Weekly Report - 09 February 2023 (WR-23-06)

BRAZIL: The interest rate war

Anyone reading the Brazilian media this last week might conclude that an open battle has been in progress, pitting newly elected President Luiz Inácio Lula da Silva against the head of the central bank, Roberto Campos Neto. The real conflict may be less dramatic: neither side looks set to win a victory in the short term.

President Lula has been gunning for the central bank since the beginning of this month. On 2 February he criticised central bank autonomy, introduced in 2021 by his predecessor and ideological opponent, right-winger Jair Bolsonaro (2019-2023). On 6 February Lula said there was “no justification” for the central bank to hold its benchmark Selic interest rate at 13.75%. The bank’s explanations for such high interest rates were “disgraceful”, he said.

Lula also railed that the country “has a culture of living with high interest rates which are incompatible with economic growth”, adding “we need to grow again, this is urgent”. Lula said official “European style” inflation rate targets are too low, calling for more flexibility for a developing country like Brazil. He also called on business groups to lobby the bank and demand an interest rate cut.

At a breakfast for journalists on 7 February, Lula suggested that Campos Neto’s four-year term at the head of the bank might be reviewed. He said that in his own first two terms in the presidency (2003-2011) he had been responsible for monetary policy and therefore a legitimate target for criticism, but that had changed because of central bank independence. “No longer,” Lula commented. “Now the central bank is to blame. Now the senate can change the central bank’s president.”

Campos Neto has fought back from his own corner in the media war.  On 6 February he defended his institution’s autonomy: “the more independent you are, the more effective you are, and the less the country will pay in terms of cost of inefficiency in monetary policy”. Campos Neto also stood by the recent decision of the central bank’s monetary policy committee (Copom) to hold the Selic at 13.75%. The latest available Copom minutes say rates are being held high because of the danger that annual inflation (currently running at 5.87%, down from a peak of 12% earlier in 2022) will begin to “drift upwards” and to counter the new government’s expansive fiscal policy.

A central bank survey of private economists shows that their consensus forecast is that the Selic will remain unchanged for most of this year, with the first reduction (75 basis points) not expected till November. They also predict inflation of 5.78% this year (above the 3.25% target level) and of 3.93% in 2024 (above the 3.0% target). GDP, meanwhile, is expected to grow by under 1%. If these forecasts prove to be accurate, they are generally bad news for Lula since they suggest that he will pay a high political cost for a stagnant economy during his first year in office.

A full political showdown between the two men looks unlikely, however. Campos Neto’s term as governor runs until the end of 2024, roughly halfway through Lula’s third presidential term. He has given no indication that he intends to retire early. The mandates of the eight central bank directors expire at different times between now and 2025. Although Lula will choose their replacements, Campos Neto and his current directors will retain a majority on Copom until late 2024.

Lula could seek to pass legislation in congress to force Campos Neto out, but this looks unlikely, not least because of the strength of conservative parties in the legislature. Senator Randolfe Rodrigues, the government leader in the upper house, has in any case confirmed that there is “definitely” no guidance on any government plans to replace Campos Neto or to change the legislation on central bank autonomy.

So, what is the fight about? It could be that Lula wants to ensure that the central bank and not his government gets blamed for sluggish growth. “He needs to appease his political base to negotiate more freely later with the central bank,” says André Perfeito, an economist at Necton, a brokerage.

The risk of pandering to the base is that financial market and investors may take fright. Henrique Meirelles, who led the central bank during Lula’s first term in the presidency, had some blunt advice: “The less he talks about the subject, the better one can control expectations and lower interest rates,” he told Reuters news agency.

Senator Jaques Wagner of the left-wing Partido dos Trabalhadores (PT), a close associate of Lula, told the national daily Folha de São Paulo that Lula was merely saying what most Brazilians think: that current interest levels inhibit investment and job creation. He said that Lula had no plans to reduce central bank autonomy, or to curtail Campos Neto’s tenure, but the president’s comments have made financial markets jittery, with the real losing ground in foreign exchange markets.

Wagner added that the finance minister, Fernando Haddad, would be talking to Campos Neto while “respecting his autonomy”, adding “no-one can resolve all these issues inside their own head”. Wagner also suggested that central banks around the world are re-thinking their exclusive focus on monetary stability and recognising the importance of other objectives, such as social stability.

Financial markets

It is likely that financial markets will remain nervous over tensions between monetary policy and fiscal policy for at least another couple of months. In April the finance minister, Fernando Haddad, is due to present a new fiscal responsibility law to congress.

Fiscal deficit fears

A recent set of spending announcements by the new government, including the relaunch of a housing programme and proposed increases in the minimum wage and income tax exemptions for workers, have raised concern over this year’s fiscal deficit. Rafaela Vitoria of Banco Inter expressed the financial market’s view, saying that interference in monetary policy “can be more negative for inflation, un-anchoring expectations and creating more inflationary pressure”.

Sinking of aircraft carrier fuels controversy

The Brazilian navy sank a 32,000-tonne decommissioned aircraft carrier on 4 February in Brazilian waters off the country’s north-east coast using controlled explosions.

The São Paulo, which had originally been purchased from the French navy in 1998, was decommissioned and sold for US$10.5m to Turkish marine recycling company Sök Denizcilik Tic Sti last year, but it was turned back before reaching the Mediterranean, after the Turkish government barred it from docking at any of its ports, and towed back to Brazilian waters. The Brazilian navy responded by calling on the Turkish owners to repair it in a Brazilian dockyard, but it was subsequently banned from entering any Brazilian ports when an inspection showed it was taking on water. The navy then decided that the only remaining option was to sink it.

 Federal prosecutors made an eleventh-hour attempt to block its sinking but to no avail. Ibama, the federal environmental agency, had also sought to delay the sinking, calling on the navy to “assess alternatives to mitigate, repair and safeguard the environment”.

Valter Andrade, a Brazilian journalist covering national defence and security issues, has warned that the wreck might become a “mini-Chernobyl”. The environmental lobby group Greenpeace claimed that the sinking has deposited “tonnes of asbestos, mercury, lead and other highly toxic substances into the seabed”.

The São Paulo’s fate may yet lead to litigation. Sök Denizcilik’s legal representative in Brazil says the Brazilian state is legally responsible for disposal of the carrier under the 1989 Basel Convention on the transnational movement of hazardous wastes. Greenpeace claims the sinking is a violation of three international treaties: the Basel Convention, the London Convention on the prevention of marine pollution, and the Stockholm Convention on persistent organic pollutants.

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