By PAULO NOGUEIRA BATISTA JR.*

The high stock of international reserves, held in the Lula and Dilma governments, gives room for maneuver to the economy if the government knows what to do with it

What economy will the future president inherit? Let's say it's Lula. He has said that, if elected, he will take on a much worse country than in 2003, when he became President of the Republic for the first time.

Is this statement true for the economic field? For some areas, yes, but not for all, and especially not for one that is of strategic importance: the situation of the external accounts – crucial to define the country's vulnerability to foreign pressure. Without taking this aspect into account, a realistic assessment of the options open to a new government cannot be formed.

FHC left everything hanging by a string

I begin by briefly assessing the economic situation at the time when Lula won the 2002 elections. Fernando Henrique Cardoso was leaving the Presidency after eight years in power. The results in the economic area were generally poor. FHC did control inflation, yes, but he left everything else hanging by a string, as I have already had occasion to show (in a 2005 book, Brazil and the International Economy). By the end of the government, even inflation was getting out of control.

Brazil's external fragility, during the FHC period, from 1995 to 2002, resulted from a substantial current account deficit, dependence on foreign capital, premature liberalization of capital movements and the reduced level of international reserves. The external restriction was, in fact, a chronic problem since the 1980s, never overcome – and aggravated by the exchange rate appreciation resulting from the Real Plan.

In the period 1999-2001, Brazilian reserves were only around US$30 to 35 billion. When the crisis worsened in 2002, partly because of fears of Lula's victory, the Central Bank had no bullet in the needle. It had not taken advantage of periods of relative tranquility to reinforce its cash position in foreign currency. The melancholy solution was to turn once more to the IMF. In December 2002, at the end of the FHC government, net reserves, after deducting obligations with the Fund, were just US$ 17 billion.

Well, you don't have to have spent, like me, eight and a half years at the IMF to know what that means. A country that resorts to the Fund loses autonomy in conducting its economic policy. He is obliged to follow the precepts of the institution, which are not always adequate and well adapted to national peculiarities. More importantly, the IMF is both a technical and a political body. Advanced countries, particularly the United States, dominate the institution. Turning to the IMF means, in practice, turning to the US, with all that that means. And, with an apology for the second self-citation, I refer you to my book Brazil doesn't fit in anyone's backyard, where you can find a discussion of the political economy of the IMF.

The external sector of the Brazilian economy

But I don't want to stay too long in the past. How is the painting today? Brazil's external situation is much better than it was in 2002. The deficit in current transactions (trade balance, services and income) is small, at 1,7% of GDP in 2021. This is because the trade balance surplus largely offsets expenses with services, interest on the external debt and the heavy net remittance of profits and dividends abroad (almost US$ 30 billion last year). Net direct investment (discounting investment by residents abroad), which is a more stable form of capital, covers almost all of the current account deficit.

The central point is the high stock of international reserves, the result of the accumulation effort carried out by the Lula and Dilma governments. With much delay, the Brazilian economic authorities began to strengthen reserves significantly from 2006 onwards (other developing countries, notably in Asia, started much earlier, in the 1990s). We paid the IMF in advance and later became the institution's creditors for the first time. Subsequently, under the Temer and Bolsonaro governments, the level of reserves was more or less stable. At least at that point there was no damage in the post-coup period. At the end of 2021, reserves stood at US$362 billion, growing from 2020, thanks to the SDR (Special Drawing Rights) allocation of US$15 billion. Brazil's situation is much more comfortable than that of other emerging countries, Argentina and Turkey, for example.

external vulnerabilities

I do not want, reader, to give the impression that our external position is invulnerable. There are weak points. For example: what would happen to the deficit in current transactions, which measures the net dependence on foreign capital, if there was a resumption of economic growth, especially in combination with exchange rate appreciation? In other words, the deficit adjusted to exclude both cyclical effects and perhaps exaggerated exchange rate depreciation is larger than the observed deficit.

Another potential problem: what would happen in the case of an abrupt reduction in international liquidity caused by a tightening of US monetary policy? With a very open capital account, the result would be strong pressure on the exchange rate. It is true that the floating exchange rate provides some protection, freeing the Central Bank from defending a certain exchange rate target. Reserves are also a guarantee against external threats.

However, an additional exchange rate depreciation would make controlling inflation more difficult. And reserves are no longer what they were in previous periods. They must be evaluated not only in absolute terms, but also in relation to other relevant indicators. Since 2015, they have been gradually falling relative to imports of goods and services, relative to a broad monetary aggregate (M2) and compared to short-term external debt (by residual maturity).

the future government

Despite these caveats, the point is that Brazil, in one crucial respect, is in a considerably better position than it ever was – not just in 2002, but for much of the 1980s and 1990s.

This gives room for maneuver to the Brazilian government, current and future. The current government doesn't know what to do with it. Will the future government know?

*Paulo Nogueira Batista Jr. he holds the Celso Furtado Chair at the College of High Studies at UFRJ. He was vice-president of the New Development Bank, established by the BRICS in Shanghai. Author, among other books, of Brazil doesn't fit in anyone's backyard (LeYa).

Extended version of article published in the journal Capital letter, on February 18, 2022.