March 28, 2012
Image Credit: Secretaria de Assuntos Estratégicos Presidência da República under Creative Commons license
“The process of cutting interest rates has not come to an end in Brazil.”
— Alexandre Tombini at a G20 meeting in Mexico, February 2012
While earning his Ph.D at the University of Illinois in the 1980s, Alexandre Tombini was known as quite the introvert. But he had a reputation for being a different person on the soccer pitch. Tombini defended the goal post and attacked opponents with uncharacteristic aggression, often sending his foes limping off the field with eye-popping tackles. It was almost as if the Brazilian reveled in the fine art of tackling, using enough force to stop a rival striker, but deftly gauging his attack to avoid being thrown out for foul play. Today, as president and head of Brazil’s central bank, Tombini is counting on much the same instincts and sense of balance to achieve a goal more significant than those in his university soccer games — to defend growth in Brazil while tackling inflation.
Indeed, the monetary authority of Brazil is under intense domestic and international scrutiny now. After a decade of expansion, especially since the stellar 7.5% GDP growth in 2010 on the back of a fiscal stimulus, the Brazilian economy appears to have lost a bit of its momentum. The demand for the Latin American country’s primary export, iron ore, has weakened amid the slowdown in China. And some of its key industries, such as the automobile sector, which became the world’s fourth largest by unit sales in 2010, have been losing steam following a phase of rapid growth. Meanwhile, other industries in the BRIC economy, like textiles and shoe manufacturing, are in deep water due to a flood of Chinese imports at home and the pressure of a relatively strong Brazilian real in the overseas market.
Yet, despite being in a downtrend for the past six months, the rate of inflation in Brazil remains stubbornly higher than the central bank’s comfort level of 4.5%. As of March 27, the rate stood at 5.8%, having fallen from a high of 7.3% in October 2011. The gap of 1.3 percentage points between the central bank’s target rate and the current rate of inflation may not seem much, but in a nation that was plagued by hyperinflation barely two decades ago, policy makers look at inflation as not just a prickly issue, as other countries do, but also a historical enemy. In fact, although Brazil has long shed its image as an economic basket case, the specter of its past runaway inflation looms large, as the country continues to suffer from an exceptionally high rate of interest, the highest in any major economy today.
Currently, the country’s latest benchmark interest rate, the SELIC rate, is 9.75% after about five consecutive cuts since August 2011. To Brazilians, this single-digit rate may seem like a dream. After all, the period between 1999 and 2010 recorded an average SELIC rate of 17.22%, with a historical high of 45% in March 1999. The only exception was in 2009, when at the peak of the global financial crisis the rate plunged to a single-digit level of 8.75%. However, it appears now that the paradigm for interest rates has shifted in Brazil. Having realized that Brazil’s relatively high interest rates compared to the rest of the world are a structural limitation of the emerging economy, the federal government led by president Dilma Rousseff has declared that it favors lower interest rates in the long term. In fact, in early March, Rousseff declared that “rate cuts are necessary to avert a tsunami of foreign speculative capital,” which was chiefly responsible for pushing up the Brazilian real’s value to a 12-year high in 2011 and hurting the country’s export competitiveness. Against this backdrop, Tombini and his team at the central bank are shouldering an onerous task; they must consistently keep inflation under check but at the same time adhere to a policy bias toward lower interest rates.
“Part of the story we’ve seen since late August has been the slowdown
in the global economy, and the many revisions that
we have had since then in terms of expectations of global growth —
in Europe and even Asia and the US.
So the slowdown and the many transmission channels to
emerging markets have no doubt reduced the inflationary pressures
that we had in early 2011.”
— Alexandre Tombini
When Tombini, the 48-year-old son of a United Nations economist, took the helm at the central bank in January 2011, it appeared he was up to task. Two short stints at the IMF and Brazil’s Finance Ministry notwithstanding, the University of Illinois alumni had spent the major part of his professional life at the central bank. Moreover, Tombini belonged to a generation of Latin American economists who studied at the American university as part of a scholarship program established by the highly respected economics professor Werner Baer. More importantly, he enjoyed immense credibility as somebody who was a part of the team that had formulated Brazil’s inflation-targeting system in 1999. Despite sporting the right credentials though, public expectations were not high. Indeed, Tombini had big shoes to fill.
His predecessor was Henrique Meirelles, Brazil’s longest-serving central bank president and somebody who had brought down inflation from 12.5% to 5.6% during his 8-year tenure. Besides, Meirelles had gained so much trust in the global financial community that Brazil’s dollar-denominated bonds had gained 250% between 2003 and 2010. In sharp contrast, Tombini was considered low-profile and an unimpressive communicator. The economic situation at the time also raised doubts about his ability to succeed. Increasing wages and an easy credit policy was driving Brazilian consumption and the country had ended 2010 with its inflation at a 6-year high. Tombini’s key priority was to somehow influence a change in the government’s “policy mix”, a delicate dance where budget deficit cuts would enable a fall in interest rates without the risk of inflation. It was all the more difficult for Tombini, given that Brazil’s central bank is not formally independent, and no board member at the bank is given a fixed term.
Tombini, who has two children from his American law graduate wife, started his term conventionally, raising interest rates successively to rein in inflation. However, true to his style, he surprised bond investors in August 2011 by suddenly cutting rates when inflation was high and rising. And, he didn’t stop at that, continuing to cut rates even as inflation spiraled to 7.3% in October 2011, prompting analysts to berate Tombini for being reckless. In fact, his unusual policy moves apparently baffled even his colleagues. According to a Businessweek article, a Brazilian central bank board member disagreed with the rate cuts so much that he was reported to have “slammed phones and stomped through hallways.”
But was there genius in this madness? Now, as Tombini completes his fifth quarter in office, he has acquired a legion of supporters among Brazilians, the international media and the analyst community. He is being hailed as somebody who anticipated in August the slowdown that struck the entire world in the last few months of 2011. Some economists have even said that Brazil managed to post a small GDP growth during the fourth quarter of 2011 owing to the interest rate cuts. However, the short-term growth notwithstanding, what’s important for Brazil is that it seems to be on track to achieve its long-term economic goals. The country registered a primary budget surplus in January, indicating that the federal government has achieved some degree of fiscal restraint. What’s more, from the central bank’s standpoint, benchmark interest rates are already in the single digits and inflation has never been closer to the target rate in the past few years.
Apparently, the quiet and reserved Mr. Tombini has executed another superb “tackle.” The question now is will he end up winning the game?
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