Brazil: Mantega talks of war as Dutch disease diagnosed

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By:
Rob Dwyer
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US now cheaper than Brazil for production; Chile and Argentina also suffering

Brazil remains determined to use a wide range of macro-prudential measures to combat the appreciation of the real.

Brazil’s finance minister Guido Mantega, writing in Euromoney’s sister publication Emerging Markets to coincide with the IDB conference in Montevideo, says that the unprecedented monetary looseness in the developed economies, particularly the US, "has caused a currency tsunami with an impact on foreign exchange rates and the creation of financial bubbles".

He adds that, despite little support from other Latin American countries over the use of capital controls: "The Brazilian government will not stand idly by in this currency war. We have an arsenal of measures that are capable of stopping or neutralizing the overvaluation of our currency and stemming the excess inflows of foreign capital into the currency."

Last month, Brazil extended – from two to five years – the period for charging the 6% IOF tax levied on loans taken out by Brazilian firms. The central bank has also expanded its intervention in the FX market through buying dollars, spot auctions and issuing swap contracts.

Brazil’s finance minister Guido Mantega
Brazil’s finance minister Guido Mantega
The re-ignition of the currency wars comes as the American Chamber of Commerce issued a report saying that the cost of industrial production is now lower in the US than in Brazil. During the past five years, the labour cost in dollars has increased by 46% in Brazil and 3% in the US – largely driven by the appreciation of the real. Job creation in Brazil is slowing: 150,600 jobs were created in February compared with 280,700 in the same period in 2011.

"Brazil is suffering a serious case of Dutch disease and it’s also present [to a lesser extent] in other countries in the region," claims Guillermo Mondino, head of emerging markets research at Citi. "Obviously, as the Dutch disease gets more accentuated, we are going to see more social, political and economic consequences."

There is widespread sympathy for Brazil’s struggles with its currency appreciation, caused in a large part by US quantitative easing and low interest rates, but there is little support for its policy of capital controls.

"The debate over the introduction of measures to avoid currency appreciation has been rekindled and it remains unresolved," says Rodrigo Vergara, governor of the central bank of Chile. "But we are convinced in Chile that a floating exchange rate is the most appropriate for our country. All efforts to persistently keep exchange rates at levels beyond margins aligned with the fundamentals are not sustainable and may generate higher inflation."

The IMF has given its tacit approval to Brazil’s capital controls, with its western hemisphere director Nicolás Eyzaguirre saying countries should be able to use these defensive measures in "the short term".

However, with US interest rates expected to remain at historical lows until 2014, the question becomes, what is the short term?

Critics say that international organizations such as the IMF should advocate free-floating exchange rates.

Philip Suttle, deputy managing director of the Institute of International Finance, says that "the IMF’s position would have been inconceivable 10 years ago" and the dangers are that its position "will give increasing confidence to countries such as Argentina to do increasingly tough things [with economic regulations]".

Brazil also appears to be using its economic slowdown to cut aggressively its headline interest rate, thereby lowering the real interest rate and lessening the attraction of the country for foreign capital. The Selic was cut by 75 basis points in early March and more cuts are signalled.

However, Vergara also warns of the dangers of broadening the objective of monetary policy away from inflation targeting. "You create confusion as to the objective of the monetary authorities," he says. "[Is the motivation to control] inflation or the exchange rate? The exchange rate should not be the objective of monetary policy – the main goal is price stability."

Marcelo Carvalho, head of Latin American research for BNP Paribas, also has a terse warning for Brazil. Pointing to the more open Latin American economies that are outpacing Brazil’s GDP growth of 2.8% in 2011, he says: "With the currency wars, be careful what you wish for. If you want to scare investors away, then you might succeed."