Brazil’s challenge: boosting growth without triggering inflationBrazil is building on 10 years of robust economic fundamentals.
Economic growth, which has long been
anemic, is beginning to pick up. Inflation continues
to be low. Consumer prices rose only 3 percent between
January 2006 and January 2007 and inflation expectations
remain low. Brazil’s external position is solid, with a strong
current account surplus—1½ percent of GDP last year—and
international reserves around $97 billion, equivalent to about
175 percent of its short-term debt.
Despite the improvement, economic growth remains low.
Real GDP grew less than 3 percent in 2006 and is projected
to grow 3.5 percent in 2007—above the annual average of
2½ percent it has registered since 2000, but below the Latin
American average. Brazil recently announced a new program
intended to use increased public investment spending and
tax incentives to boost annual growth to 4.5–5.0 percent.
Even though the focus on raising growth is welcome, unlocking
Brazil’s vast economic potential—and accelerating the
reduction in poverty and income inequality—will require
deep structural reforms. This will be the overriding policy
challenge for the next few years.
Brazil has made important progress
Brazil has come a long way in the past decade. After a period
of high volatility and crises, South America’s biggest country
reduced inflation drastically by the mid-1990s under the Real
Plan, an innovative inflation-fighting program based on an
exchange rate anchor. Following a period of strong and continued
pressure on the exchange rate, the Real Plan gave way
to an inflation-targeting framework in mid-1999, with flexible
exchange rates and stronger fiscal policy underpinnings. This
framework has allowed Brazil to withstand the market turbulence
associated with the 2002 elections and the mild market
impact of a sequence of corruption scandals in 2005. The
contrasting market reactions to the two episodes point to the
improved strength of economic fundamentals in Brazil and the
new era of stability in the country. This stability has been maintained
and strengthened by President Luis Inácio Lula da Silva,
the candidate initially feared by the markets in 2002.
A new law ensures fiscal responsibility
Low inflation, narrowing income disparities, and reduced poverty
are among the many achievements of the past 10 years.
The 3.1 percent increase in consumer prices last year was
well below the middle point of the Central Bank’s inflation
target range of 4½ percent. Income disparities (as measured
by Gini coefficients) remain high, but shrank to a historic
low in 2005, and the percentage of people under the poverty
line has fallen to 30 percent, or 13 percentage points below
its 1993 peak. Public debt–to-GDP ratios, although still high,
have also been declining since 2002 as a result of years of
fiscal effort and institutional changes. Among key changes,
the cornerstone was the enactment in May 2000 of the Fiscal
Responsibility Law, which sets out for all levels of government
rules designed to ensure medium-term fiscal sustainability
and establishes strict transparency requirements to underpin
the effectiveness and credibility of such rules.
At the same time, growth has been disappointingly low.
The average rate of growth of 2½ percent since 2000 is well
below the 20th century average of about 5 percent. Actually,
low growth has been a problem since the early 1980s, when
the economy began to suffer the consequences of a forced
development strategy base on continued accumulation of
external debt despite two worldwide oil price shocks. In particular,
inflation in the 1980s and early 1990s soared despite
repeated stabilization plans. The hard-won economic stability
initiated in the mid-1990s now seems well-established
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