Brazil’s Central Bank cut the benchmark overnight interest rate by 100 basis points from 9.25 percent to 8.25 percent. The announcement Wednesday marks the fourth time in a row that the Banco Central do Brasil has cut the Selic rate by a full percentage point.
The BCB’s decision comes at a unique political and economic moment in Brazil’s history. It is necessary to examine three factors are to understand why the BCB chose to lower interest rates again. First, President Michel Temer is under increased pressure as corruption charges plague his administration. Second, after the worst depression in the nation’s history, economic growth is starting to pick up. Finally, after spiking to more than 10 percent in 2016, inflation has fallen to its lowest levels since the late 1990s.
Michel Temer ascended to the presidency a year ago after his predecessor, Dilma Rousseff, was removed from office for using an illegal accounting technique to fund certain welfare programs. Initially, there was optimism early in his administration’s fiscal conservatism and pro-business economic policies would boost Brazil’s economic growth. While Brazil’s two-year economic depression ended in 2017, President Temer has had little to celebrate this year.
In May, an audio recording emerged in which President Temer approves of paying hush money to Eduardo Cunha, the former president of the Chamber of Deputies who was arrested in 2016 on corruption charges. In a separate incident, court testimony also accuses Temer of receiving bribes from the Brazilian meat packing company, JBS.
As a result of the May revelations, the Prosecutor General, Rodrigo Janot, formally accused President Temer of corruption before the National Congress. Last month, the Chamber of Deputies narrowly voted not to move forward with a corruption trial against President Temer.
In addition to President Temer, many other federal politicians and government officials have been accused or convicted on charges related to corruption in recent years. As a result of the political turmoil, the Brazilian government has been slow to make any meaningful changes to help grow the economy. Two exceptions are a rule to allow companies to drill for oil without first partnering with the state-owned oil company and a constitutional amendment to bring down government spending.
The BCB’s decision to lower interest rates again is critical for President Temer who has become one of the most unpopular presidents in history. July polling data from Ibope showed only 5 percent approved of President Temer’s job in office, while 87 percent did not trust him. A boost in economic growth may be the only thing that can save this administration.
Brazil exited its worst economic depression this year after it registered growth in the first and second quarters of 2017. However, Brazil’s economic growth forecast continues to be weak. In a July update to its World Economic Outlook, the International Monetary Fund predicts that the Brazil will grow at 0.3 percent in 2017 and 1.3 percent in 2018.
The IMF points to “ongoing weakness in domestic demand and an increase in political and policy uncertainty” as contributing factors to its prediction of slow economic growth through 2018 in Brazil.
The current government in Brasilia has been unsuccessful at enacting fiscal policy measures to grow the economy. Luckily low inflation rates give the Banco Central do Brazil greater room to use monetary policy to boost the economy. A Central Bank’s most versatile tool to stimulate the economy is lowering the interest rate. The BCB has used this tool in the past, such as during an economic downturn in 2013, and it appears willing to use it again in the face of historically low inflation.
Inflation in Brazil is at its lowest point in decades. Prices rose 2.71 percent in July 2017 compared to the same time last year. Inflation in 2017 is on track to fall within or just below the Central Bank of Brazil’s target of between 3 and 6 percent. Reuters reports that the expectedly low inflation numbers are due to several factors including “an abundant harvest.”
Lowering interest rates can also raise inflation by boosting borrowing and spending. During most of Brazil’s recent economic depression, high inflation meant that the BCB could not lower interest rates to stimulate economic growth without exacerbating inflation. More than any other region in the world, governments in Latin America are keenly aware of the severe economic damage that high, uncontrollable inflation can cause. In general, we see the need to control inflation take precedence over boosting consumer spending and economic growth in Brazilian economic policy with the noticeable exception in 2013.
For months, President Temer has seen low inflation as his legacy. In April, Reuters reported an aide to President Temer saying, “The legacy of a new economic matrix is very important for the president.” While that still may be the case, his administration clearly believes that it can continue to push interest rates lower without causing consumer prices to increase too sharply.
Unlike the Federal Reserve of the United States, the BCB is not a fully independent organization. In early 2017, the Temer administration decided to shelve any plans to make the BCB more independent. A senior member of Temer’s economic team told Reuters in January that they would look at legislation to make the BCB more independent “when inflation stays on target for some years and interest rates find an equilibrium.”
With interest rates still around 6 percent higher than inflation rates, the Central Bank of Brazil still has room to lower interest rates further in the future. Should consumer prices continue to rise at the low levels we are currently seeing, the government may decide to reduce the Selic rate again this year to give economic growth a further boost.
However, should prices begin to rise faster than expected, monetary policymakers must be willing to hit the brakes to dampen inflation. Brazil need only look at Argentina, Venezuela, or its own past to know how damaging inflation can be to an economy and its people.
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