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Brazil's New Protectionist Mood

Interviewee: Bernarndo Wjuniski, Senior Analyst, Senior Medley Advisors
Interviewer: Christopher Alessi, Online Editor/Writer, CFR.org
October 24, 2012

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On the heels of the U.S. Federal Reserve's announcement last month that it would launch a new round of quantitative easing--so-called QE3--by purchasing an additional $40 billion in mortgage bonds per month, Brazil accused the Fed of inciting a global "currency war" by adopting "protectionist" policies. Brazilian Finance Minister Guido Mantega suggested that an expansionary U.S. monetary policy would trigger volatile capital inflows into emerging markets like Brazil, causing currencies to appreciate and damaging trade. Mantega is "correct by saying that in the short run QE3 leads to pressures for the appreciation of currencies across the emerging markets space, which is stronger than the benefits that these countries are going to get from stronger U.S. growth," says Bernardo Wjuniski, a visiting professor at the Getulio Vargas Foundation and a senior analyst for Latin America at Medley Global Advisors. However, Wjuniski says, Mantega is "definitely exaggerating the impact that not only QE3 has on the Brazilian currency, but also the impact that the Brazilian currency has on the local manufacturing sector and on local growth."

How and why is Brazil relevant to the global economy?

The first important thing is that Brazil's [economy] can grow from its domestic demand, as it's a country with a huge middle class, which is currently importing a lot, and it's definitely a very important destination for exports from the whole world. In the past, before this recent decade, Brazil was primarily seen as a place for investment by companies that were planning to produce commodities, or were planning to use the country as a platform for exports. And now you have a completely different situation. You have a country that is important because of its size for global demand. And the second thing is, from the export side, Brazil is one of the most important exporters of primary goods--on the commodities front, and most recently for oil. So the role of Brazil in the global economy is becoming more and more important [for maintaining] the equilibrium between exports and imports of the world.

What should be made of Brazil's slowing growth in the last two years--2.7 percent last year and a projected 1.54 percent this year? Why is growth slowing, and what are some potential policy responses?

There are two primary reasons for the slowdown in growth. One is a cyclical factor, and the other is structural. The cyclical story is the recovery from the 2008-2009 crisis, which was based on stimulus, and in 2010, the economy was definitely growing above its potential level, which created inflation. In the beginning of last year, Brazil adopted many protectionist policies to contain inflation, which included hiking interest rates. These policies resulted in a significant slowdown by the second semester of last year. At the same time, the global economy was heated by the second round of this crisis, which affected the investment side and confidence. So all of this together had a strong cyclical impact, which pushed the economy down last year and for the most part of this year.

They have cut interest rates, they have intervened in the currency to have a more depreciated currency—policies to rebuild demand and protect the economy in the short run, which are contradictory to their long-run policies.

The structural story is the fact that while domestic demand is the main driver of growth, it's clear that the space for these demands [to drive] the economy at the same pace it had in the past is [shrinking]. This happened basically because the [surplus] labor has mostly been used; it's hard to see wages growing at the same pace they have for the last decade. So while you can still expect this [consumer] demand to continue pushing the economy, levels of growth are [and will be] lower than they were in the past--unless Brazil starts to change its policies toward growth from the investment side, and you're starting to see some signals that the government is try[ing] to do this. They've announced a concession program for infrastructure, and they're trying to invest in education; these are signals that policy is slowly moving toward trying to build a new [growth] cycle from a different side. But at the same time, the government needs to rebuild global growth in the short run, and still needs a lot of [aggregate] demand policies to do so. They have cut interest rates, they have intervened [to weaken the real]--policies to boost demand and protect the economy in the short run, which are contradictory to their long-run policies. The most challenging part of policymaking in Brazil is to find a way to have short-term growth, and at the same time to build policies that definitely could change direction in the long run.

Why is Brazil such an attractive destination for foreign direct investment?

Particularly from the commodities side, Brazil's main sectors are growing at a fast pace and look set to continue to do so.

Particularly from the commodities side, Brazil's main sectors are growing at a fast pace and look set to continue to do so. This includes oil, mining, and agriculture--and all of this should continue growing despite slowdown in the short-run from global growth, because it's clear that demands for these products are going to continue rising in the long run. So most of the foreign direct investment money that comes to Brazil goes to these sectors. And there is also some money coming in for investments in companies, which are going to benefit from this cyclical-demand cycle, which will last for quite some time. There are a lot of automobile companies coming here, manufacturing companies in general; they are coming to benefit from the demand. Also, as a consequence of rising protectionism: If you want to have access to [consumers], the Brazilian government is saying you have to produce here. These are the two kinds of foreign money you have been seeing for the past couple of years in Brazil.

Brazilian Finance Minister Guido Mantega had a strong reaction to U.S. plans for further quantitative easing. Will the U.S. policy spur a "currency war" and damage growth in emerging markets like Brazil, as he suggests?

In some ways, [Mantega] is using the currency story as an excuse for other problems.

That's partially correct. He's correct by saying that in the short run, QE3 leads to pressures for the appreciation of currencies across the emerging markets space, which is stronger than the benefits that these countries are going to get from stronger U.S. growth. It's a temporary issue. The appreciation of the exchange rate happens immediately, while the extension of monetary policy will only benefit these countries in a couple of years from now. The problem is that he's definitely exaggerating the impact that not only the QE3 has on the Brazilian currency, but also the impact that the Brazilian currency has on the local manufacturing sector and on local growth. There are many other reasons for why you don't have a competitive industrial sector in Brazil. There are a lot of domestic constraints: the tax burden is high. You have a country with very bad infrastructure, and where the quality of education is low compared to other countries. In some ways, [Mantega] is using the currency story as an excuse for other problems.

What about policy responses from Brazil, such as the reverse dollar swaps that have already been conducted, in response to QE3?

All these capital controls and interventions are short-lived in general. Not only because the market finds ways to bring money in, but also because they contribute to a negative externality for the economy. What they end up doing is keeping the currency stable, and then the stability is only positive for trade, which [attracts capital]. The interventions also have a significantly high cost on the international reserves, because you need to stabilize some of the money you are putting in on a monthly basis, and the difference between what the local treasury thinks and what you get in return for your international reserves is high. I don't see how these policies can be sustainable in the long run. While the effects of the expansionary monetary policy in the United States are stronger on currencies, [currency intervention] could be an option, but it's probably being used in a stronger way than it should.

What are other challenges in the U.S.-Brazil economic relationship?

The main one is trade, because it's clear to me that the Brazilian response to QE3 is not only coming through this currency intervention, but through a rising protectionism. More and more, you have policies that protect the local manufacturing sector, [which are] a response to U.S. policies. So I think this is a complex period of time for trade between Brazil and the United States, and I feel that the government here wants to play a tough game on the trade side in the next couple of years.

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