By JOSÉ LUIS OREIRO*
If adequate instruments are given to the Central Bank, as was done in the Euro crisis in 2012, the Central Bank will be able to do what is necessary for the stability of the currency.
In recent weeks, we have been witnessing a dantesque spectacle in which two parallel realities appear to exist. On the one hand, the real Brazil of the mainstreet is expected to close 2024 with GDP growth of around 3.5% (with an upward bias), unemployment of around 6% of the workforce, and an inflation rate that, after a period of sharp increase between the end of 2020 and mid-2022 (during the government of the Beast of the Apocalypse), showed a clear downward trend, stabilizing throughout 2024 in the range of 4 to 4,5% per year, as shown in figure 1 below. Contrary to what is stated in prose and verse by conventional economists, the continuous drop in the unemployment rate after the first half of 2021 was not accompanied by a tendency for inflation to accelerate. In fact, the correlation between the monthly inflation rate accumulated over 12 months and the unemployment rate between January 2020 and October 2024 is a measly 0.08, statistically equal to zero! The Brazilian labor market, due to its enormous structural heterogeneity, is still far from full employment.
On the other hand, painted in dark and terrible colors by analysts and financial market operators, we see an economy in which the exchange rate has shown a clear depreciation trend in the last two months, having surpassed the mark of R$6,00 per dollar last week. Even after the interest rate shock given by COPOM in last week's meeting, in which the board unanimously increased the Selic rate target by 100 bp, to 12,25% per year, and committed to at least two more increases of the same magnitude, these already under the management of the “Keynesian” Gabriel Galípolo; the Focus bulletin – as shown in figure 2 below – apparently acting in “tow” of COPOM’s signaling, is increasing its projections on future interest rates week after week, in a true march of folly where each increase in the Selic rate target by Copom has the sole effect of making the “market” believe that the Selic needs to be even higher than Copom signals to stop a supposed loss of inflationary control, which insists on not appearing in the data released by IBGE.
How is it possible that such divergent views on the state of the Brazilian economy can coexist in the same time and space? Analysts at Faria Lima may argue that the good numbers in the real economy are a reflection of the past – perhaps of the “reforms” made by the Temer and Bolsonaro governments – while the current numbers in the financial markets – basically exchange rates and interest rate futures – are leading indicators of a disaster that is about to befall the Brazilian economy. This disaster would be “fiscal dominance”, a situation in which an unsustainable trajectory of the public debt as a proportion of GDP due to the lack of fiscal control originating in the current Lula government, would cause the market to anticipate a higher level of inflation in the future as the only way for the government to satisfy its intertemporal budget constraint. Under these conditions, higher interest rates will only cause more inflation. And, by a somewhat Portuguese logic, lower interest rates would also have the same effect. Thus, the country would become Argentina in the space of 12 to 18 months.
This is the narrative that Faria Lima, together with the mainstream media, is pushing down the throats of Brazilian society in an attempt to create a fait accompli: Faced with the fiscal and exchange rate crisis, the Lula government would have no other option than to surrender, pull down its pants, and make cuts in social welfare, health, and education spending. The bag of evils is quite macabre: unlinking the BPC and the salary bonus from the minimum wage, de-indexing social security benefits from inflation, and exempting the government from increasing health and education spending in line with the increase in tax revenue. These are Paulo Guedes' 3 D's. Bolsonaro didn't agree to do it because he wanted to win the election, but he lost. So it's up to Lula to sacrifice his support base to deliver the fiscal adjustment that the market wants, otherwise...
What the mainstream media and Faria Lima do not say, perhaps out of ignorance, perhaps out of bad faith, or for some convex combination of both reasons, is that over the last 18 years – yes, this includes the Lula I, II, Dilma governments – the exchange legislation has been modified with the subliminal objective of taking away from the Central Bank of Brazil the power to intervene in the exchange market in an efficient and effective manner, that is, in order to interrupt purely speculative movements in the exchange market, fueled by the irrationality, greed, prejudices and herd behavior of financial market agents.
As we read in the document “Simplification measures in the foreign exchange area prior to the entry into force of Law No. 14.286 of 2021” from the Central Bank of Brazil (See using this link)
“In 1933, through Decree No. 23.258, it was established that resources resulting from Brazilian exports must enter Brazil. This measure was adopted in a context of severe shortage of foreign currency. It should be noted that two years earlier, Decree No. 20.451 had established a state monopoly on the purchase of foreign currency. For most of the last century, export revenues were practically the only primary source of resources to contribute to the search for equilibrium in the country's balance of payments. In that context, exporters were subject to controls and administrative sanctions, including financial fines of up to 200% of the value of the transaction in the event of failure to enter Brazil with their export revenues.”
Furthermore: “The BCB also exercised exchange control over import transactions, linking the documents for the clearance of goods from the customs authority to the exchange contracts received from banking institutions. Exchange control procedures were also present in the area of services and international capital. Thus, Brazil lived for decades with bureaucratic restrictions on access to foreign currency in the exchange market, in addition to the requirement for prior and subsequent authorizations in the area of international capital.”
However, “The process of making the foreign exchange market more flexible in Brazil began with the creation of the floating rate exchange market by the National Monetary Council (CMN), through a resolution issued in 1988. In this market, it became possible for Brazilian residents, including exporters, to establish funds abroad through transactions in national currency and with the intermediation of foreign financial institutions. With the start of the floating rate market in 1989, Brazilian exporters began to live with a paradoxical and asymmetrical situation. They were subject to the obligation to receive revenues from their foreign sales through the managed rate exchange market and, from 1990 onwards, through the free rate exchange market. On the other hand, they had regulatory support to simultaneously or at a later date establish funds abroad without restriction through the floating rate exchange market.”
During the Lula I administration, this flexibility was accentuated because “Law No. 11.371 of 2006 allowed for the flexibility of the requirement for exchange coverage in exports, with the CMN now having the authority to establish the percentage of export funds that can be kept abroad. In that year, the CMN established a limit of 30% for keeping these funds abroad. In 2008, the CMN allowed Brazilian exporters to keep 100% of the funds related to the receipt of their exports abroad. The end of the exchange coverage requirement was an important economic and managerial instrument for exporting companies, while contributing to a better insertion of the country in the international market. Another important cost-cutting measure for companies brought about by Law No. 11.371 of 2006 was the end of the collection of fines on Brazilian import operations for late payment or failure to contract an import exchange operation. Until then, if there was a delay of approximately 180 days from the due date of the obligation, without contracting the respective exchange transaction in the form established by the BCB, the importer was obliged to pay a fine on the value of the import. This fine was no longer justified, given the fact that, as of Law No. 11.371 of 2006, Brazilian companies were able to make payments for imports with funds available abroad, which were no longer subject to the rules for contracting exchange transactions in the Brazilian exchange market.”
But the most radical change was introduced with law 14.286 of 2021. According to an article from Agência Senado (using this link) the main changes in the foreign exchange market brought about by this law were:
Physical person
For individuals, one of the main changes is the permission to sell foreign currency, as long as it is not professional but occasional. The practice, although common, was not permitted by law. An example is the sale of currency left over from a trip, for example. The limit is US$500 between individuals.
The amount that each person can carry when traveling internationally has also changed. The limit, which before the approved legal framework was in reais, is now in dollars. Now, instead of R$10, each person will be able to travel with up to US$10 without breaking the law. The same rule applies to those leaving and arriving in Brazil. The change was necessary because the value had been fixed in the 90s, at a time of almost parity between the values of the dollar and the real. Today, a dollar is worth almost R$5,50.
Investments
The new legal framework allows banks and financial institutions to invest funds raised in Brazil or abroad, in addition to facilitating the use of Brazilian currency in international transactions. According to the government, this will help finance importers of Brazilian products. The flow of funds is now direct between companies in the same group.
Source: Senate Agency
Well, when we look at the work as a whole (see figure 3), it is easy to see that the Central Bank's ability to intervene in the foreign exchange market has been gradually diminished over time, mainly with the end of the exchange rate coverage of exports, with the final straw being law 14.286 of 2021, which allowed Brazilian residents to invest in fixed income abroad, astronomically increasing the amount of capital that can leave the country. If before this law, only capital that entered in the form of IDP or portfolio investment from non-residents could leave Brazil, roughly speaking; with the new law, residents can withdraw from their demand deposit, savings and investment fund accounts to invest abroad, without limit. It is clear that, given the new foreign exchange legislation, Brazil's international reserves are insignificant to prevent a speculative attack on the Brazilian currency, exactly what is happening now. In this context, there is no point in selling reserves, holding line auctions, raising interest rates or appointing Henrique Meirelles as president of the BCB. All of this will be in vain. You can't fight with a knife when you're armed with a bazooka. You need an atomic bomb. First, the National Monetary Council needs to reinstate the requirement for 100% exchange coverage for exports in order to force exporters to internalize the dollars they have abroad. In addition, the National Congress needs to repeal Law 14.286 of 2021. But the mere announcement of this repeal would fuel even more the speculative attack against the Real. Therefore, it is up to the President of the Republic to issue a provisional measure suspending the effects of this law for a period of 180 days, until a new institutional framework for Brazil's exchange rate policy is built, which will prevent the Brazilian nation from being held hostage by the petty and unpatriotic interests of the Farias-Limers. This is a fight that the Brazilian nation needs to fight to the end. With God's grace, we will win.
If the right tools are given to the Central Bank, then just like the European Central Bank during the Euro crisis in 2012, the BCB will be able to do whatever is necessary to preserve the stability of the Real, and believe me it will be enough. (https://www.youtube.com/watch?v=W97hM8eCE5g)
Figure 3
*José Luis Oreiro is a full professor of economics at UnB. Author of, among other books, Development macroeconomics: a Keynesian perspective (LTC). [https://amzn.to/49KlGsv]
Originally published on author's blog.
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