This essay looks at various issues relating to the Brazilian Real, including its relationship with other currencies and financial mechanisms designed to maintain stability for the currency.
First of all, attention is focused on how the Real plan helped to combat hyperinflation from 1987 to 1997. During this 10 year period, Brazil saw a large part (40%) its Gross National Product (GNP) swallowed up by hyperinflation; thereby ensuring that only the basic essentials such as food and clothing were purchased, and cash or savings accounts were discarded due to the rapid decline in the purchasing power of the Real. Therefore non-essential products and services suffered a decline in revenue resulting in bankruptcies and increased unemployment. In addition, prices and wages were linked to the inflation rate, attempting to soften the impact for the consumer; thereby creating an unsustainable financial ratio between buying power and inflation.
In 1993, led by Dr Franco, the former governor of the Brazilian Central Bank, the 'Real Plan' adopted a mechanism that ensured no political interference was tolerated. Previously, special interest groups had been allowed to manipulate currency controls for their own advantage; thereby adding fuel to the hyperinflation crisis. This mechanism was able to be implemented due to exposure of collaboration between the former President and politicians, the resultant public 'outcry' allowed this mechanism to be enforced; thereby serving to lessen the possibility of corruption by the political establishment. Democracy was temporarily 'sidelined' in order to transfer financial control into the hands of the Central Bank, Finance ministry and the Treasury by utilizing amended legislation driven by the newly empowered financial authority. This enabled strict budgetary control, including restricting the banks funding politicians over-priced projects. In addition, wages were frozen and prices were allowed to be influenced by the marketplace. Finally, this triad of financial institutions instigated an artificial 'Unit of Real Value', which later became known as the 'Real'. Perhaps the 2 principles of the 'Eternal Triangle', 'Adjustment' and 'Confidence' were allowed to dominate, sacrificing liquidity in the short term.
The Brazilian government then proactively undertook measures to defend the peg of the Real against the U.S. dollar including only allowing a limited annual devaluation of the Real against the dollar. This was achieved by raising the interest rates so as to increase the viability of the Real as an attractive investment vehicle. Also by raising the costs of credit, the flow of money was restricted; thereby reducing inflationary influences. The implementation of fiscal discipline enabled prices to drop as marketplace demand decreased. Initially, there were initial casualties, such as the bankruptcies of some banks that had previously engaged in practices that favored special interest groups, and a lowering of the consumer's purchasing power leading to unemployment and a lower level of lifestyle. However, by creating fiscal reality within the financial marketplace; stability of the Brazilian currency was realized. One of the benefits of reducing money supply is to create greater competition between industry suppliers and bankers; thereby forcing down prices and creating a more efficient costing mechanism.
Here again the principles of the 'Eternal 'Triangle' were effectively implemented by restricting liquidity in the short term, so as to ensure that stability was achieved, thereby instilling renewed confidence in the new economic model, by both the domestic and international financial community. By utilizing the ability to mechanically adjust the value of the Real by raising interest rates and enabling tight fiscal policies, the rate of inflation was brought down to a more realistic sub 10% .
In evaluating the costs and benefits of this primary strategic initiative by the Brazilian
government, in pegging the Real to the U.S. dollar, this paper notes the following. By 1998, the inflation rate had continued to fall, finally settling at around an annual rate of 2%. Moreover, another benefit derived from these disciplinary measures was that the Brazilian economy began to grow with a GNP of around 3% to 4% per annum, and whilst this did not measure up to the extraordinary high growth trends experienced by major economic powers such as China (+/- 10% GNP), it was a step in the right direction. During this period of fiscal discipline and relative economic security, international investors began to view Brazil as an increasingly viable investment alternative; thereby assisting in Brazil's economic recovery and return to currency control stability. This return of investors enabled more liquidity to be pumped into the Brazilian economy thereby increasing confidence by both investors and Brazil's own business community. This included the ability of manufacturers and business leaders to invest further into corporate infrastructure and longer term projects; thereby also creating additional employment opportunities and more consumer spending power.
However, the above stated benefits were offset with varying cost factors. These included Brazil's increased trade deficit which was running at around 4 % of GDP. Furthermore, the Brazilian government were allocating financial resources that were in excess by as much as 7% of its incoming tax revenues; thereby creating the in-balance within Brazil's economic infrastructure. At that time, some nationally and internationally based financial experts, claimed that this situation was due in part, to an over-'zealous' preoccupation with a high value Real. This strategy led to difficulties being imposed on Brazil's exporters, struggling to compete on price
According to many financial sources, the Brazilian Real was overvalued against the American dollar by more than 15%. Therein lay the Brazilian government's dilemma. If it abandoned either in part, or in full, its financial policies which had removed the nightmare of hyperinflation, the return of inflationary influences may become a reality. However, the public sector debt necessitated the Brazilian government borrowing more money to finance its infrastructure; a much needed investment vital to ensure the growth of their economy. This borrowing exerted an upward pressure on interest rates, thereby creating difficulties for local businesses to access credit in order to finance their expansion plans necessitated by a growing economy.
Furthermore, another factor affecting the distribution of money supply related to their allocation of GDP resources. Much of the GDP revenue was allocated to state and local authorities, whilst only about a third ending up in the Federal coffers. Moreover, an added drain on the revenue received by the Federal budget was swallowed up by re-directing 90% of the revenue to other government departments and institutions, salaries of government employees and local civil servants, employee pensions, social and healthcare programs and servicing the interest of federal, state and local debt. Surprisingly, despite the relatively strict fiscal controls that had initially aided the reduction of hyperinflation, the allocation of tax revenues had been a legislated enactment facilitated within the constitution. One of the possibilities regarding why this legislation was allowed to remain, was the perception during the years of hyperinflation that the
budget disbursement was subject to rapidly declining value; thereby reducing the 'real cost' when measured against the true value of a currency. However, after the years of fiscal discipline and resultant reduction in the rate of inflation, the majority of tax revenue allocated outside of Federal control represented a true cost, due to the value of disbursement being maintained; thereby retaining most of its value in the medium and long term.
Another legacy of the previous financial infrastructure related to its proportionately high government employee or civil servant salary costs. Their salaries were significantly higher than those paid within comparative functions within the private sector, followed by very generous pension packages that were many times more lucrative than those enjoyed by employees within the private sector. This in-balance between government and private employees resulted in a governmental function that was not cost effective or cost efficient. Steps were taken to amend the constitution in order to correct this in-balance and bloated civil servant remuneration, however difficulties were presented by an existing governmental system incorporating multi-layered remuneration levels which accepted and supported the necessity of stricter financial discipline for Brazilian citizens, but were uncooperative regarding reforming its own inefficient financial system and hierarchy.
As in all dramatic and comprehensive changes within a country's infrastructure, the success was limited due to self-interest groups within government infrastructure. Notwithstanding, the aforementioned benefits derived by actions taken by the three financial organizations were indeed substantial and went a long way in turning around the Brazilian economy. In many governments, a 'top heavy' administration is often the consequence of 'importing' additional manpower needed to facilitate proposed amendments and changes. Success is invariably endowed with a cost, and for Brazil that cost included an administration that was
an expensive burden for the tax payer. From the above scenario, it is reasonable to assume that although liquidity was not a major problem; the ability to adjust was compromised by the uncooperative stance of the civil workforce. Here it is noted that the concept of the 'Eternal Triangle' depicted only a partial function of the ability of enact adjustment.
Another development that occurred along Brazil's path to a sustainable growth without the paralysis of hyperinflation was when the Asian currency crisis impacted global markets in 1997, especially markets that were vulnerable to currency volatility such as 'new economies' or emerging economic powers. However, the shockwaves were not just limited to vulnerable economies as a year later Russia then defaulted on its debt, creating even more panic selling; investor confidence severely compromised. The Brazilian government reacted to these unexpected developments by raising interest rates and legislating further burdens on the Brazilian tax payer by raising taxes. This measure was intended to increase investor confidence in the currency, reduce the budget deficit whilst ensuring financial discipline by the Brazilian consumer. Unfortunately, not all these objectives were realized as the Real did stabilize bringing a measure of confidence to the investor, yet at the expense of the economic growth which slowed down due in part to a reduced consumer demand on products and services; triggered by the higher taxes and less disposable income. This economic slowdown therefore delivered disappointing results relating to overall government revenue, as the tax increases were offset by the lower economic performance; resulting in an overall net decline in revenue for the Federal budget.
During this period of extreme volatility, many investors re-located their investments into so called 'safe havens' primarily into U.S. treasury bonds, known as the 'flight to quality'. Whilst the yields on U.S. bonds dropped to low levels, the yields on Brazilian bonds tripled within a few
days, creating unsustainable future repayment commitments for the Brazilian Treasury. Brazil was the largest economy within Latin America so unwelcome attention was directed at their vulnerable financial situation. However, the situation was not so 'one sided' as first perceived due to the United States dependence on Latin America for 20% of its exports and also many U.S. companies had significant investments with Latin America.
It was at this time that the Brazilian President was re-elected, suggesting that the population supported the President's efforts in combating problems besetting the Brazilian economy. Following his re-election, the President initiated an approach to the International Monetary Fund (IMF), so as ease the severity of the economic crisis. The IMF granted funds subject to stringent conditions including a reduction in government spending. These conditions were created so that the government could enact an overdue reform of its civil service and an overhaul of its taxation system; all with a view to reaching a budget surplus and securing a low
ratio of debt to GDP.
Due to a measure of intransigence by opposition by both political and business opponents, the government was only able to implement a limited compliance to the IMF conditions; thereby resulting in a mixed market perception regarding Brazil's ability to service its debt.
In hindsight, it is easy to offer however, during a period of global upheaval corrective strategies can at best be seen as a gamble. After the Asian and Russian crises, attempts to re-adjust fiscal policies, including currency devaluations resulted in a negative impact on the Brazilian economy. As has been noted earlier, strict fiscal discipline was implemented which dramatically reduced inflation, however, not all government hierarchy and its workforce supported all the measures, especially when the proposed measures had an effect on their own individual financial situation.
Perhaps, historians may view the initial actions by the three financial institutions as endowed with good intent, however as is often the case when combating such adversity as triple digit inflation, the measures or adjustments as conceived by the 'Eternal Triangle' concept were possibly over-reactionary and therefore, whilst providing a short term solution by reducing the hyperinflation, did exert a negative influence on Brazilian business confidence; another important part of the 'Eternal Triangle' formula.
This paper suggests that the Brazilian government could have marketed its strategies more effectively to all participants found within the Brazilian economy, including the business community, opposition political opponents and perhaps most of all, the Brazilian public. By adopting a 'go it alone' policy' the three financial institutions were initially successful in achieving their primary goal, however without a strong economic growth supported by a cooperative civil servant workforce, their strategies became vulnerable when external influences and factors outside their control occurred, such as the Asian crisis and the Russian government's decision to default on its financial obligations. Following these two crises, Brazil's economy fell back into inflationary problems and economic recessions. Also during the period of negotiations with the IMF, the United States as a major IMF contributor insisted that Brazil repay its debt obligations within 30 months, at an interest rate 3% points higher than would have been normally implemented. These added pressures brought about by perceived U.S. self-interest groups did little to assist in the recovery of one of their primary trading partners; evidence clearly shows that Latin America accounted for 20% of U.S. exports, with Brazil as the leading Latin American importer of U.S. goods and services.
Another unfavorable strategy imposed by international monetary institutions backed by the U.S. was the facilitation of the new Brazilian currency known as the 'Real'. The U.S. and other major financial players planned to enable the selling of the Real when its value matched the U.S. Dollar, however when its currency was worth more than the U.S. Dollar, it was no longer required to sell its forex reserves; thereby increasing Brazil's debt to foreign creditors. Perhaps, Brazil could have ignored external pressures from U.S. self-interest groups and reduced its dependence on foreign creditors by allowing market forces to intervene rather than by pegging its rate to the U.S. Dollar accompanied by all the conditions imposed by U.S. and IMF monetary decision-makers.
However, the Brazilian government did eventually allow their currency to float in 1999, thereby enabling true market evaluation influence its true value. Perhaps, this step should have been enacted earlier thereby allowing the country more time in which to address its currency exchange rate issues. Other larger economies such as China have resisted U.S. pressure to link their exchange rate to the U.S. Dollar; thereby allowing it a greater measure of independence from the U.S. currency. In addition, the U.S. has been perceived as a manipulator of global currencies by managing and manipulating the U.S. Dollar to its own advantage, balancing the rate to favor its exporters whilst ensuring that all global currency transactions utilized the Dollar as the international currency benchmark. This was strategically leveraged by U.S. financial regulators whilst disadvantaging other emerging economies such as found in Latin America.
Perhaps Brazil should have enacted more control over the floatation of its currency, thereby in part mirroring the U.S. by manipulating its currency to optimize exports and to lessen the costs of serving its foreign debt. During the Brazilian government's efforts to increase the value of the Real, significant foreign reserves were utilized as collateral; thereby weakening its foreign reserves holdings. This in turn led to a deficit, which in hindsight could have been prevented had the Brazilian government acted with more restraint, and instead enacted more internal financial discipline and fiscal responsibility, both within its financial community and also by educating its citizens regarding the inflationary dangers induced by the easy access of credit.
According to many credible sources, in 2004, the Brazilian financial authorities enacted strategies designed to increase their forex reserves. This long term strategy enabled a measure of stability to be injected into its economy. Perhaps, this measure could have been implemented immediately after the Asian currency crisis and Russia's debt default. By enabling the gradual increase in foreign reserves immediately after these crises, the Brazilian economy would not have been so vulnerable to external compliance pressures by more powerful economies.
In conclusion, maintaining flexibility is important for an emerging economy such as Brazil. Attempting to access IMF and thereby U.S. assistance, had eroded Brazil's independence and ability to maneuver as and when market forces dictated. Hopefully, this emerging leading Latin American economy will learn from these mistakes and seek a long term strategy to retain sovereignty over all its financial strategies, without succumbing to short term fixes that have previously led to a decreased ability in determining its own financial future.
