Creating Financial Stability in Brazil

The most important lesson Brazil learned in reforming its economy was identifying the most critical problem generating constraints on growth, said Henrique Meirelles, governor of the Central Bank of Brazil. "At the end of the day, through public finances the state was creating the instability in Brazil," said Meirelles, who spoke to students November 4 at Harper Center in Hyde Park. The event was sponsored by the Center for Latin American Studies and the student-led Latin American Business Group.

Households and corporations were not overleveraged, and the banking system was solvent, he said. "The problem was basically the high level of sovereign debt and dependence on external capital, along with the low level of international reserves and the insecurity that brought," Meirelles said. "The currency was not convertible and so forth."

Brazil addressed these problems — rising inflation, high-risk premiums, high unemployment, and a high minimum wage — with "very austere monetary policy and strong fiscal adjustment," he said. The result was "quick disinflation" of an annualized rate of 30 percent during 2003 that actually fell to zero during July of that year, Meirelles said. Eventually, inflation returned to its target level, where it has remained, he said.

Meanwhile, Brazil reduced public debt, sovereign debt exposure, and its risk premiums, Meirelles said. A drop in domestic demand was redirected to exports, creating a trade surplus, he said. Brazil began accumulating reserves, repaid the International Monetary Fund, and repaid all restructured and domestic-denominated debt, Meirelles said.

Public sector net debt is falling significantly, he said. During the first four months of the fiscal crisis of 2008, the ratio of debt to GDP actually fell 4 percent because Brazil held $200 billion in international reserves and owed only $80 billion in foreign currency in sovereign debt, Meirelles said. "As a result of the reserves, the [Brazilian] real went up in value, bringing the net debt level down," he said. "That is so-called 'automatic stabilizing' and was one of the reasons Brazil was able to get out of the crisis so fast and so effectively."

Furthermore, the reserves allowed Brazil to loan to corporations, banks, and exporters, Meirelles said. "We had a solid banking system because of the lessons learned during the crises of the 1980s and 1990s," he said. "The banking system was well capitalized. The central bank held liquidity, mandatorily placed by banks to conserve reserves, which provided a liquidity cushion that proved to be essential during the crisis. The markets almost came to a stop, but we were able to restore normality in a few months."

Brazil's ability to weather the most recent financial crisis — the country's worst foreign exchange crisis ever in terms of flight of capital as a percent of GDP — is evidence of its economic resilience, Meirelles said. In the coming years, Brazil must increase domestic savings, improve public expenditures in investments and infrastructure, simplify its tax system, create a legal environment more favorable to business, and provide greater incentive for long-term investment, he said.

"The good news is that people are now interested in discussing the agenda for the long-term future in Brazil," Meirelles said. "A few years ago at an event like this, people would be asking me how to get out of the current crisis or inflation for the next three months. The conversation never went beyond one year. Evidently, now the country has the conditions to talk long term."

—Phil Rockrohr