Guido Mantega, Brazil’s bellicose minister of finance, likes fighting talk. The man that sparked the currency wars headlines in 2011 is at it again. This time he is using loaded words such as Brazil having an "arsenal of measures" at its disposal when talking about his ability and willingness to deploy new capital controls.
It’s easy to understand why. Sitting in Brasilia – looking at Brazil’s slowing growth and rising currency – he takes aim at the obvious target for his frustration: the unprecedented monetary looseness of the US, which is creating Mantega’s large capital inflows.
Why wouldn’t he want to stem the flow and halt the rise of the real? The central bank has accumulated a $360 billion foreign-currency reserve and buying more dollars would add to this hugely expensive policy.
In this situation, even the IMF is backing the use of macro-prudential measures in the "short term". The problem is that Mantega’s enemy isn’t short term. The low-rate environment in the US is likely to persist into 2014 and there might be even more quantitative easing.
So Mantega is also responding with his own monetary loosening – fighting low US interest rates with lower domestic interest rates to lessen Brazil’s attractiveness to yield-hungry investors in developed markets. This is dangerous.
New risks and costs enter the equation when monetary policy begins to be used for targets other than domestic inflation. For the first time in recent history, the markets’ expectations of inflation – revealed in recent surveys of economists – show deviation from the central bank’s official target of 4.5% inflation plus or minus 2%.
Economists are saying they don’t believe the government can manage inflation, or, more likely, it now has other priorities. Many believe that 2012 will be the mirror image to 2011, which started strongly and ended weakly, and they expect that the stronger growth at the end of this year will necessitate interest rate hikes in the beginning of 2013 if not the end of 2012.
The problem with Mantega’s latest war is that it is one he cannot win. Unless, that is, he first beats the enemy within. The Brazilian government needs to turn its big guns inward and begin to battle for domestic reform.
Colombia shows the way for Brazil. Juan Carlos Echeverry, Colombia’s minister of finance and public credit, likened one of the battles his government faced during their recent wave of domestic reforms to Stalingrad.
"My philosophy, my mantra is macro[economic management] is mostly fiscal, and fiscal is mostly micro[economic management]," says Echeverry. "So the causality is passing and passing reforms. Once you fix the micro the fiscal is fixed, and once the fiscal is fixed you basically have the macro in place because you then have more room for exchange, monetary and inflation policy. Micro leads to good macro."
Mantega and his colleagues need to be taking the fight to their fiscal budget and driving through a series of reforms. This isn’t to propose that the government should cut social safety nets; instead there are plenty of targets for the elimination of waste and inefficiency, and government programmes that are being milked should be made more secure.
This won’t be easy. It might be politically difficult. And the bad news is that president Dilma Rousseff’s administration is now in its second year. Unpopular reforms should ideally be tackled in year one, capitalizing on political goodwill and the electorate’s enthusiasm for change. If the government doesn’t act soon, it will be too late.
It’s easy to understand why Brazil sees the developed world as the cause of all its problems, but getting angry and starting currency wars won’t help.
Brazil needs a war but it needs to be a fiscal war.
