Roberto Campos Neto, President of the Central Bank of Brazil, discusses the bank’s outlook and possible future risks with Global Finance.
Global Finance: What is the main risk for the Brazilian economy in the coming 12 months: inflation or lack of growth? Why?
Roberto Campos Neto: Inflation and growth are some of the numerous challenges faced by the global economy in the aftermath of the Covid-19 crisis. Countries still face lingering difficulties with the pandemic, risk of a tightening in global financial conditions and the buildup of public and private debts. All these factors affect emerging economies, including Brazil.
Brazilian GDP grew 1.2% in the first quarter of 2021 compared to the previous quarter. This result led the GDP to return to the level of the last quarter of 2019. In the second quarter of 2021, the worst quarter in terms of deaths from Covid-19, Brazilian GDP declined 0.1% in relation to the first quarter. Recent indicators, however, show positive evolution in the economic activity, and the prospective scenario includes a robust recovery over the second half, as the effects of vaccination are felt more broadly. In particular, the service sector will benefit from this movement.
In the baseline scenario of the Central Bank of Brazil (BCB), the output gap is expected to close over time, although at a slower pace. The median of market expectations points to GDP growth rates of 5.2% in 2021 and 1.9% in 2022.
As regards inflation, it is important to mention that the rise in prices across the globe seems related to factors that have a more cyclical component and others which have a more structural nature. For instance, higher capacity utilization in industries, bottlenecks in specific sectors, shifts in consumption between goods and services, and the need for firms to adapt towards a greener economy have pushed up prices of several inputs, from semiconductors to industrial commodities. It is still unclear to which extent each of these factors bring temporary or more persistent impacts on inflation.
When it comes to inflation in Brazil, it is showing signs of higher persistence, and the latest releases showed a more unfavorable composition. It is noteworthy the surprise with the underlying services inflation and the continuing pressure on industrial goods, which cause core measures to rise. In addition, there is pressure in volatile components, such as the additional increase in electricity fares and food prices, both due to adverse weather conditions, as heat waves, frosts and droughts. These adverse weather conditions are responsible for the largest upward contributions for inflation, both in 2020 (food prices) and 2021 (monitored prices, electricity in particular). Together, all these factors have led to a significant revision of short-term forecasts.
Therefore, the adjustment that is being implemented by the BCB’s Monetary Policy Committee reflects the perception that the recent deterioration of inertial components of inflation, in a moment of reopening of the service sector, could result in additional deterioration of inflation expectations. Ultimately, the BCB understands that, at this moment, the strategy of a quicker monetary adjustment by increasing its policy rate to a level above the neutral is the most appropriate strategy to guarantee the anchoring of inflation expectations, and it is also in line with BCB’s fundamental objective of ensuring price stability.
GF: Did the health crisis change the economy in a permanent way? Is there something that should prompt central bank to change their policies?
Neto: One important change is that the Covid-19 pandemic accelerated the structural shift toward new technologies. Social distancing measures required adapting business for remote working, the adoption of new digital technologies and a rearrangement of the productive sector. Many of these changes are expected to remain even after the pandemic is over and should affect labor markets and the structure of the economy in the next years.
In the labor market, the increased use of technology has reduced the demand for less qualified workers. This change had a strong impact on the economy, especially the services sector, which had to reinvent itself with less use of informal labor. One of the consequences of this change is that the return to the pre-pandemic employment level may be slower, especially for workers in the informal sector.
In addition, the increased use of technology, together with a greater social demand for a more sustainable and inclusive economy, has resulted in major changes in demand and prices of several inputs, such as semiconductors and commodities. One question that remains from this structural change regards its potential impact on long-term inflation.
In this context, the themes of social inclusion, digitization and environmental sustainability have become elements of great importance in the recovery from this crisis.
In Brazil, we are aware of these transformations and the BCB implemented a broad agenda of reforms for the financial system: the Agenda BC#. Among important initiatives in this agenda to create a more inclusive financial system, we have the implementation of an instant payment system (Pix); the implementation of the Open Finance and the Regulatory Sandbox; the modernization of the FX legislation; and the implementation of financial education actions.
The BCB acknowledges in its agenda the society’s demand for a more sustainable recovery. The BCB has a long history of supporting the environmental agenda, implementing measures directly related to this matter and actively taking part in the international debate. Continuing in this path, the BCB launched a broader sustainability agenda, as a part of the Agenda BC#. The BCB´s premise is to lead by example within the National Financial System and to deliver concrete results to the Brazilian society on a regular basis. Our goal is to remain at the frontier of knowledge to face the future social and environmental challenges.
GF: The Central Bank of Brazil was recognized full independence from the political power with a legislation approved in February 2021. What signals is this providing to the market and what are the advantages for the central bank?
Neto: The Law of Autonomy of the BCB was approved by the Brazilian Congress in February 2021 and has been ratified by the Brazilian Supreme Court in August 2021. This law is the result of a long process of institutional maturation, where the benefits of an autonomous, transparent, and responsible central bank have become clear to society.
The Law of Autonomy has some important elements. It defines price stability as the BCB’s main objective. Without prejudice of this main objective, the institution will also aim to ensure the stability and efficiency of the financial system, smooth fluctuations in the level of economic activity and foster full employment. The law also determines fixed and non-coincident four-year terms for the governor and the deputy-governors. These mandates overlap only partially with the presidential mandate.
One of the main reasons for the central bank's autonomy is to separate the political cycle from the monetary policy cycle. Autonomy allows the institution to pursue its objectives in a technical, objective, and impartial manner, reducing economic instability in periods of government transition and aligning the BCB´s practices with the best international ones. Economic literature and international experience show that central bank autonomy is associated with lower and less volatile inflation, without compromising economic growth.
The institutional change brought by the autonomy will contribute to consolidate the gains achieved in recent years in terms of price stability and financial stability. Legal autonomy will promote greater credibility for the market of BCB’s actions and thus facilitate the achievement of low inflation, lower structural interest rates, lower risks, and greater monetary and financial stability. Overall, by guaranteeing operational autonomy to the BCB, the law provides greater confidence that the institution will be able to meet its objectives.
GF: What is the economic outlook for Latin America overall?
Neto: Growth prospects for Latin America countries have improved markedly this year due to the acceleration of the immunization efforts, the progressive reduction of restrictions and its effect on activity, and the maintenance of fiscal and monetary stimuli. Economic recovery perspectives are now far brighter than what they were at the beginning of the year.
However, there are still some challenges ahead. First, these countries face an environment of low structural growth and rising political polarization. These political noises generate volatility in the short term and affect even more the output growth. Second, some of these countries have weaker fiscal conditions, especially high levels of public indebtedness. After all, macroeconomic equilibrium is more sensitive to fiscal imbalances in emerging economies than in advanced economies. In this sense, the implementation of structural reforms would be needed to put these countries in a higher growth path.
Regarding monetary policy, the reduction of monetary stimulus by the Federal Reserve, expected to be announced in the coming months, should contribute to trim down global liquidity and increase the funding costs for emerging economies. On the domestic side, there is the issue of managing above-target inflation, which is the most complex test for Latin American central bankers now. Higher input costs continue to push prices up, as fast global economic recovery amid highly stimulative policies, especially in advanced economies, lead to important mismatches in goods supplies, higher transportation costs and stretched commodities prices. Past currency depreciation has also played a role in pressuring prices, as demand recovery has allowed for firms to recompose mark-ups. Lastly, Latin American countries have been hit hard by food commodity price increases, since food represents a large share of their population consumption basket.
All these factors make it difficult for Latin American central banks to sustain expansionary monetary stances. Indeed, since the beginning of the year several central banks have started to normalize their monetary policies. Keeping inflation expectations anchored and avoiding sidetracking the still ongoing economic recovery is now the biggest challenge for the central banks of the region.