argentina? What is the best thing that could happen, from Brazil’s point of view? Do the clouds stay there for a while and slowly dissipate, or do you get a big cloudburst and then it’s all over with and you’re back on your own again?
You’re asking the Argentina question. The global economy will manage, it’s a business cycle. The underlying productivity trends are still there as well. Whether it be another quarter or two or three we’ll find out in due course: that I’m not capable of predicting, but I’m not losing that much sleep over it either.
In the case of our neighbour and partner, they are putting up a really heroic effort to turn the situation around. I believe that they need time to work things out. I find it hard to understand why people would prefer a burst, as you said. I think that makes no sense for us. They deserve time, they’ve done a lot over the years, and with time and support, if we support them I believe they’ll find a way out of this slump.
But so long as they’re taking their time working this out, Brazil has no real access to the capital markets, a very high cost of capital, a very weak currency, and rising interest expenses.
Our borrowing expense has gone up, indeed, but just last week [this is August 10] we had three very significant transactions: the $1.6 billion samurai bond, the issuance of 10-year subordinated debt, tier-2 capital, by Banco Itaú at less than 500 basis points over, and we had a very nice securitization of remittances from Japan, a transaction by Banco do Brasil. So the private sector seems to be finding ways of dealing with this, and we, the government, are done for the year. We announced last year a target of $5 billion to $7 billion in borrowing; we’re right at $7 billion, slightly under. So it’s OK. It’s not the environment we would choose if we had a choice, but it’s one that we can manage. Plus the support we have received from the IMF makes me confident that we’re going to sail through these turbulent waters and get out stronger than we went in. We’re also making sure we do all the fine-tuning and the extra effort that is needed, which again I believe will strengthen us further.
But are these the sort of arguments which would have swayed you back in your old job at Soros? Isn’t Brazil still vulnerable to speculative attack?
Speculators always look for situations that are unsustainable, situations where there can be a break or a negative trend, in the case of an attack. They also look for positive trends, of course. I think we’re constructing something here that speculators are going to like as a positive trend, as a turnaround story. With the floating exchange rate and healthy banks, we’re not the typical target: quite the contrary. If you look back at all the exchange-rate events of the last ten years, we don’t fit in the profile. So I’m actually hoping that the speculators will kick in at some point, but that they’ll be joining forces with us. That’ll be fine. People are checking us out, and they see that we’re doing our part.
You and the central bank are doing your part; the question is whether the government is really capable of keeping Brazil’s head above water given the initial conditions.
We’re a country with a 3.5% of GDP primary surplus, debt-to-GDP in the low 50s, healthy banks, a floating exchange rate, our GDP trends are quite positive. Our problem is our history. The 1980s and the early ’90s were not the best for us, and more recently the world has been hit by a succession of shocks, and with every new one we seem to be able to turn things around and strengthen our situation further. I think this will be no different. And I believe the basic ideas that were defended and put in place – fiscal responsibility, transparency, efficiency – are here to stay.
What about central bank independence?
Central bank independence is a subject that is being discussed. The House just voted two nights ago at a committee level on the constitutional amendment that would pave the way for the discussion of a new central bank law, so the subject is being debated. But perhaps just as important as the law, which would be something important to discuss in Congress without any question, to my mind, is the fact that Brazilians don’t want to go back to the old days of high inflation and high volatility. Particularly the poor, who are taxed by inflation beyond any other social group.
Society here understands well the harm that the central bank does when it’s not focused on stability. Therefore almost by default people here in Brazil expect us at the central bank to do our job, to worry about inflation, to worry about the financial system’s soundness, and so on. This is an important change, in that eventually it will be translated into a new legal environment, I am certain of it. It is not something that is coming over the top. If you go around, talk to people in the street, they want no part of our hyperinflationary history. In the end I think this will change, it will be institutionalized. But it’s coming from the bottom up, that’s very important.
These people are going to be voting at the end of next year in the presidential election, which is a big question mark for markets in the medium term. The other, of course, is the energy crisis.
The elections I touched upon a bit when I referred to the basic ideas that we’re defending. It’s way too early to tell who will win, so there’s a lot of scenario analysis that is difficult to do. To me the most important thing is to keep in mind what I just said. I find it impossible that someone will win defending fiscal irresponsibility, defending non-transparent or opaque government policies, and a return to inefficient ways of organizing society. So the downside of a change, in my mind, is lower than some people think. I am positive that the outcome won’t set the clock back.
As far as energy is concerned, the social response to the crisis has been tremendous. Nobody’s happy about it of course, but the savings have been higher than we had anticipated, substitution possibilities are being explored to the limit by businesses, and we also have a secondary market where energy is being traded. That is very important because the high-energy-intensive sectors can sell to the rest of the economy.
Beyond that, we are revisiting the regulatory environment to make sure that investors in the energy sector find it attractive to invest. This is what we have done in telecommunications as well. We can do the same with energy. There is some fine-tuning being done there as we speak. So we feel the pipeline of investments for the future will be adequate. There’s plenty for 2003, so the short-term challenge is to manage this rationing period, and that is ahead of schedule. The long-term challenge is to make sure that the investor climate in the sector is positive, is adequate. And I am also very confident that we will deliver that. So, so far so good. It looks OK.
But the currency’s going to be under a lot of pressure next year, isn’t it?
No, I don’t expect so. It’s very hard to predict, but we’re working on the fundamentals, making sure they stay in place. The currency has weakened substantially; people might take the other view. You never know.
