At the mercy of the "sentiment of the market"

Fernando J. Cardim de Carvalho
Instituto Brasileiro de Análises Sociais e Econômicas (IBASE)

Almost three years after the country changed its exchange rate regime, from semi-fixed to floating exchange rates, the economy is still exhibiting mediocre growth rates, high unemployment, and perverse income distribution profiles. In fact, if the exchange rate regime adopted in early 1999 did allow Brazil to deal with external shocks in a much better way than, for instance, Argentina, it has not been enough to reduce the external vulnerability of the Brazilian economy. As a result, the Brazilian economy has been crawling along giving little room for adopting more effective policies to combat social exclusion and poverty.

Brazil’s current state of external vulnerability has many roots: the indiscriminate trade opening policies first implemented at the late 1980s; the financial liberalization and capital account opening policies adopted during the 1990s; and the overvaluation of the domestic currency with respect to the US dollar, as an element of the stabilization plan of 1994. The stabilization strategy relied heavily on the availability of imports made cheap by exchange rate overvaluation. Sustaining such a strategy, however, required maintaining high interest rates to attract capital inflows (enough to pay for the trade deficit) and, thus, rising external debt[2]. To grow, the Brazilian economy needs rising imports and, to pay for the imports, rising capital inflows. Heavily dependent on capital inflows and having lost most of its capital control instruments, the Brazilian economy is constrained in its growth perspectives by the “sentiment of the market”, as unforgettably put by former IMF Managing Director Michel Camdessus. In fact, if financial investors are happy with their perceived opportunities in Brazil, they will supply the means necessary to cover trade deficits. If not, growth is stalled by rising interest rates and fiscal austerity, the government is forced to adopt to attract investors back to the country. Inflation has been beaten by the stabilization plan, but sustainable output and employment growth has become a chimera. Instead, the Brazilian economy lives through periods of stop-and-go, with stops lasting longer than go-times, depending on how international investors react to worldwide as well as domestic turbulences.

During the last months of 2000 and for the whole of 2001, financial investors actually had plenty of reasons to harbor bad feelings about the Brazilian economy. Even though the real has no longer been overvalued for quite some time, exports took much longer than expected to react and when the reaction timidly began, the US went into a recession, worsening trade expectations to everybody. In addition, the Argentine economy has been floundering since the end of 2000, with no end for the crisis in sight. Some degree of contagion to the Brazilian economy is, under these circumstances, inevitable. Domestic problems should also be added to this list. In the first semester of 2001, the federal government suddenly found out that the improvident energy policy it adopted for years, neglecting badly needed investment in new production capacity, was finally paying off in the form of energy rationing, that is still in force. On top of all that, political crises have been taking place almost without interruption since President Cardoso was inaugurated for the second term he coveted so much. This time, the crisis took place in the Senate, involving close associates of the President, and ended up in the dismissal of three senators, including the former and the then-current Presidents of the Federal Senate.

Consequences of the External Vulnerability

All this hit an economy in need to finance about 25 billion dollars of current account deficit, besides rolling over outstanding foreign debts. As a result, interest rates were kept at very high levels by the Central Bank (19% of annual overnight rates for an annual inflation rate of about 7%), which was reflected in average interest rates being charged for credit to the private sector of 55% in June 2001 (up from 51% in December 2000). At these rates, credit supply could only stagnate, bringing down the economy with it. According to IMF estimates (made public in December 2001), the economy should grow by only 1.8% in 2001 (a much lower rate than the one projected by the Brazilian government).

Under these circumstances, it should not be surprising that open unemployment remains very high (6.2% in August 2001, not counting disguised unemployment in the form of “informal” jobs like street-peddling).

Slow growth and open unemployment do not tell the whole story of what is going on in the labor market, though. Less than half of the Brazilian workforce actually have a formal labor contract, enjoying the benefits of legislation, collective bargaining, social security, etc. In fact, some kind of perverse mechanism has been in operation in which earnings for informal jobs have been growing at much higher rates than earnings for those with labor contracts. According to IBGE (Brazil’s Central Statistics Office), while earnings of employees with labor contracts was only 7% higher in July 2001 than the average of 1993, compensation for informal jobs had increased  33%. For the self-employed compensation had grown slightly more quickly and for employers it increased 41% in the same period.

By the end of 2001, the Senate was expected to begin voting on a proposal sponsored by the Federal Government changing current labor laws to allow “more flexibility” into the labor market. Labor protection laws, although hardly effective as it has just been seen, were blamed for the slow growth of employment, so the Labor Minister prepared a proposal allowing firms and workers to negotiate directly a large number of labor rights that were guaranteed by law. In other words, the federal authorities interpreted the low growth rates of employment not as a problem of enforcement of labor rights but as evidence of superiority of less regulated labor markets. As has been amply demonstrated by the experience of countries that liberalized their labor markets, including the USA, one should expect from this some positive influence on growth levels, insufficient though to compensate the perverse impact on labor compensation. Functional income distribution should therefore get worse in the near future.

Three Significant Initiatives

Not everything was bad news, though. The Federal Government has launched and began to implement some potentially significant social programs. The strategy seems to be to de-emphasize the Community in Solidarity initiatives, led by the First Lady, that used to be an umbrella campaign to include federal social programs, in favor of topic initiatives that may achieve greater visibility when they are announced one-by-one. Foremost among these is the Bolsa-Escola program, in which very poor families are given a small grant if they keep their  children (from 7 to 14 years old) at school. Although the program has been criticized for the low value it grants per-child, it is still a positive initiative, combining some attenuation of extreme poverty with a stimulus to families to give children at least basic formal education instead of putting them precociously to work. Some critics accept the principle behind the program, but argue that if it focused on a smaller number of communities in this initial phase, instead of widening the coverage, it could be able to give families a higher grant, and to be more effective in improving their living conditions.

Another major advance to note refers to initiatives to combat racial discrimination. The subject received a large amount of attention in 2001, as a byproduct of the UN Conference Against Racism that took place in Durban, South Africa. The position taken by the Brazilian government in that conference has been generally praised as very progressive, although there remains some criticism directed at its low ability to implement that position domestically. Be it as it may, opening the debate around a subject that has always been deliberately ignored not only by authorities but also by a large share of the Brazilian population, which has, for the most part, happily accepted the myth of a racial democracy prevailing in the country, is in itself a great step forward. Beyond rhetoric, some measures have been actually taken, even if largely symbolic, as the decision by the Agrarian Reform Minister to reserve quotas for the employment of Afro-Brazilians in the Ministry’s jobs and the debates around the creation of quotas for minorities at public  universities.

Finally, one should not ignore the important victories obtained by the health authorities against multinational drug producers, inaugurating a pattern that is beginning to spread to other countries. The Brazilian Health Ministry has been praised for its anti-AIDS policies that include the free distribution of drugs to those infected by the HIV that cannot afford them. The Brazilian government reserved the right to break patents protecting the manufacturers of those drugs if they tried to use their monopoly power to impose unreasonable prices on their medicine. The case was taken to the WTO, and despite the strong pressure of drug manufacturers, the Brazilian authorities stood firm and held their ground. The right to treat events like the AIDS epidemics as a national emergency was recognized, opening an important precedent to developing countries in their relations with monopolistic producers of strategic goods, such as special medicines. In the end, those firms had to retreat and accept the need to negotiate prices within reasonable parameters with the Brazilian government.

Fiscal Policy

One crucial side-effect of the external vulnerability, as it was mentioned above, has been the need to maintain the good will of international investors to having them finance balance of payments large deficits. An important instrument to keep that good will has been to offer high interest rates being paid on financial placements made in the country.[1] Rising interest rates impact directly the service of public debt. If interest rates are kept low, capital flight ensues and, in a floating exchange rate system, the local currency is devalued. In either case, the impact on public finances is disastrous. By far, most of the public debt in Brazil is indexed either to overnight interest rates or to exchange rates. If the authorities allow the real to devalue, debt service will rise; if they raise interest rates to avoid devaluation, debt service will rise as well.

In December 1998, in the eve of the change of exchange rate regimes, and witnessing strong capital outflows, Brazil signed a stand-by agreement (SBA) with the IMF. One should keep in mind, that up to this moment, the liberal policy mix implemented so far was done on the initiative of the national government. Liberalization policies were adopted by the Brazilian government because of the latter’s political persuasion, not by imposition of foreign institutions (as it was the case in the crisis countries in Asia). The coincidence of views between the Brazilian government and the Fund did not prevent the latter from attaching many sets of conditionalities to the SBA, among which the priority pursuance of positive fiscal primary surpluses (that is, fiscal surplus before servicing the public debt) for the duration of the agreement. Since the Brazilian government has actually signed a new SBA in 2001, even before the first was actually concluded, the conditionalities remain. In fact, the Brazilian government made the priority given to servicing public debt over other fiscal expenditures (including social expenditures) the form of a law, through the Fiscal Responsibility Act.

The precedence of public debt servicing over other expenditures has not only led the federal government to cut planned expenditures but also to withhold payment even for the programs that are actually budgeted. Thus, as it is shown in the table below, prepared by Luiz Fenelon, of INESC, some of the social expenditures programmed for 2001 are not only far from completion, they are in fact virtually non-existent.


Implementation of budgetary programmes in 2001
(As of 16 November 2001)

Programme Implementation (%)
Urban infrastructure 0
Construction of federal highways 0
Electricity in rural areas 0
Energetic policy management 1,36
Basic sanitation 2,35
Energy in small communities 4,81
Social reinsertion of minors in conflict with the law 6,71
Innovation for competitiviness 9,88
Brasil in action 11,43
Struggle against poverty 11,49
Active Community 14,74
Quality and efficiency of SUS 22,92
Support for health research 26,98
Protection of the Amazon 32,17
Quality school for all 32,27
Defence of children's rights 42,74
Source: SIAFI/STN - COFF-CD and PRODASEN - Prepared by INESC


The difficulty of significantly improving living conditions for the majority of the country’s population has been less a problem of adopting the right specific programs, but rather one of a low priority given to social goals.[1] Government policy has been dominated by the concern with the “sentiment of financial markets”, which leaves small room for any change of priorities. It is to be expected that 2002 will bring some change, being the year of general elections, but the latitude for any real change is limited in the strategy adopted by the present administration and one should not expect much more than marginal improvements, if any.


[1] The data used in this chapter come from Brasil - Memorando de Politica Economica, Finance Ministry of Brazil, 12/09/2001; and from the website of the Central Bank of Brasil, except when otherwise noted.  

[2] Overvalued exchange rates cause current account (that is, the trade and services balance) to emerge because a cheap foreign currency stimulates imports and reduces exports. Cheap imports compete with local production preventing the latter’s prices from rising. The flipside, of course, is increasing foreign indebtedness, since if one imports more than one exports, one has to borrow to pay for the excess imports.

[3] One should keep in mind that international investors do not include just foreign investors, but also residents that became able, because of financial liberalization, to take their money out the country and make their investments abroad. Thus, even if foreign investors do not invest in domestic securities, the authorities still have to keep the good will of the domestic investors, lest they flee with their capital away. With financial liberalization it is not the nationality of the investor that matters, but their range of investment. Capital flight begins at home. Brazilian investors brought the past exchange regime down in 1998, just as Mexicans did in Mexico in 1994, Thais in Thailand in 1997, and so on. Capital controls are needed not to prevent foreigners from leaving but residents from fleeing.

[4] This point was extensively debated in the article by Célia Kerstenetsky and Fernando Carvalho included in the Brazilian edition of Social Watch, Observatório da Cidadania, for 2000.

Fernando J. Cardim de Carvalho is Professor of Economics – Universidade Federal do Rio de Janeiro (UFRJ) and IBASE collaborator.