Brazil's Central Bank Vows to Control Inflation

10/01/2015 - 10h13

Brazil's central bank is willing to do whatever is necessary to control inflation while the country grapples with the thorny issue of how to rebalance the nation's public finances, a senior official has said.

Tony Volpon (pictured), head of international affairs at the central bank, said while tax increases to balance the budget could raise prices, monetary policy would be adapted to ensure that inflation eventually converges to the official target of 4.5 per cent.

"I would much rather that we have a sustainable fiscal situation even if that means higher inflationary pressures that we need to control at our end," said Mr Volpon in an interview at the central bank's headquarters in Brasília.

"We know how to deal with that and we are ready and willing to deal with it again and bring inflation down to target."

The comments come after Brazil's currency, the real, last week broke through its all-time low against the dollar of over R$4 - a fall in value that was only arrested after central bank president Alexandre Tombini threatened possible intervention using Brazil's foreign exchange reserves.

The currency's moves reflected bearishness on emerging markets after the US Federal Reserve decided not to raise interest rates citing weakness in China's economy.

It also showed a lack of confidence in Brazil's fiscal sustainability after flip-flopping by the government on its budget deficit targets cost the country its investment grade rating from Standard & Poor's.

President Dilma Rousseff has been trying to put a fiscal adjustment through congress to rein in Brazil's growing public debt burden but rebellious lawmakers have rejected elements of the plan, especially tax increases.

"The Fed was maybe thinking it was doing something helpful in not raising interest rates," said Mr Volpon, former head of emerging market research at Nomura who joined the central bank earlier this year. But by calling attention to its concerns over China through its decision, it "all of a sudden accelerated the selling of emerging markets".

Mr Volpon said despite the bearishness, markets were overpricing the risk that Brazil would not be able to implement a sustainable fiscal adjustment.

Upward moves in credit markets last week, such as credit default swap rates for Brazil that showed the cost of insuring the country's debt was above that of war-torn Lebanon, were due to technical factors, such as cross-hedging of positions.

"This is a country where the public sector is still a net creditor in dollars," said Mr Volpon. "We have about $50bn of overall external sovereign debt against $370bn of reserves."

Mr Volpon said the country was already adjusting across three important areas.

The sharp depreciation in the currency was lowering the current account deficit to more sustainable levels. It was also reviving net exports after years of them being crushed by a strong exchange rate during the commodities supercycle of the last decade, when Brazil sold iron ore and soybeans to a booming China at record prices.

Monetary policy was also holding tight with the central bank maintaining its benchmark Selic rate at a high of 14.25 per cent.

Where there had been a lag was in the fiscal adjustment. This was due to a structural shift in the economy that had created a shortfall in government revenues - a gap that would have to be met through deeper spending cuts or higher revenues.

"You saw the tax burden go up continually while we had the China-led boom," said Mr Volpon. "We were sort of in a win-win situation. There was enough money for profits, there was enough money for salaries, there was enough money for taxes."

But with the end of the boom, corporate Brazil's ability to produce the same tax revenue had disappeared. This new reality was dawning on society, fuelling the debate between the Ms Rousseff and congress about where the axe should fall.

Mr Volpon said while this debate was not proceeding as fast as markets would like, it was progressing.

In particular, the market turbulence last week had tempered resistance in congress to fiscally responsible measures. Last week, lawmakers did not oppose presidential vetoes of a series of populist bills known as the "fiscal bomb" that if passed would have sharply increased the budget deficit.

"I absolutely do not believe we are in some kind of unsustainable spiral," said Mr Volpon. "In fact, I think it is all converging to a fixed point of stability and these are adjustments are working We just need to persist."

He said for its part, the central bank was waiting to see what new measures would be agreed between the government and congress to ensure the country plugged the budget gap. Recent discussion was of reintroducing a tax on financial transactions, the CPMF.

Mr Volpon said whatever was decided, the central bank hoped to have more clarity before its next monetary policy committee meeting on October 21, at which it would debate what was needed to deal with the implications for inflation.

Copyright The Financial Times Limited 2015