Economist Monica de Bolle says both Brazil’s financial market and the government are interpreting André Lara Resende’s proposal to lower the benchmark Selic rate selectively, focusing on the parts that suit their interests. De Bolle is a senior researcher at the Peterson Institute for International Economics in Washington.
In an article published on his website on September 25, Lara Resende, one of the architects of Brazil’s Real Plan, argued that high interest payments—not the primary budget balance—are the main problem with public debt. He proposed that the Central Bank gradually reduce the Selic over about 12 months to approximately 7.5% a year. The proposal drew attention amid reports that he would meet President Luiz Inácio Lula da Silva and praise for his ideas from figures linked to the government.
De Bolle said Lara Resende was not advocating that interest rates be cut by force, which she said does not work. She noted that his article also calls for efforts to improve public finances. In her view, the proposal brings back a debate Brazil has avoided for decades: the need to reduce indexation in the economy.
A portion of Brazil’s public debt is tied to the Selic, so government expenses rise immediately when the Central Bank increases rates. De Bolle said this mechanism helps explain Lara Resende’s argument that high interest rates can also fuel inflation. Rising public debt can increase the risk premium, destabilize the exchange rate and weaken the real, adding to inflationary pressure.
De Bolle described the proposed change to debt indexation as a form of restructuring, even if undertaken voluntarily. Drawing on her experience working on Argentina’s and Uruguay’s debt restructurings at the International Monetary Fund in the 2000s, she said such an operation would require fiscal adjustment. It would also need clear communication and coordination of monetary, fiscal and external policies to limit the risk of capital flight.
That concern is one reason Lara Resende proposes using Brazil’s international reserves to contain depreciation of the real, De Bolle said. She described the reserves as an important buffer in a volatile world.
She also expressed reservations about creating a council to coordinate fiscal and monetary policy. While the idea may make sense in theory, she said it would be difficult to implement because fiscal policy involves not only the federal government but also states, municipalities and state-owned companies.
Sources: Folha Mercado.