Brazilian Central Banker Stands Pat
As Argentina Struggles to Pay Debts
By JONATHAN KARP
Staff Reporter of THE WALL STREET JOURNAL
July 18, 2001
RIO DE JANEIRO -- In his previous life, as a speculator, Arminio Fraga might have delighted in the shocks convulsing Brazil.
Its biggest neighbor, Argentina, is struggling to avoid defaulting on its debt. Domestic energy rationing has thrust unwanted holidays on factories, just as a sluggish global economy chokes off foreign investment Brazil needs to revive growth. And with the left-wing opposition on the rise ahead of 2002 presidential elections, Brazil's currency has depreciated 22% against the dollar this year.
But as governor of Brazil's central bank, Mr. Fraga is fighting this tide of anxiety in Latin America's biggest country. Facing his greatest challenge as helmsman of Brazil's two-year-old floating exchange-rate regime, he shrugs off uncharacteristic recent criticism from Wall Street and maintains that Brazil's current economic policies will preserve the country's hard-won stability.
"I still feel the long-term trends will win over the short-term storm," Mr. Fraga said in an interview. He estimated that most of the shocks will "go away in a couple of quarters," though he declined to predict how each will play out.
Mr. Fraga was speaking on the eve of a meeting in which the central bank is expected to raise interest rates Wednesday for the fifth time in five months. Foremost in the central bankers' calculations will be an assessment of Argentina's economic fragility and its contagious effect on Brazil.
An agreement by Argentina's provincial governors to cut spending lifted Latin American markets Tuesday and helped pull Brazil's currency, the real, up from a succession of historic lows. While Argentina's effort to avoid defaulting on $130 billion in debt remains highly unpredictable, this latest improvement suggests to economists that Mr. Fraga will raise the benchmark Selic rate only moderately, possibly by as little as half a percentage point, to 18.75%.
That would mean a rise of three percentage points so far this year. Mr. Fraga, without commenting on market predictions, says that given the rapidly deteriorating economic scenario, the relatively small rate increase proves the success of Brazil's fiscal austerity and an exchange-rate policy governed by an inflation target instead of a specific currency value.
"While we are frustrated that we're taking a bit of a detour from the path that we had envisaged, I feel very strongly that had we not invested in all these reforms, we would by now have been blown out of the water," he says. Two years ago, he temporarily pushed interest rates to 45% to stabilize the then recently floated real.
But the weakening currency threatens Mr. Fraga's ambitions to win an investment-grade rating for Brazil. The credit-rating agency Fitch Tuesday changed the outlook on Brazil's sovereign rating to negative from stable, citing Argentina contagion worries and a climbing debt burden as a percentage of gross domestic product.
The Princeton-educated Mr. Fraga, who turns 44 years old Friday, has been instrumental in improving Brazil's global credibility since being recruited from his job with financier George Soros in March 1999. But the recent decline of the real despite interest-rate increases and market interventions has cost Mr. Fraga some of Wall Street's confidence.
After the central bank raised interest rates more than expected in June and vowed to spend $6 billion this year in the foreign-exchange market to support the currency, dealers didn't accept the explanation that the move was aimed at stemming speculation. They rushed to hedge their exposure, driving the real to historic lows. "The central bank has lost considerable credibility in recent weeks," Francis Freisinger, a Merrill Lynch economist, wrote to investors early this month.
Mr. Fraga defends the strategy, noting that it initially bolstered the real, only to be undermined within days by renewed default concerns about Argentina. He also counters critics who say he shouldn't have shown his hand on intervention. "I've been a speculator myself," he says. "I believe that in the end you're better off being clear about your intentions."
So he went to New York last week to clear up any lingering confusion: The central bank wants the market to set Brazil's exchange rate but will inject $50 million a day as balance-of-payments support to smooth out volatility. Intervention will come only in exceptional circumstances.
In the weeks ahead, Mr. Fraga faces a delicate balancing act. Consumer prices are already rising beyond the government's 6% ceiling for this year. Yet boosting rates to cool inflationary pressure from a weaker currency or selling even more dollar-linked bonds would risk swelling Brazil's public debt, much of which is tied to rates or the dollar. Mr. Fraga expects foreign direct investment to be $20 billion this year, down from $33.5 billion last year.
He knows that monetary policy isn't bulwark enough, and without confirming details, he doesn't deny local reports that Brazil is preparing budget cuts and other fiscal measures. At the same time, support for extending Brazil's stabilization program with the International Monetary Fund, due to expire on Dec. 1, is growing within the government and business community.
Mr. Fraga says the government is committed to fine-tuning its policies to stay the course and is confident that the worst of Brazil's currency woes are over.
"I don't know where the real will go in the near term," he says, "but if you take a long-term view, it is unlikely that it will depreciate much further in real terms."
Write to Jonathan Karp at jonathan.karp@wsj.com |
