The bigger-than-expected interest rate cut drew almost no criticism. Few reputable economists remain fearful about inflation. Most, like the government and business, are worried about the real economy. The general expectation had been for a 1.5 point cut in August. Copom said that it was making the change (and its biggest cut since June 1999) because inflation was coming back down to its target levels.
The progress on the pension fund deal is clear. Former President Fernando Henrique Cardoso, whose pension fund reforms were thwarted by Lula when he led the Partido dos Trabalhadores, seems to share this view: he has taken to making bitter comments about Lula's government and its opportunism.
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The third bit of good news is growing evidence that the employment situation is turning. The country's manufacturing heartland, the state of São Paulo, saw a marked improvement in July: after four consecutive months of job losses, industry barely laid anyone off in July, the Federação das Indústrias do Estado de São Paulo (Fiesp) reported. More importantly 2,636 of the jobs lost since the beginning of the year were restored. Industry expects things to get even better in September, and some consumer industries are forecasting a bumper final quarter of the year. This tightening up of the job market is already feeding through: the retailers association in São Paulo (the Federação do Comercio do Estado de São Paulo) reported that the number of people who said that they were not making purchases because they were afraid of losing their job has dropped. In July 28% cited this as a reason; in August, just under 26% did. Even so, the retailers are still grumbling.
Retailers are hopeful that the tightening up of the labour market will be franked, by pay rises in the final quarter of the year. Over the past two years, people have seen their real wages fall sharply. Retailers hope that the pattern will be reversed in the final quarter of the year when key industries, such as banking and metalbashing, make their annual pay awards.
The fourth bit of good news is the government's growing confidence in its economic management. It is signalling that the next budget will be pretty expansionary. The government is determined to raise the growth rate to 3.5% next year and realises that it has to boost spending to do this. Some bankers say that they are a bit bothered by the federal government's decision to allow municipalities to borrow more. The government argues that imposing automatic spending limits penalises 2,000 municipalities that are well managed but right up against their borrowing limits. The national monetary council (CNM) has ruled that states, municipalities and parastals cannot borrow more than R$1.2bn (US$400m) a year. Proponents of easier spending limits point out that state companies, such as Petrobrás, are often hugely profitable, so subjecting them to borrowing limits is ridiculous.
The president of the Banco Nacional Desenvolvimento Econômico e Social, Carlos Lessa, argues that the government needs to take a closer view of the intricacies of public spending. In particular, he said, it needs to distinguish between current and capital spending. The IMF, he argues, has insisted on a single category for public spending.
Interest rates
Antônio Palocci, the finance minister, was careful not to crow about the cut in interest rates. He stressed that Copom was still following a gradualist path. The president of the central bank, Henrique Meirelles, had given economists a coded hint (which few of them picked up) that there would be a significant cut in rates in August, by saying that gradualism did not mean that the bank was not flexible. Flexibility now seems to be the key central bank term for interest rate cuts. Following the cuts, Meirelles said that the country was now ready for growth. He said that the effects of the change of policy would be felt in the final quarter of the year.
The markets, and the planning minister, Guido Mantega, were less guarded. Mantega claimed that nobody could call the central bank cautious now. The stockmarket jumped by almost 4% in the following couple of days and hit a two-year high. Turnover in the futures market, BM&F, was heavy following the Copom decision (almost 600,000 interest rate contracts were traded) as people adjusted to the size of the cut.
Businessmen too were enthusiastic: Horacio Lafer Piva, the president of the Fiesp, praised the decision to cut rates. The Fiesp, which has been a strong critic of the high interest rate policy, speaks for the country's industrial heartland. The Fiesp argued that the central bank's determination to squeeze inflation out of the economy was halting industry in its tracks.
Lafer Piva, along with a host of other commentators, argued that Copom's caution, until yesterday, was one-eyed. They argued that the bank should have cut interest rates earlier, rather than waiting until it was obvious that inflation was falling back towards the government's target levels of 8.5% for this year and 5.5% for next year.
Retailers, who have seen sales dry up, argued that the bank was still being too cautious. Abram Szajman, president of the Federação do Comercio do Estado de São Paulo, argued that the bank should have been bolder. He said the small cuts (2.5 points in August, 1.5 points in July and half a point in June) would delay the recovery. Some economists are already calling for a cut of at least 3.5 percentage points at the September Copom meeting.
Their argument is that, with inflation falling, the central bank should be able to bring real interest rates down the levels in Chile or Mexico. In Chile, real interest rates are 2.75%, while in Mexico they are around 3%. Brazil has a record as an inflation recidivist, so economists soberly assume that real interest rates will still be between 6% and 8% in a year's time. Real interest rates in Brazil have actually risen this year, because inflation has been falling faster than interest rates.
The effect of the high interest rate policy is clear. The economy is on the edge of a recession: it is only being held back by the strength of exports and the buoyant agricultural sector. Few economists reckon that the economy will grow by more than 1.5% this year, though most believe that the economy will pick up in the final quarter. In the second quarter, the economy was expected to have grown by 0.8% on the same period of 2002. In the first quarter, the economy grew by 2% year-on-year though it contracted by 0.1% quarter-on-quarter.
To be fair, economists are nudging up their forecasts for GDP growth, following the cut in rates on 20 August. The consensus for 2004 is now 3%. The consensus on inflation for this year is also falling: it is now down to 9.6%. For next year, the consensus is 6.2%.
Jobs
Trade unionists point out that, despite the apparent improvement in São Paulo, urban unemployment across the country is still rising. In July, the official rate was 12.8%, up from 11.9% in July 2002. The rate was, however, down from the 13% rate in June. The unemployment rate does not give the whole picture, because the workforce is growing so fast: in July it was 5.4% bigger than in July 2002. The number of people in work this July was 4.3% higher than a year ago, at 18.3m. Even so, the number of people unemployed has risen by 318,000 since July 2002. Incidentally, the official statistical agency, Ibge, noted that in real terms average wages have fallen by 16.4% in the past year, to R$833.5 a month (US$278).
Macro-economics
The government itself is a major beneficiary of the cut in rates. Back-of-the-envelope calculations show that the cut will save it around R$11.25bn a year in interest payments. This assumes, bleakly, that there are no further cuts in rates. The federal government has R$456bn in debt tied to the Selic yield.
The government, which had been braced for some problems in the debt markets as its key pension reform bill was batted about by congress, claims that its precautionary measures, which included borrowing more in July, have paid off. The government believes that its pension reform is all but through congress now, although the senate is showing signs of wanting to make some major amendments. The pension reform is crucial because it will cut government spending and thus put the fiscal accounts on a firmer footing.
The less the government has to spend on servicing its debt the more it can pump into public works projects. Guido Mantega, the development minister, hinted that the bill for the government's public works projects between 2004 and 2007 could be well above the R$191bn (US$63.6bn) mooted earlier in August. The government is currently drawing up a list of priority projects.
The projects seem likely to draw on a mixture of public and private finance. Mantega hinted that the proposed new carriageway for the BR101 in the northeast could involve private finance because the road is likely to prove popular with tourists. The transport minister, Anderson Adauto, did not hide his disappointment with the figures being bandied about. He claimed that his officials were worried by the promises because they knew that no governments had improved, modernised or even looked after what had been built.
Exports
Even the trade account is performing well. After a weak start to August, the surplus in the first three weeks of the month surged to a new record, US$1.92bn. This was the highest since 1988. Exports are running at US$4.7bn in the first three weeks. Imports were US$2.8bn.
For the year to 24 August, according to the ministry for development, trade and industry, exports were up by 24% year-on-year, at US$43.82bn, while imports were down by 3% at US$29.45bn. The trade surplus so far this year now stands at US$14.37bn. This is the highest since 1981.
The government has tried to help the industry by cutting taxes, and the industry is hopeful that things will start to pick up in the final quarter of the year. Next year the industry is counting on growth of between 4% and 5% and the trade deal with the European Union to boost production.
The industry is already exporting to new markets such as China, South Africa, Russia and Europe. Most carmakers in Brazil now export at least 15% of their output. Anfavea reckons that the proportion could easily hit 30%.
FDI
The central bank reported that foreign direct investment (FDI) in July was US$1.2bn, beating its expectation of US$800m. July's figure was the first time this year that FDI has got over US$1bn in a month. In June, FDI was US$186m.
The pick-up in FDI is another shot in the arm for the economy. The central bank is now forecasting that FDI this year will be around US$10bn. The bank expects FDI to continue at a level of at least US$1bn-plus a month for the rest of the year. In the first three weeks of August, the FDI inflow was US$700m, according to the bank, putting the country on course for US$1.1bn for the month. The bulk of the FDI is going into industry.
The motor industry got a boost at the end of August when Dana, the world's biggest maker of axles for pick-up trucks, announced that it would shift its production of oil pumps and engine parts to Brazil. The company said that it would shut one plant in the US and two in Europe as a result of the decision. Dana already has 21 factories in Brazil, employing 4,000 people. The Brazilian operations currently export 22% of their output.
Pension fund reform
The government hammered together a deal on its key pension fund reform in the lower chamber of congress in mid-August. President Lula da Silva and his government appear to believe that the pension reform is now all but done. In a nationwide TV and radio broadcast following the deal, Lula implied that the government was now looking beyond pension fund reform. The budget is starting to loom large. Lula admitted that agrarian reform was a challenge and was now one of his principal preoccupations. So far, the government has managed to prevent confrontations with the militant Movimento dos Sem-Terra (MST) spinning out of control and into violent confrontation.
The government made significant concessions to get its pension bill though the lower chamber of congress. In return for the concessions, the government got a crucial no-more-amendments commitment from the two main opposition parties.
The price for the no-amendments commitment is high. The government agreed that state pensions over the R$2,400 (US$800) maximum will be cut by only 30%, rather than the 50% it originally wanted. Professor Luzinho, the deputy leader of the Partido dos Trabalhadores (PT) in the lower chamber, claimed that the deal meant that the work of the lower chamber was now finished. The professor, who represents São Paulo for the ruling PT, said that the reform was now in the hands of the senate.
The pressure for the change came from the right-of-centre parties, the Partido da Frente Liberal (PFL) and the Partido da Social Democracia Brasileira (PSDB). The PFL wanted the government to spell out that the heirs of people who died in service would be eligible for the pension up to the R$2,400 ceiling plus any extra, less 30%. The draft text sought to tie widows' and orphans' pensions to the amount that had been paid into the state scheme. The PSDB wanted guarantees for people who had worked for the state for a minimum of two years. Ricardo Berzoini, the pensions minister, said that the changes to the pension reform would not cost much. He put the total costs at R$3bn (US$1bn). This means that the government will save R$49bn, rather than the R$52bn it originally envisaged, over the next 20 years.
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