Brazil’s in­sti­tu­tional limbo

Financial Mirror (Cyprus) - - FRONT PAGE -

In­ter­na­tional in­vestors are watch­ing closely as Brazil­ians pre­pare to vote in the sec­ond round of the pres­i­den­tial elec­tion on Oc­to­ber 26. Their vote will not only de­cide who will be the coun­try’s next pres­i­dent; it may also de­ter­mine the fu­ture of the Cen­tral Bank of Brazil (BCB), and there­fore the coun­try’s macroe­co­nomic tra­jec­tory.

While the in­cum­bent pres­i­dent, Dilma Rouss­eff, sup­ports the BCB’s ex­ist­ing in­sti­tu­tional frame­work, her op­po­nents con­tend that mon­e­tary pol­icy is plagued by po­lit­i­cal in­ter­fer­ence, which would best be ad­dressed by giv­ing the BCB greater au­ton­omy. But no can­di­date has yet ad­vanced a pro­posal for re­form that would re­duce the scope for po­lit­i­cal in­ter­fer­ence while en­sur­ing greater ac­count­abil­ity and pro­mot­ing fi­nan­cial sta­bil­ity. If Brazil is to sus­tain strong and sta­ble eco­nomic growth, the cen­tral bank will need an over­haul.

Mon­e­tary pol­icy has long played an im­por­tant role in Brazil­ian pol­i­tics. Dur­ing the democrati­sa­tion process of the 1980s and 1990s, suc­ces­sive gov­ern­ments tried to tame hy­per­in­fla­tion, which reached 2,477% in 1993. The in­tro­duc­tion of the “Real plan,” launched in 1994, man­aged to sup­press an­nual price growth to an “ac­cept­able” 22% by the fol­low­ing year. Rid­ing on the plan’s suc­cess, its ar­chi­tect, Fer­nando Hen­rique Car­doso, a for­mer econ­omy min­is­ter, was twice elected Pres­i­dent (in 1994 and 1998), un­der­scor­ing voter con­cern about price sta­bil­ity.

To­day, as cen­tral bankers in de­vel­oped coun­tries fret about the threat of de­fla­tion, Brazil­ian politi­cians are once again forced to re­spond to wide­spread fears about slow­ing growth and a re­turn to high in­fla­tion. Un­for­tu­nately, the pres­i­den­tial can­di­dates’ plans for the BCB fall short of what is re­quired. His­tor­i­cally, Rouss­eff’s Work­ers’ Party (PT) has re­sisted giv­ing the bank for­mal au­ton­omy, and she has played a dis­tinctly pop­ulist card dur­ing the cam­paign, ar­gu­ing that BCB au­ton­omy would hand too much con­trol to pri­vate bankers.

Ma­rina Silva, the So­cial­ist Party’s can­di­date, de­manded for­mal bank in­de­pen­dence – an ar­gu­ment sub­se­quently adopted by the So­cial Demo­cratic Party (PSDB) can­di­date, Aé­cio Neves, who now faces Rouss­eff in the elec­tion run-off. But Neves wants de facto, rather than for­mal, op­er­a­tional au­ton­omy for the BCB. Like Car­doso, Neves is com­mit­ted to in­fla­tion tar­get­ing, cre­at­ing a pri­mary sur­plus, and main­tain­ing a float­ing ex­change rate. While such poli­cies may pro­mote price sta­bil­ity, his pro­posal ne­glects the two most im­por­tant is­sues for the BCB: le­gal au­ton­omy and in­sti­tu­tional re­forms that en­sure ac­count­abil­ity to cit­i­zens.

A le­gal com­mit­ment to BCB au­ton­omy would con­trib­ute to cur­rency con­fi­dence in a way that in­for­mal au­ton­omy can­not. Le­gal struc­tures have a di­rect im­pact on in­fla­tion ex­pec­ta­tions, be­cause law can pro­vide in­sti­tu­tional pro­tec­tion to pub­lic goods, such as price and fi­nan­cial sta­bil­ity. Prop­erly de­signed and ex­e­cuted, in­sti­tu­tional re­form could also in­crease BCB ac­count­abil­ity to so­ci­ety at large while guard­ing against un­due po­lit­i­cal in­flu­ence and lob­by­ing by the big banks.

The BCB is ripe for re­form. It is a 50-year-old tech­no­cratic bu­reau­cracy es­tab­lished un­der a mil­i­tary dic­ta­tor­ship, with few le­gal in­stru­ments for po­lit­i­cal and so­cial ac­count­abil­ity. In­sti­tu­tional re­form must there­fore move beyond the BCB’s in­ad­e­quate price-sta­bil­ity tar­get, which is set ac­cord­ing to a nar­row in­fla­tion in­dex that fails to re­flect the ex­pe­ri­ences of or­di­nary Brazil­ian con­sumers. For ex­am­ple, the re­ported 2013 in­fla­tion rate was 5.9% (com­pared to a 4.5% tar­get); but prices for food, a ma­jor share of most house­holds’ bud­gets, rose by 8.4%, hit­ting the poor es­pe­cially hard. The Rouss­eff ad­min­is­tra­tion has kept the re­ported in­fla­tion rate ar­ti­fi­cially low by sup­press­ing prices for state-run ser­vices.

Price sta­bil­ity should be ac­com­pa­nied by other tar­gets, es­pe­cially fi­nan­cial sta­bil­ity, but also, pos­si­bly, em­ploy­ment. Rouss­eff thwarted Congress’s at­tempts to in­tro­duce such tar­gets in 2011, and they would, of course, need to be care­fully de­signed to avoid past mis­takes. But, done right, an ex­panded range of cri­te­ria by which to as­sess BCB poli­cies, by en­hanc­ing ac­count­abil­ity, would strengthen the le­git­i­macy pol­i­cy­mak­ers le­gal au­ton­omy.

There is also scope for in­sti­tu­tional re­form to pro­mote greater fi­nan­cial sta­bil­ity. The 2008 fi­nan­cial cri­sis and its af­ter­math high­lighted the con­se­quences of the BCB’s out­dated in­sti­tu­tional de­sign. The Bank had in­suf­fi­cient le­gal back­ing for ac­tion needed to sta­bilise the fi­nan­cial sys­tem. This left then­Pres­i­dent Luiz Iná­cio Lula da Silva, to re­sort to a se­ries of dra­matic mea­sures, in­clud­ing the use of the de­posit-in­surance fund and state-owned banks to bail out failed fi­nan­cial in­sti­tu­tions. Lula claimed that this ad hoc ap­proach gave Brazil a de­gree of flex­i­bil­ity lack­ing in other coun­tries; but it was not cost-free, as he claimed, and the re­sults did not en­dure.

Rapid ex­pan­sion of pri­vate debt raises other, larger con­cerns. Other cen­tral banks have recog­nised the need for new in­stru­ments to en­sure fi­nan­cial sta­bil­ity; so must the BCB. In­sti­tu­tional clar­ity on the BCB’s man­date for fi­nan­cial sta­bil­ity and the in­stru­ments at its dis­posal could help Brazil avoid fu­ture crises – or at least weather them more ef­fec­tively.

Brazil’s pres­i­den­tial elec­tion ap­pears to of­fer two un­sat­is­fy­ing choices: a con­tin­u­a­tion of the sta­tus quo, with the BCB sub­ject to po­lit­i­cal in­flu­ence, un­der Rouss­eff; or an in­for­mally au­ton­o­mous BCB with an out­dated in­sti­tu­tional ap­pa­ra­tus, un­der Neves. Only Silva’s ini­tial pro­posal in­cluded calls for in­sti­tu­tional re­form of mon­e­tary pol­icy and fi­nan­cial reg­u­la­tion; and it is far from cer­tain that her en­dorse­ment of Neves in the run-off will sway his view should he win.

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