IMF Survey: Has Brazil’s impressive recovery been driven by external or domestic factors?
Collyns: Certainly Brazil has benefited from a growing world economy. Rising commodity prices have boosted its exports, and low U.S. interest rates have led to lower spreads on emerging market debt and high global liquidity. But, more important are the sustainable macroeconomic policies that Brazil has established. A major trigger of its current strong cyclical recovery has been a substantial cut in interest rates, made possible by the credibility of its inflation-targeting regime. Also key to increasing confidence was the government’s strong commitment to fiscal discipline, notably its successful pursuit of a high primary surplus.
IMF Survey: Brazil has grown strongly before, only to see growth falter and inflation pick up. Has the economy finally reached a turning point?
Owen: We do see encouraging signs of a structural improvement in performance: macroecononic volatility has been reduced substantially, and exports have been very strong. Previous recoveries often ended because of external constraints. Strong export performance gives us hope that this will not happen this time around. Also, the cumulative effects of structural reforms—many of which have focused on improving the business environment—have encouraged a strong rebound in domestic investment. As a consequence, the IMF is now projecting sustained growth of 3-4 percent a year.
IMF Survey: You have cited the role of inflation targeting. Brazil also introduced a flexible exchange rate in 1999. How important have these reforms been?
Collyns: The reforms have been key to allowing Brazil to integrate more fully into the world economy with confidence. And it is not just the policy framework. Consistent implementation over the past five years by two different governments has been crucial. Inflation targeting is fine in theory, but to work well, it has to be implemented resolutely and transparently. And since it is easier to implement such a framework when you are reducing interest rates, questions about the credibility of a regime often linger until the economy has gone through a full cycle. The Brazilian central bank has clearly demonstrated its willingness to raise interest rates on at least three occasions: first, immediately after the introduction of inflation targeting; then, during the turbulent situation in 2002; and, more recently, as it has raised rates in response to domestic inflationary pressures. These steps have helped establish the central bank’s credibility.
IMF Survey: Brazil’s debt has gone down, but is it sustainable?
Owen: Vulnerabilities remain, but a strong fiscal policy has made the debt dynamics sustainable. Our projections show a continuing decline in the debt-to-GDP ratio to reach the average for investment-grade emerging market economies within the next few years. This lowering of the debt ratio would consolidate Brazil’s position in emerging markets, reduce risk spreads, allow Brazil’s debt to be ranked as investment grade, and provide room, eventually, for a countercyclical fiscal policy to ease economic downturns.
The composition of debt also matters. Until recently, a substantial portion of Brazil’s debt was linked to the exchange rate. The authorities have since reduced this amount significantly. A higher proportion is, however, still linked to short-term interest rates. In the future, the government intends to further raise the fixed-rate component to make the debt less sensitive to financial market shocks.
Another area of improvement is international reserves, which have been increasing substantially in recent months. Continued steps to build reserves will help to bolster confidence further.
IMF Survey: The IMF has also raised concerns about spending.
Owen: Brazil has achieved its fiscal adjustment largely by raising revenues. There is a growing consensus in the country that the tax burden is now high, so it is absolutely critical to look for ways to control expenditure, including by looking at its composition. Expenditure has been restrained in recent years by cuts in discretionary spending. Greater budget flexibility could help provide more resources for priorities such as infrastructure and social spending and allow for better-quality fiscal adjustment.
IMF Survey: Brazil has been underinvesting in infrastructure for years. How can it boost investment and still meet its fiscal objectives?
Owen: Brazil is participating in an IMF-led pilot project to help strengthen the quality of its public infrastructure spending, consistent with continued prudent fiscal management. In addition, and to really make a difference, Brazil will need to secure more private sector involvement in infrastructure spending. In 2004, Congress approved legislation on public-private partnerships, and a number of these projects are expected to be launched this year.
IMF Survey: Once a relatively closed economy, Brazil has seen its exports increase dramatically. How did this change come about?
Collyns: In the 1960s and 1970s, Brazil focused on building an industrial base through import substitution. Since then, inspired by Asia’s export-led development, it has turned to an outward-looking strategy. But while Brazil liberalized its trade regime in the early 1990s, its overvalued exchange rate discouraged exports. More recently, a tighter fiscal policy and greater exchange rate flexibility have improved Brazil’s external competitiveness, laying the basis for rapid export growth. And Brazil’s strong performance in the past two years is not just in the commodities sector. It has one of the highest proportions of manufacturing exports to GDP in Latin America, and has been able to penetrate a wide range of markets. This success has, in turn, influenced attitudes toward trade liberalization. Policymakers now recognize that it will be to Brazil’s tremendous advantage if the Doha trade round succeeds, particularly if it includes a significant increase in access for agricultural products to industrial country markets.
IMF Survey: Poverty and social inequality persist despite the recent growth. What can the government do?
Owen: Growth will be important, but it is not enough on its own. Targeting resources to the people who really need them will be key. One important element is to channel more resources to specific poverty alleviation programs. The government’s program, Bolsa Familia, brings together all the targeted benefits under a single umbrella.That is a very positive development, but the quality of spending in sectors like health care and education must also be improved.
Collyns: Brazil has been one of the leaders in Latin America in designing social programs that do not just transfer money to poor people but also address the roots of poverty by tying the resource transfers to participation in health care and education programs that boost overall human capital.
IMF Survey: Labor market reform is seen as essential for lower unemployment and higher growth and for reducing the informal economy. What measures would the IMF recommend?
Collyns: One of the remarkable features of Brazil is the size of the informal economy; it currently employs more than 50 percent of the labor force and this number is rising. This has a number of negative consequences. First, it means that the normal protection to workers afforded by labor law is not extended to a large part of the workforce. Second, it reduces incentives for employers to train their employees. And, third, it erodes the tax base. In addition, the wage bargaining framework in the formal sector is very heavily regulated. The IMF’s advice on labor market reform builds on recommendations that many others, including the World Bank and the ILO, have made. We would like to see greater flexibility in wage bargaining and a reduced tax burden on labor, as high taxes discourage employment. There is also considerable scope for making employee protection schemes more efficient. A well-designed labor market reform can benefit all parties.
IMF Survey: How important has IMF financing been to Brazil’s recovery?
Collyns: The IMF played a very important role in supporting the government’s strong policies during a difficult time. I emphasize “supporting” because the Brazilian authorities have maintained very strong ownership of their policies. Our role has basically been to provide financing and reassure the markets. Initially, Brazil drew on IMF resources to supplement its reserves, but from the fall of 2003 until the arrangement expired in March of this year, it treated the loan as precautionary. During this period, the IMF continued to play an important role in providing a safety net. When the loan expired, the authorities decided they no longer needed an IMF program. The transition at the end of the program was extremely smooth, with no questions asked by the financial markets, a tribute to their confidence in the government’s macroeconomic policies.
IMF Survey: What can other emerging market countries learn from Brazil’s experience?
Collyns: I would emphasize that successful macroeconomic policymaking depends on having strong institutions. Brazil’s success is the result of hard work over many years by successive governments to build effective institutions.
The other lesson is that it is perfectly feasible to combine sound macroeconomic management with policies that address inequality and poverty. In fact, the two reinforce each other: good macro policies improve confidence, lead to lower interest rates, encourage growth, and therefore provide more employment and resources for social programs. Higher employment and well-funded social programs then, in turn, contribute to economic success by improving human capital and generating political support for sound economic policies. Brazil’s government has shown us that there is an important synergy there and that holds a lesson for other governments in Latin America and elsewhere.
IMF Survey: What can the IMF learn from its experience of lending to Brazil?
Owen: When a country has strong ownership of its economic policies, an IMF-supported program can succeed without extensive policy conditionality. In fact, the conditions attached to Brazil’s loan were designed to closely match the authorities’ own policy agenda. I also think that the IMF’s willingness to take calculated risks—to agree to a program even in the face of political uncertainty—has been vindicated.
IMF Survey: Where will Brazil be five years from now?
Collyns: People have long called Brazil the perennial country of tomorrow—implying that it will never achieve its full potential. I am hopeful that this is no longer true. I am optimistic Brazil will be able to grow fast, address the deep problems of poverty and inequality, and become a major player in the global economy over the next 5 to 10 years. That does not mean it can afford complacency. There has been success, but the government is very aware that it needs to continue to reform the economy. If it manages to make good progress and deepen its agenda, the prospects for Brazil are extremely strong.
IMF Survey: On a personal note, what do you take away from the experience of working on a country like Brazil?
Collyns: The Brazilian experience has a lot to teach the IMF and the rest of the world. Brazilian policymakers think deeply and are committed to good policies. They are very aware, of course, of the political realities, but they are also determined to do things better. I very much admire them for that. Personally, I learned a lot about how you achieve good policymaking in practice. It’s fine to sit in an ivory tower and design elaborate policies, but what matters is how you go out and sell and implement those policies.
Discipline does it
Brazil has been running a substanial primary fiscal surplus
(percent of GDP)
Data:Central Bank of Brazil