Former central banker says it may be time to cut interest rates, but government needs to send signals in the right direction

05/23/2023

Arminio Fraga — Foto: Leo Pinheiro/Valor

Arminio Fraga, former president of the Central Bank and founding partner of Gávea Investimentos, says it may be time to lower interest rates in Brazil, but stresses that the Central Bank depends on fiscal support. “The Central Bank in general does an excellent job in this area, nobody there is a sadist. There are people who think that the Central Bank is at the service of the rentiers. It is the government that is at the service of the rentiers, as it is the biggest borrower and thus puts pressure on interest rates.”

According to the economist, the macroeconomic tripod established in 1999 is “totally unbalanced.” However, he says that an increase in the deadline for achieving the inflation target could make the president of the Central Bank “feel protected” to carry out his monetary policy.

The economist defends a new social security overhaul, only four years after the difficult approval of the first one, in addition to the administrative and fiscal reforms. “We have been living for a long time in a short blanket without a solution. There is an absurd lack of priority and quality in public spending,” he said. He criticizes the attempts to undo measures taken by the Bolsonaro administration, such as the revision of the privatization of Eletrobras and the sanitation framework, in addition to this week’s change in Petrobras’s pricing policy: “It’s a kind of Bolivarian vision, it’s part of the design of a country that we know doesn’t work.”

Although he acknowledges the efforts of Finance Minister Fernando Haddad and Planning Minister Simone Tebet for giving straightforward signs of intent to restore fiscal credibility, Mr. Fraga says he is disappointed. “I imagined that the lessons of the PT [Worker’s Party] in power had been reasonably absorbed.” But when asked about his public support for Luiz Inácio Lula da Silva in the election campaign, a decision he links to the defense of democracy, he replies firmly: “I don’t regret my vote. It was a big decision, and it was close.”

In the United States on a short break to be with his family, Mr. Fraga says he is working on a book. “I always get things done, more than I should,” he said. “And I still do a lot of chauffeuring for my grandchildren,” he jokes. Read below the main excerpts from the interview:

Valor: How do you rate the new government so far?

Arminio Fraga: From an economic point of view, I confess that I expected more. I imagined that the lessons of the PT in power, both positive and negative, had been somewhat absorbed and that Brazil was moving towards solving the problems that today hinder its full development. On the macroeconomic side, from the beginning, the speeches of the party in general, including those of the president himself, were worrisome and even furious on fiscal responsibility and the role of the Central Bank. Then, on the micro side, there was a lot of noise around many issues where progress had been made in recent years, always in the opposite direction of what would be desirable. Issues like social security and labor regulations were on the radar. The feeling is that the vision has always been backward. The basic sanitary framework was another issue. Fortunately, Congress did a good job of defending what it had already decided. Now Petrobras, with a kind of Bolivarian vision, is part of a country design that we know does not work. And it also has environmental implications because we are talking about subsidizing fossil fuels. There is also uncertainty about what we are going to do with [Brazilian Development Bank] BNDES and state-run banks in general. I see this whole area much worse than I imagined.

Valor: And what is the impact of all this misguided discourse?

Mr. Fraga: Both the Finance and Planning ministries gave the right signal on the fiscal issue, which is to adjust and restore Brazil’s credibility. It is a fundamental pillar of the macroeconomic tripod. With the interest rates we have, the Central Bank needs help. Our macroeconomic policy is unbalanced, giving too much weight to monetary policy and too little to fiscal policy. This is one of the roots of the current level of interest rates in Brazil, which are extremely high, especially by international standards. The question is what to do about it. For me, number 1 on the list is to regain the lost fiscal responsibility. I give credit to the Finance Ministry in general for initiating the discussion when the president of the Republic was clearly against it. He may be changing his mind now, but he has started running in the opposite direction, believing that the country that has its own currency can spend at will. The truth is that no country receives a strong currency as a divine gift. A strong currency is built every day. And ours, unfortunately, is not [being built]. It is built on colossal interests, and nobody can think that this is good. At least the discussion is now on the right track, which is to work on building a primary balance.

Valor: When will we be able to get out of this discussion to solve the distributive conflict, to face relevant issues for development and improvements for the population, such as health and education?

Mr. Fraga: The distributive conflict is old and exists because of legitimate and huge demands that everyone wants to satisfy. But the question is how. Public spending in Brazil has gone from about a quarter to a third of GDP in the last 30 years. There has been no austerity over time. What there has been is a colossal lack of priority. And it is not possible to convince most people that this is going to stop. For example, administrative reform is an important issue, but there is a total rejection of this government. Public investment, which in fact has been very low for some time, has suffered as a victim of short-sighted choices. What can be done in the short term? What are the priorities? If the Brazilian government were to borrow money at 2% in real terms, it might even be worth taking some risks. How is that going to happen in Brazil? There is an absurd lack of priority and quality in spending. What we should do is obvious: evaluate everything we do and act if we find something that is not working properly or does not represent an adequate priority.

Valor: You often defend the administrative reform, because the expenses with the government apparatus take a lot of the budget. But it takes more time, and the country urgently needs a solution. What are the risks of the public accounts getting out of control?

Mr. Fraga: The risks are high. What could be done is to combine what can be done now with concrete measures that will have an impact in the medium term, but which improve expectations now, such as beginning a debate about one more social security overhaul. An Ipea [Applied Economics Research Institute] report from February shows that even in optimistic scenarios, social security numbers tend to get really worse. Ditto for an administrative reform, which, besides the fiscal impact in the medium term, would improve the state’s efficiency. I’m not even talking about it being passed. But it is not even being considered. And it can be approved by a supplementary law, without even having to amend the Constitution. Another example is the review of tax benefits, but recently, for example, the renewal of the benefits for the free trade zone for 50 years was passed. So how do you do it? The blanket is short, but it is necessary to open all the work fronts and set them in motion to allow a turnaround in expectations and put this country in a position to grow more.

Valor: Is it possible to repeat the 7% growth seen between 1950 and 1980?

Mr. Fraga: If you look at it per capita, that growth was around 4%. It looks less difficult. When you consider that this development strategy exploded and led to a lost decade, and if you take that into account, it goes down to 3% per capita. If sustainable, it would be a huge success. It is not impossible, but I see the government today moving in the opposite direction of what is desirable. If you look at the last four decades, in two of them Brazil had a decline in GDP per capita. For a country that should be closing the gap with the most advanced economies, losing 20 years is sad.

Valor: How to get out of high interest rates with inflation still so resistant? A difficult equation.

Mr. Fraga: There are tools, but the policy needs some convincing. In fact, interest rates are very high, and not just the [key interest rate] Selic. Brazil is paying 6% in real terms over 30 years. I don’t know how anyone can think that our debt is small with that interest rate. What we can do at the moment is to get our accounts in order and try to make the economy work more fairly and efficiently.

Valor: Is it time already to lower interest rates?

Mr. Fraga: Maybe, but it will depend on the fiscal aspect and also on the credit conditions. The Central Bank is doing a great job in this area. Nobody is a sadist. Some people think that the Central Bank is at the service of the rentiers. The government is at the service of the rentiers — because it is the biggest borrower in the economy — and pushing up this interest rate. There is a simple way to assess this. Has inflation been below target? I would say no. So, the problem is different, it is a diagnosis problem.

Valor: And should the inflation target be discussed again?

Mr. Fraga: The goal is adequate; it should be long-term. I would just give it more time to be accomplished, one more year. This alternative deserves reflection by the CMN [National Monetary Council], which should give this mandate to [Central Bank President Roberto] Campos Neto, so he can feel protected. I see many countries in the world implicitly doing something along these lines. The target system is by far the best way to coordinate what the Central Bank and the fiscal area do: the government sets the target; the Central Bank pursues it and is accountable.

Valor: You said you voted for the current president in the name of democracy. How do you see today’s decision?

Mr. Fraga: I do not regret my vote. It was a great decision, and it was that close. As Pedro Malan, Edmar Bacha and I wrote in the open letter to Lula in November, we expected that the economic policy would be reasonable. And there, in the discussions when we were writing that short text, we wanted to give the sense of hope, not of belief, that this was going to happen.

Valor: And do you still see our democracy in danger?

Mr. Fraga: There is a lot of recent literature, many authors who defend the line that democracy is being eaten at its edges. I am not competent to go deep into that debate, but it is a relevant point. And for those of us who have spent so much time without democracy, we can’t play around with it. It is a permanent state, there is a lot of tension in the air between the branches of government. Brazil is radicalized and the world is radicalized. The main defenses are working. What are these defenses? The press, freedom of expression, the third sector, which acts in an absolutely crucial way in several areas, academia, and culture, which gives life to the issues in an inspiring or more playful way. These defenses are activated in Brazil, and it is good that they continue.

Valor: The government has already mentioned that it wants to review the privatization of Eletrobras. Can this happen?

Mr. Fraga: In the case of Eletrobras, a legitimately elected government decided and sold control of the company. Now the new administration wants to backtrack, an unacceptable default. And I think it will not happen because the government probably knows that it would end up losing in the courts.

Valor: In this scenario of strong growth of corporate debt in recent years, with the extension of maturities and reduction of costs, especially through capital markets, what should be the new role of BNDES?

Mr. Fraga: The BNDES has to be strict and justify everything it does. Even though I have the greatest admiration for the bank’s staff, which is one of the best that this country has, they often worked with a rather archaic development model, without justification and evaluation. And this was pushed to its limits during the Rousseff administration. Then there was a course correction. I have never thought that the BNDES should have a fixed size, but I think that it should remain within a strict framework of defining and justifying the reasons for certain actions so that they can be evaluated and then expanded or discontinued. In the past, when I heard the phrase “this sector is strategic,” I started scratching my head. It rarely was. This discussion is healthy, I am not against it, but it is important to review and evaluate.

Valor: You have been involved in areas outside your traditional habitat of economics and finance. Why did you decide to go down this path?

Mr. Fraga: For a few years now, I have been focusing more on the topic of inequality and lack of opportunities. I am involved in three areas, outside my traditional habitat. Two of them are through public policy institutes. IEPS (Institute for Health Policy Studies) and IMDS (Institute for Mobility and Social Development). Both are up and running. The third one reflects my green side. I have always been green. I would love to have a social, liberal, democratic, green party that I could join one day. I have always thought that Brazil should get involved in this area to help with climate change, to take care of the planet’s biodiversity, and also for our quality of life. That should be clear for everyone. I am talking about clean air, clean rivers, clean beaches. Today we have extraordinary examples from Costa Rica and New Zealand. I am a shareholder of the company Re.green, a wonderful project of reforestation with biodiversity of degraded areas, made possible by carbon sales. It has enormous potential. It is a difficult project to carry out, and risky, but you will not find a single person in our company who is not thrilled even in the face of all these challenges.

*Por Liane Thedim, Catherine Vieira — São Paulo, Rio de Janeiro

Source: Valor International