LACEA/LAMES 2007 BRAZIL" 05/10/2007

Transcription

1 LACEA/LAMES 2007 Policy Responses to Sudden Stops in BRAZIL" 05/10/2007 Márcio Garcia

2 Introduction (1/2) Brazil suffered in 2002 a sudden stop. Capital flows fell by some USD 24 billion, around 6% of GDP, at the time. The 2002 Brazilian sudden stop is particularly interesting because: Brazil is the largest Latin-American country; Large L turnaround of the current account for international ti standards; d Successful case in view of sudden stop episodes no meltdown case; Combination of high international risk aversion episode with domestic presidential elections that would elect a (then believed to be) non-market- friendly candidate; Very large increase of country risk and exchange rate devaluation;

3 Introduction (2/2) Excessive credit risk generates important and unusual effects in financial markets, as the futures exchange rate market in backwardation, i.e., forecasting appreciation of the BRL. This implies on-shore dollar rates below the international market ones, just the opposite of the normal case created by high country risk; The Brazilian Central Bank (BCB) used many non-orthodox anti-crisis tools to mitigate the effects of the confidence crisis: exchange rate derivatives, daily allowance of exchange rate directed to international trade financing, political negotiation to generate a statement of all candidates that if they won, they would not renege sensible economic policies; Non monetary liabilities of the government became dollarized to provide crisis insurance for the private sector, especially the banking sector, at a high cost to the government budget. Insurance against interest rate increases were also provided, in the form of zero duration bonds.

4 Contents Section 2 Sequence of events that t lead dto the 2002 sudden stop : first, the 1999 crisis that led to the floatation of the Brazilian currency is briefly reviewed, and then the flexible exchange rate period is analyzed, emphasizing the impact on asset prices; Section 3 policy responses and its effects; Section 4 discussion of important issues and constraints that shaped the macroeconomic policy reactions and outcomes; Section 5 policy lessons from the episode.

5 Exit from the crawling peg and the floating: facing old and new crises

6 Table 1: Macroeconomic Indicators of the Floating Period of the Real Plan GDP Growth 0,3% 4,3% 1,3% 2,7% Inflation(CPI) 89% 8,9% 60% 6,0% 77% 7,7% 12,5% Exchange Rate Depreciation 48,0% 9,3% 18,7% 52,3% Nominal Interest Rate (Selic) 24,8% 17, 6% 17, 5% 19,2% Real Interest R ate 14,6% 10,8% 8,9% 6.2%* Fiscal Surplus (%GDP) Pi Primary 33% 3,3% 36% 3,6% 38% 3,8% 40% 4,0% Nominal -5,8% -3,6% -3,5% -4,7% Current Account USD Billion -25,30-24,20-23,20-7,60 %GDP -4,8% -4, 0% -4,6% -1,7% * Due to the unexpected increase of inflation, the ex post real interest rate of 6.2% may be underestimating the ex ante real rate by 4.9%, i.e., the ex ante real rate would be around 11.1%.

7 Fed Funds Target x Selic Target 27% 7% 25% 6% 23% 5% 21% 4% SELIC F ED FUNDS 19% 3% 17% 2% 15% 1% Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Selic Target Fed Funds Target

8 70% 60% 50% 40% 30% Interest Rate Decomposition lo g annual rate 20% 10% 0% Jan-95 Apr-95 Jul-95 O ct-95 Jan-96 Apr-96 Jul-96 O ct-96 Jan-97 Apr-97 Jul-97 O ct-97 Jan-98 Apr-98 Jul-98 O ct-98 Jan-99 Apr-99 Jul-99 O ct-99 Jan-00 Apr-00 Jul-00 O ct-00 Jan-01 Apr-01 Jul-01 O ct-01 Jan-02 Apr-02 Jul-02 O ct-02 1-Year-US Treasury Rate Forward Premium Covered - Interest -Parity Differential 1-Year-Domestic Rate

9 35% 30% 25% 20% 15% Interest Rate Decomposition log a nnual rate 10% 5% 0% Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Covered-Interest-Parity Differential EMBI+ BR

10 25% Interest and Exchange Rates: The first Crisis Bout 20% 15% 3 2,75 BRL/USD Exchange Rate 10% 5% 0% -5% 2,5 2,25 2 1,75 1,5 Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec Jan- Feb- Mar BRL/USD - Exchange Rate Forward Premium One-Year Interest Rate EMBI+ BR Domestic USD Rate SELIC EMBI+_BR - CIPD

11 Interest and Exchange Rates: The second Crisis Bout 35% 30% 25% 20% 4 3,75 3,5 3,25 Rate 15% 10% 5% 3 SD Exchange 2, ,5 2,25 log annual rate BRL/U 0% -5% -10% -15% 1,75 1,5 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01 Jan-02 Mar-02 May-02 Jul-02 Sep-02 Nov-02 BRL/USD - Exchange Rate Forward Premium One-Year Interest Rate EMBI+ BR Domestic USD Rate SELIC EMBI+_BR - CIPD

12 Forward Premium Decomposition: Expected Depreciation and Currency Risk 30% 4 20% 3,6 BRL/USD Exchange Rat te 10% 32 3,2 0% 2,8 log annual rate -10% 2,4-20% 2-30% 1,6 Jan-00 Feb-0 Mar-0 Apr May-00 Jun-0 Jul-0 Aug-0 Sep-0 Oct-0 Nov-0 Dec-0 Jan-0 Feb-0 Mar-0 Apr May-01 Jun-0 Jul-0 Aug-0 Sep-0 Oct-0 Nov-0 Dec-0 Jan-0 Feb-0 Mar-0 Apr May-02 Jun-0 Jul-0 Aug-0 Sep-0 Oct-0 Nov-0 Dec BRL/USD - Exchange Rate Forward Premium Currency Risk Expected Depreciation

13 BRL and USD Domestic Yield Curves: 10/22/ % 60% 50% annual 40% 30% 20% 10% 0% 1 month 6 months 1 year 2 years 3 years Term Domestic Interest Rate in BRL Domestic Interest Rate in USD

14 IBOVESPA 20, , , , U SD 12, BRL 10, , , , jan-99 mar-99 mai-99 jul-99 set-99 nov-99 jan-00 mar-00 mai-00 jul-00 set-00 nov-00 jan-01 mar-01 mai-01 jul-01 set-01 nov-01 jan-02 mar-02 mai-02 jul-02 set-02 nov-02 IBovespa BRL IBovespa USD

15 Policy responses and policy effects

16 Public Sector Borrowing Requirements - % of GDP 5% 0% -5% -10% -15% Nominal Surplus Primary Surplus Operational Surplus

17 6,00% 4,00% 2,00% 0,00% Current and Trade Accounts and The Exchange Rate 4,0000 3,5000 3,0000 % of GDP jan/99 apr/99 jul/99 oct/99 jan/00 apr/00 jul/00 oct/00 jan/01 apr/01 jul/01 oct/01 jan/02 apr/02 jul/02 oct/02 jan/03 apr/03 jul/03 oct/03 jan/04 apr/04 jul/04 oct/04 jan/05 apr/05 jul/05 oct/05 Exchange jan/06 apr/06 jul/06 oct/06 jan/07 apr/07 Rate (BRL/USD) 2,00% 4,00% 6,00% 8,00% Exchange Rate Current Account Surplus Trade Account Surplus 2,5000 2,0000 1,5000

18 The Dedollarization of the Public Debt ,00 120% ,00 100% ,00 80% ,00 60% mi llion ,00 40% ,00 20% 0,00 0% Jan-95 May-95 Sep-95 Jan-96 May-96 Sep-96 Jan-97 May-97 Sep-97 Jan-98 May-98 Sep-98 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 Public Debt in Reais / Public Debt Public Debt Public Debt in Reais

19 Issues and constraints t that t shaped the macroeconomic policy reactions and outcomes

20 Resilience of the banking sector (and the public sector)

21 Federal Bond Debt: Composition and Maturity 60,00% 50,00% 40,00% 30,00% 20,00% 00% Months 12 6 % of GDP 10,00% 0,00% -10,00% 0-6 jan/95 jul/95 jan/96 jul/96 jan/97 jul/97 jan/98 jul/98 jan/999 jul/999 jan/000 jul/000 jan/01 jul/01 jan/02 jul/02 jan/03 jul/03 jan/04 jul/04 jan/05 jul/05 jan/06 jul/06 jan/07 jul/07 Others Price-Level Linked Selic Nominal Exchange-Rate Linked Duration Maturity Márcio G.P. Garcia Economics Department PUC Rio

22 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% Federal Bond Debt: Composition Constant R$ Millions jan/94 jul/94 jan/95 jul/95 jan/96 jul/96 jan/97 jul/97 jan/98 jul/98 jan/99 jul/99 jan/00 jul/00 jan/01 jul/01 jan/02 jul/02 jan/03 jul/03 jan/04 jul/04 jan/05 jul/05 jan/06 jul/06 jan/07 Exchange-Rate Linked Nominal Selic Price-Level Linked Others

23 Shock persistence and new sources of financingi

24 Foreign Direct Investment USD Millions USD Millions jan/96 mai/96 set/96 jan/97 mai/97 set/97 jan/98 mai/98 set/98 jan/99 mai/99 set/99 jan/00 mai/00 set/00 jan/01 mai/01 set/01 jan/02 mai/02 set/02 jan/03 mai/03 set/03 jan/04 mai/04 set/04 jan/05 mai/05 set/05 jan/06 mai/06 set/06 jan/07 mai/ Foreign Direct Investment (Monthly) LHS Foreign Direct Investment (Accumulated Last 12 Months) RHS 5000

25 Financial account (US$ Million) Direct investment (net) Brazilian direct investment Equity capital Affiliated enterprise loans Foreign direct investment Equity capital Direct investor loans Portfolio investment (net) Brazilian portfolio investment Foreign portfolio investment Financial derivatives (net) Other investments (net) Other Brazilian investments (net) Loan and financing (net) Long-term Short-term (net) Currency and deposits (net) Other assets (net) Long-term (term) Short-term (net) Other foreign investments (net) Trade credit - suppliers long- and short-term ( Long-term Short-term t (net) Loans (net) Monetary authority (net) Exceptional financing (net) IMF Other Other long-term loans Remaining sectors (net) Long-term Short-term (net) Currency and deposits (net) Other liabilities (net) Long-term (net) Short-term (net)

26 Foreign reserves management

27 Interbank line of credit position US$ billion Trade credit Itemization Others Total Export Import Total 2001 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

28 Statement of international reserves growth Itemization Reserve Position (End of Previous Month) NET PURCHASES (+)/ SALES (-) OF CENTRAL BANK (interventions) US$ billion Spot Lines with repurchase Export lines TOTAL (Net purchases) 2001 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

29 Foreign Reserves ,00% 10,00% 8,00% 6,00% 4,00% 2,00% 0,00% jan/95 abr/95 jul/95 out/95 jan/96 abr/96 jul/96 out/96 jan/97 abr/97 jul/97 out/97 jan/98 abr/98 jul/98 out/98 jan/999 abr/999 jul/999 out/999 jan/000 abr/000 jul/000 out/000 jan/01 abr/01 jul/01 out/01 jan/02 abr/02 jul/02 out/02 jan/03 abr/03 jul/03 out/03 jan/04 abr/04 jul/04 out/04 jan/05 abr/05 jul/05 out/05 Foreign Reserves (%GDP) Foreign Reserves (in US$) Foreign Reserves Adjusted (Foreign Reserves minus IMF resources)

30 Monetary policy: The Brazilian Experience with Inflation Targeting

31 NOMINAL AND REAL EXCHANGE RATES AND CPI INFLATION 20% 4,3 18% 4 16% 3,7 14% 12% 10% 3,4 3,1 2,8 2,5 BRL/USD 8% 2,2 6% 1,9 4% 1,6 2% 1,3 0% jan/99 jul/99 jan/00 jul/00 jan/01 jul/01 jan/02 jul/02 jan/03 jul/03 jan/04 jul/04 jan/05 jul/05 1 CPI Inflation (last 12 months - LHS) Nominal Exchange Rate (BRL/USD) - RHS Real Exchange Rate - RHS

32 NOMINAL AND REAL INTEREST RATES AND CPI INFLATION 50% 40% 30% % per year 20% 10% 0% jan/99 jul/99 jan/00 jul/00 jan/01 jul/01 jan/02 jul/02 jan/03 jul/03 jan/04 jul/04 jan/05 jul/05-10% -20% CPI Inflation (monthly annualized rate) Real Interest Rate (with monthly inflation - annualized rate) Nominal Interest Rate (SELIC) Real Interest Rate (with last 12 month inflation - annualized rate)

33 Brazilian Performance With Inflation Targeting Y ear Target Decision i Date Target Inflation (CPI) GDP Growth 1999 June, 99 8,00% ±2,00% 8,94% 0,25% 2000 June, 99 6,00% ±2,00% 5,97% 4,31% 2001 June, 99 4,00% ±2,00% 7,67% 1,31% 2002 June, % 3,50% ±2,00% 12,56% 266% 2,66% 2003 June, 01 3,25% ±2,00% * June, 02 4,00% ±2,50% * January, 03 8,50% ±2,50% 9,30% 1,15% 2004 June, % 3,75% ±2,50% * June, 03 5,50% ±2,50% 7,60% 5,71% 2005 June, 03 4,50% ±2,50% ** September, 03 5,10% - 5,69% 2,94% 2006 June, 04 4,50% ±2,00% 3,14% 3,70% 2007 June, 05 4,50% ±2,00% 3,6% *** 4,3%*** 2008 June, 06 4,50% ±2,00% 3,89%*** 4,18%*** 2009 June, 07 4,50% ±2,00% 3,98%*** 4,15%*** * Revised Targets. ** Objective, instead of Target (whatever that means). *** Market s expectations on June/22/07. Source: Brazilian Central Bank W ebsite (

34 COUNTRY RISK: EMBI+ AND EMBI + BRAZIL 31/dez/91 31/dez/92 31/dez/93 31/dez/94 31/dez/95 31/dez/96 31/dez/97 31/dez/98 31/dez/99 31/dez/00 31/dez/01 31/dez/02 31/dez/03 31/dez/04 31/dez/05 31/dez/06 EMBI+ EMBI+ BR

35 6 Primary Fiscal Balance and Net Public Debt(% of GDP) ,6 0,55 0,5 0,45 0,4 0, ,3 0,25 0,2 dec/96 mar/97 jun/97 sep/97 dec/97 mar/98 jun/98 sep/98 dec/98 mar/99 jun/99 sep/99 dec/99 mar/00 jun/00 sep/00 dec/00 mar/01 jun/01 sep/01 dec/01 mar/02 jun/02 sep/02 dec/02 mar/03 jun/03 sep/03 dec/03 mar/04 jun/04 sep/04 dec/04 mar/05 jun/05 sep/05 dec/05 mar/06 jun/06 sep/06 dec/06 mar/07 2 Net Public debt (% of GDP) RHS Primary Fiscal Balance Last 12 Months (% of GDP) LHS

36 FLEXIBILIBITY IN FACE OF LARGE EXTERNAL SHOCKS

37 Policy Lessons Brazil improved its fiscal policy stance by the end of 1998, but decided to float. During the 2002 sudden stop, several non-orthodox measures were taken to avoid further damage to the economy: exchange rate derivatives, daily allowance of exchange rate directed d to international ti trade financing, i political negotiation to generate a statement of all candidates that if they won, they would not renege sensible economic policies. These measures were deemed successful, and prevented further damage, paving the way to the good times after Fiscal policy remains the Achilles heel of the economy. Although there is a substancial primary surplus, and the interest rate burden is falling, primary expenditures are rising fast, and social security is a major problem for the near future.

38 Muchas Gracias h k d d d i f I thank Laura Macedo and Pedro Maia for superb research assistance. Eduardo Cavallo and Alejandro Izquierdo read carefully several versions and provided excellent comments. Of course, they are not responsible for the flaws and mistakes.