A BrazilWorks review of
GEGI Working Paper
Kevin P. Gallagher and Daniela Magalhães Prates deepen our understanding of Brazil’s exchange rate policy challenges and responses, made all the more important by the upcoming Brazilian presidential election that features disparate policy approaches to the exchange rate.
Gallagher and Prates frame their policy analysis by describing the recent challenges,
“Indeed, Brazil has been blessed and cursed with high commodity prices (from 2003 to mid-2008 and 2009-2011) and low interest rates in the core economies after the 2008 global financial crisis. Such an environment, coupled with the high domestic policy rate and the sophistication of the Brazilian financial system, has made Brazil a much sought after destination for carry trade operations through short-term financial flows that are largely transmitted through the foreign exchange derivatives market. Speculative operations into this market have accentuated the upward pressure on the exchange rate, which has come with higher commodities prices, leading to what we refer to here as “a financialization of the resource curse (pp. 2).”
During Brazil’s commodity led economic growth of the past decade, how did Brazilian monetary and exchange rate policymakers sidestep the “Dutch disease” and limit the appreciation of the Real and volatility of the exchange rate?
Gallagher and Prates proceed to describe the primary aspects of the exchange rate challenges and present a convincing policy analysis of those measures aimed at influencing the nature of the currency market and pricing of the Real. First and foremost, the author’s argue that Brazil is uniquely positioned to “exert countervailing power over the structural power of global markets.” Brazil’s financial regulators continue to exercise the authority to respond to global capital flows in a “timely and counter-cyclical manner” coupled to the interests of an export sector more concerned with a stable, competitive exchange rate than access to global capital markets (pp. 3). This foundation has allowed the Workers Party (or Partido dos Trabalhadores-PT) led federal government to enact and implement capital controls since 2003, accelerating interventions since the election of current President Dilma Rousseff and under the tenure of Central Bank President Alexandre Tombini and the Minister of Finance, Guido Mantega. The policy team, along with its national and international allies, successfully inserted the policy arguments and prescriptions of the “new welfare” economics of capital controls into the monetary and exchange rate policy framework.
The authors carry out a targeted literature review to counter the “capital mobility” hypothesis by suggesting that full capital market liberalization is not empirically correlated with high growth rates, but that emerging market economies (EMEs) are all too often bound by structural adjustment programs and trade and investment treaties with respect to the implementation of capital controls in the face of destabilizing capital flows. Brazil is different from most EMEs, thereby providing a critical case for examining the usefulness of exchange rate policies to “tame” capital flow surges and preserve currency and economic stability. Accordingly,
“In the case of Brazil, rising commodity prices has come out with expectations of continuing currency appreciation, fostering even more domestic and foreign investors ́ long positions in the Brazilian currency (pp. 11).”
The authors describe how Brazil was able to effectively neutralize several of the more important sources of exchange rate appreciation as foreign and national currency investors took ever larger and longer bets on the Brazilian real. Brazilian policymakers enjoy the constitutional authority to implement counter-cyclical taxation of cross-border financial activity and exercise this authority through the Finance and Planning ministries in tandem with the Central Bank in order to achieve broader policy goals, including low unemployment and industrial competitiveness. The policy “space” is not limited by trade and investment treaties, including the GATS and the countries Mercosul commitments, freeing policymakers to use more tools to counter the surges and prevent or delay the “sudden stops” of capital flows.
Indeed, Brazil’s exchange rate management policies were sufficiently effective at neutralizing the Real’s appreciation that Gallagher and Prates conclude,
“The regulations launched by the Brazilian government to stem the currency appreciation, especially the foreign exchange derivatives regulations, may have amplified the effects of the policy rate drops between August 2011 and October 2012 on the BRL/USD exchange rate (pp. 16).”
Yet, as the United States Federal Reserve openly planned to draw to a close its own currency market interventions in mid-2013, Brazil’s policymakers responded by successively eliminating several of the counter-cyclical capital control regulations that had contributed to curbing surges in capital flows, anticipating longer term changes in the currency markets that might favor appreciation of the U.S. dollar against the Real.
The Brazilian experience is critical for extending comparative economic policy analysis among the EMEs and raises the question; is Brazil and its EME counterparts better off by erecting and implementing capital controls to lessen the volatility of their “appreciating” currency markets and neutralize any tendencies toward the Dutch disease or are such policy tools increasing irrelevant as national economies retool for more efficient insertion into higher value added activities in global production chains, especially in manufacturing, through bilateral and regional trade agreements?
Gallagher and Prates (2014) take us a step farther toward answering this question by providing a better understanding of exactly how these measures might work or fall short as well as the political coalitions that support the use of such counter-cyclical capital controls in the face of appreciating currency. With respect to the upcoming Brazilian presidential election, these questions and Gallagher and Prates’ cogent examination are critical to developing a full appreciation of the divergent policy positions of the incumbent, President Dilma and her challenger, Marina Silva-running with the Brazilian Socialist Party (PSB) and with the support of the national finance capital and the global financial sector. Would a future Marina Silva government float the Real as long as the currency was under modest depreciation; or would she throw out the capital control toolkit altogether?