1

Monetary Policy in Brazil

Solange Gouvêa Research Department

Brazil – Russia Dialogue: Economic Policy Challenges

International policy workshop

June 2012

2

Disclaimer

The views expressed in this presentation

are mine and not necessarily those

of the Central Bank of Brazil.

3

“Inflation Targeting - First some facts:

During the Great Crisis of 2008-2009, EM showed more

resilience than advanced economies. Now, EM are

exiting the global crisis at a much faster pace than

advanced economies. This reflects sizable policy

support, favorable external conditions and solid

macroeconomic fundamentals that proved helpful

before, during and after the financial turmoil”

Guilhermo Ortiz at the Conference:

“Macro and Growth Policies in the wake of the crisis” sponsored by IMF

March 2012

Emerging Markets and the 2008/9 Financial Crisis

4

Outline

The National Financial System and the Central Bank of

Brazil

Macroeconomic Policy in Brazil: Historical Overview

Macroeconomic Policy in Brazil: Current Set Up

Inflation Targeting in Brazil

IT Framework

IT Performance

Macroeconomic Fundamentals

Social Development

Final Remark

5

National Monetary Council (CMN)

- The Minister of Finance, the Minister of Planning, Budget and

Management and the Governor of the Central Bank of Brazil

- Establishes the inflation target, prudential rules and credit policy

- The Central Bank of Brazil is the financial supervisory authority

Source: BCB

The National Financial System

The National Financial System

NATIONAL FINANCIAL SYSTEM

National Council of Private Insurance -

CNSP

National Monetary Council - CMN

Securities and Exchange

Comission - CVM

Other financial intermediaries

Stock Exchange

Bovespa

Commodities and Futures Exchange

Central Bank of Brazil - BCB

Other financial intermediaries

Exchange Brokers

Financial Institutions

Management Council of Complementary Pension - CGPC

6

Central Bank of Brazil Mission

The National Financial System

Monetary

Policy

Financial

Regulation

Financial

Supervision

Wide scope of Central Bank’s authority helps policy coordination

Ensure price stability and a solid and efficient financial system.

7

Macroeconomic Policy: Monthly Inflation

0

10

20

30

40

50

60

70

80

90

1980 1987 1990 1994 2003 2012

%

Cruzado Plan

Historical Background

8

Increasing inflation since mid-1970s

Underdeveloped fiscal and monetary institutions

Loose control on public expenditure

Low transparency of institutions and policies

GDP growth: high until 1970s; “lost decade”

(1980s)

External debt crisis in the 1980s

Sequence of failed stabilization programs (e.g.,

“freezing” of financial assets in the banking system (1990); only temporary

success)

Macroeconomic Policy: Brazil up to 1994

Historical Background

9

Previously announced.

Fiscal Adjustment.

Process of desindexation of the economy.

Favorable conditions: International reserves accumulation;

capital inflows; society “tired” of inflation

Success: rapid and lasting inflation convergence to low levels

Generated, for the first time in decades, a low inflation environment

Macroeconomic Policy - The Real Plan – July 1994

Historical Background

10

Unsustainable regime (Fiscal situation, External disequilibrium)

Mexican, Asian and Russian crises (pressure on international

reserves and domestic interest rates; sudden stop crisis )

Huge exchange rate depreciation (collapse of the managed

exchange rate system)

Uncertainty about the economy

Fears of return to high inflation

Macroeconomic Policy – 1999 Crisis

0,75

1,00

1,25

1,50

1,75

2,00

2,25

Ju

l-9

4

Ja

n-9

5

Ju

l-9

5

Ja

n-9

6

Ju

l-9

6

Ja

n-9

7

Ju

l-9

7

Ja

n-9

8

Ju

l-9

8

Ja

n-9

9

Ju

l-9

9

Ja

n-0

0

Ju

l-0

0

R$ /

US

$

Nominal Exchange Rate

Historical Background

11

Three pillars of the macroeconomic policy framework:

Inflation targeting

Fiscal responsibility

Exchange rate flexibility

Enhanced macroeconomic fundamentals, combined

with macro prudential policy and strong bank

supervision resulted in:

Improved capacity to absorb internal and external shocks

Macroeconomic and financial stability

Sustainable growth

Credit and capital market development

Current Macroeconomic Policy

Overview

12

Inflation Target Framework in Brazil

13

Adopted in Brazil in June, 1999

Targets set by the government (National Monetary Council -CMN)

Targets are announced in June of year t for calendar year t+2

Inflation index: headline CPI (IPCA) – more credible

Point target with a tolerance interval – inflation uncertainty

If the target is not achieved (outside the tolerance interval):

Open-letter to the Minister of Finance

Transparent Communication: Press release after MPC meetings,

MPC Minutes and Inflation Report

IT Framework in Brazil: Main Features

Overview

14

Increasing success in other countries:

In 2009, 27 central banks were considered fully fledged inflation targeters,

and many others were in the process of establishing a full inflation-targeting

framework.

To disinflate with better trade-off : the important role of IT as an

anchor for inflation expectations.

IT brings more transparency and accountability.

By law the monetary authority is committed to price stability.

IT Framework in Brazil: Why IT?

Overview

15

Projection Models of the BCB

Inflation targeting relies on good macroeconomic forecasts,

more than any other monetary policy regime;

Good forecasting in this framework is expected to reduce the

trade-off between inflation and output volatility;

Given the lag between monetary policy action and its effects

on prices, inaccurate forecasts may delay the action and

induce undesirable cycles.

“Essentially, all models are wrong, but some are useful.”

(Statistician George E. P. Box)

IT Framework in Brazil: IT in practice Overview

16

IT Framework in Brazil: The MPC decision-making process

Short-term projections

for key economic

variables

Model-based

Inflation

Projections

MPC (Copom)

Meeting and Decision

Communication

Communiqué, Minutes

and Inflation Report

Analysis of forecasting’s

performance (Monitor);

Fan chart

Current economic situation

and near-term outlook

Inflation nowcasting;

expectations; balance of

risks; judgment

Open Market

Liquidity at a level

consistent with Selic rate

Outlook of

the economy

17

Play a key role in inflation forecasting;

Should remain anchored to the target (in the medium to long run);

Cannot be directly observed, alternatives:

Extracted from financial market data (market liquidity, risk premium...)

Survey-based expectations:

used for inflation projections; (alternative to the model consistent

setup)

used in model estimation.(as an alternative to the rational

expectations assumption)

IT Framework in Brazil: Inflation expectations

18

IT Framework in Brazil: Survey-based expectations

Since 1999 (transition to the inflation targeting system);

Created to monitor market expectations and improve the inputs

for the monetary policy decision-making process;

Daily survey of roughly 110 institutions;

Market expectations for inflation rates, GDP growth, industrial

production growth, FX rate, interest rate, fiscal variables, and

external sector;

Top 5 ranking to foster private sector forecasting expertise.

19

Inflation target for 2011, 2012, 2013: 4.50% ± 2.00%

Inflation in 2011 (IPCA): 6.50%

Inflation projections (March Inflation Report):

(*) Median of inflation expectations as of June 15, 2012

IT Framework in Brazil: Current setup

2012 2013

Baseline scenario 4.4% 5.2%

Market expectations (*) 5.0% 5.5%

20

CPI inflation rate (IPCA)

IT Framework in Brazil : Taming Inflation Expectations

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Jul-

99

Ap

r-0

0

Jan

-01

Oct

-01

Jul-

02

Ap

r-0

3

Jan

-04

Oct

-04

Jul-

05

Ap

r-0

6

Jan

-07

Oct

-07

Jul-

08

Ap

r-0

9

Jan

-10

Oct

-10

Jul-

11

Ap

r-1

2

CPI inflation (%12m)

market expectations

central target

21

Sources: BCB / IBGE

Inflation – Convergence to Targets Economic Indicators

%,

yoy

target (4.5%)

market expectation: April 30th

market

expectation

22

Source: Focus (May 7 2012)

IT Framework in Brazil: Survey-based expectations

Dispersion of market expectations

IPCA 2012 IPCA 2013

23

IT Performance (after 12 years):

Targets fulfilled in 10 years (including last 8 years)

Confidence crisis: 2002-2003

• Uncertainty about the future policy regime

• Huge exchange rate depreciation

• Stress test for inflation targeting

Average inflation (2007-2011): 5.4%

Evidence of targets anchoring expectations

Construction of credibility: Agents’ perception of BCB committed

to the IT regime

IT Performance in Brazil

24

Brazil

Macroeconomic Fundamentals

25

Macroeconomic Fundamentals

International Reserves

Downward Trend of Public Debt

Stable and High Quality External Financing

Reserve Requirements

Downward Trend of Sovereign Risk

Liquidity Buffers

Sound Financial System and Credit Market

26

Source: BCB

Macroeconomic Fundamentals: Liquidity Buffers

86

180 205

194

239

289

352 372

0

100

200

300

400dez 0

6

dez 0

7

ago

08

dez 0

8

dez 0

9

dez 1

0

de

z 1

1

jun 1

2

International Reserves (US$ bi.)

164

197

253

172 194

395

449

396

0

100

200

300

400

500

dez 0

6

dez 0

7

set 08

dez 0

8

dez 0

9

dez 1

0

dez 1

1

jun 1

2

Reserve Requirements (R$ bi.)

27

Source: BCB

Macroeconomic Fundamentals: Falling Public Debt

3,2 3,3

3,7 3,8

3,2 3,3

3,4

2,0

2,7

3,1 3,1

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012*

52,0

60,4

54,8

50,6

48,4 47,3

45,5

38,5

42,1

39,1

36,4 35,7

35

38

41

44

47

50

53

56

59

62

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012*

Primary Surplus (% GDP) Public Debt (% GDP)

-24.7 p.p.

of GDP

28

Macroeconomic Fundamentals:Sound Financial System

Main features:

Actual and regulatory capital requirement above

international standards

High level of liquidity ratios

29

Source: BCB

Macroeconomic Fundamentals: Sound Financial System %

Actual capital ratio of Brazilian Banks

* apr 12

Well above minimum regulatory capital ratio requirement = 8%

Well above minimum Basel capital ratio requirement = 11%

30

Souce: IMF (2011)

Macroeconomic Fundamentals: Sound Financial System

109 109

88 82

76 75

66 58 55 52 50 49

43 42 39 37 33 30 29

0

20

40

60

80

100

120

%

Liquid Assets / Short Run Liabilities S

ou

th K

ore

a

Bra

zil

Po

rtu

gal

Ru

ss

ia

Belg

ium

Tu

rke

y

Un

ite

d S

tate

s

Can

ad

a

Me

xic

o

Ja

pan

Gre

ec

e

Sw

ed

en

Ch

ina

Un

ite

d

Kin

gd

om

Au

str

ali

a

Sw

itzerl

an

d

So

uth

Afr

ica

Ind

ia

No

rwa

y

31

Macroeconomic Fundamentals: Sound Credit Market

Moderate growth of credit volume

Growth rate of 18% last 12 months

New credit operations in 2012 are 10 % higher than in the

same period of 2011

Recent data show:

Falling interest rates and spreads

32 Fonte: BCB

Macroeconomic Fundamentals: Sound Financial System

0

10

20

30

40

50

60200

1

200

2

200

3

200

4

200

5

200

6

20

07

200

8

200

9

201

0

201

1

201

2

% o

f G

DP

Morgages

*

Sustainable Credit Growth (50% of GDP)

Earmarked Credit

Others

33

Fonte: BCB

Macroeconomic Fundamentals: Sound Financial System

Real Interest rate – Swap 360 days x Inflation expectations 12 months ahead

34

Source: CVM

Macroeconomic Fundamentals: Capital Market

General Overview

R$ b

illio

n

*June 2011 (12 months)

Primary Issues

35

Source: BCB *apr 12 (12 months)

Macroeconomic Fundamentals: High Quality of External Financing

3 3 1 2 1

0 1 3

1 1 1 2 1 2

4

11

19

29 29

33

22

17

10

18 15

19

35

45

26

49

67

63

0

10

20

30

40

50

60

70

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

FDI em 2011 na AL

•Brazil: US$ 67 bi.

•Mexico: US$ 19 bi.

•Chile: US$ 14 bi.

•Colombia: US$ 13 bi.

•Argentina: US$ 7 bi.

Foreign Direct Investment (US$ bi.) FDI - CC deficit (% PIB)

36

Source: BCB

Macroeconomic Fundamentals: Stable External financing

(US$ bi.)

0

10

20

30

40

50

60

70

80

jul 11

au

g 1

1

se

p 1

1

oct 11

no

v 1

1

de

c 1

1

jan

12

fev 1

2

ma

r 1

2

ab

r 1

2

Ma

y 1

2

jun

12

Others Exports

Stable External Financing

37

Source: Bloomberg

Macroeconomic Fundamentals: Sovereign Risk (CDS)

July 2011

113 b.p.

(average)

basis

poin

ts

0

500

1000

1500

2000

2500

3000

3500

4000

jan

02

jan

03

jan

04

jan

05

jan

06

jan

07

jan

08

jan

09

jan

10

jan

11

S&P: BBB

Fitch: BBB

Moody´s: Baa2 ( )

38

Brazil

Social Development

39

Both macroeconomic and inclusion

policies have led to marked improvement

in living conditions.

A significant share of low income groups

joined the middle class.

Social Development

40 Source: IBGE

GDP per Capita

Economic Indicators

US

$

US$ 12,696

41 Source: IBGE

Unemployment Rate

Economic Indicators

%

Jan 12

5.5%

42 Source: FGV

Social Mobility m

illio

n o

f people

Social Classes

*FGV forecast

43

Final Remark

44

Virtuous Policies Interaction

lower interest

rate and

improved

credibility

lower

risk

premium

stronger

effect

falling public

debt

primary

surplus lower

fiscal risk

falling net public

external debt

floating and

international

reserves

lower

external risk

macroeconomic

stability

inflation

targeting

lower

inflation risk

} }

Closing Remark

45

Thank you!

Спасибо!

46

Source: MDIC

Exports in 2010 Economic Indicators

Composition Destination

* excluded Argentina

** excluded China and Middle East

*** excluded Germany