Trends and Prospects for Savings in Brazil
Author:
A. Longo Carlos
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Language:
English
Print Publication Date:
15 Jan 1987
Keywords:
BOOK; debt; deficit; export; country; capital formation; costa e silva government; government intention; government investment; federal budget; Inflation; Gross capital formation; Government debt management; Loans; Global
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Abstract

Brazil, like most Latin American countries, is characterized by the scarcity of voluntary resources for long-term investment. Perhaps it is a cultural problem or simply the result of the poor distribution of income. The fact is that rarely have increases in investment depended significantly on the mobilization of voluntary savings via the financial or capital market. After a brief encounter with nationalistic populism, the second Government of Vargas ended in 1954 with the stabilization crisis presided over by Ministers Gudin and Bulhōes. Once this very brief crisis was over, the development-oriented Government of Juscelino Kubitscheck opted for the expansion of investment in infrastructure, the construction of Brasilia and, through the use of tariff barriers, started off the process of import substitution financed through the issuance of currency rather than through voluntary savings.

Brazil, like most Latin American countries, is characterized by the scarcity of voluntary resources for long-term investment. Perhaps it is a cultural problem or simply the result of the poor distribution of income. The fact is that rarely have increases in investment depended significantly on the mobilization of voluntary savings via the financial or capital market. After a brief encounter with nationalistic populism, the second Government of Vargas ended in 1954 with the stabilization crisis presided over by Ministers Gudin and Bulhōes. Once this very brief crisis was over, the development-oriented Government of Juscelino Kubitscheck opted for the expansion of investment in infrastructure, the construction of Brasilia and, through the use of tariff barriers, started off the process of import substitution financed through the issuance of currency rather than through voluntary savings.

The result of this orgy of development was that while gross domestic product (GDP) grew, inflation started to do the same. When the new Government of Jânio Quadros took over in 1960, savings and liquid investments had dried up in the face of the uncertainty as to price developments and government intentions. The Government of President Goulart which took over in 1961, after Quadros resigned, in no way changed the uncertainties of the situation. Far from being concerned about investments, this Government, with leanings toward the labor movement and socialistic sympathies, spurred on inflation by granting wage readjustments much larger than the budget had allowed for.

The inevitable fall of Goulart led the Castelo Branco Government to adopt a policy that was simultaneously orthodox, as it cut down excess demand, and progressive, because it completely reformed the institutions. The bank reform, the capital market reform and the tax reform all date back to this time.

Saving has been systematically declining in Brazil since the beginning of the decade and the conventional instruments for financing the public deficit are practically exhausted. The current rise in growth could suddenly be cut off if thorough institutional reforms are not undertaken. This paper begins by taking a retrospective look at the evolution of the instruments of financial intermediation in Brazil. Next we will look at the decline in saving in recent years, on the basis of national accounts data. In section four, we will present a brief overview of the main investment increases. Section five highlights the problems faced by the Government in financing the deficit, and last we will present possible scenarios and prospects for attracting savings in Brazil.

Composition of Financial Assets

Brazil’s financial institutions underwent profound changes in the mid-1970s, having hitherto essentially been banking institutions. The 1959–64 acceleration of inflation and the Usury Law (maximum annual interest rate 12 percent) accentuated the tendency to short-term lending and promoted financial disintermediation. Loans for crop financing and long-term loans were granted selectively at highly subsidized rates by the officical banks (Banco do Brasil, BNDES, savings banks). The stock markets dealt almost exclusively in exchange operations and, on a limited scale, government securities.

Law No. 4595/64, which organized the monetary system, established the Central Bank and the National Monetary Council. Law No. 4728/65 imposed discipline on the capital market by regulating the operations of the brokerage companies, establishing investment banks and distribution companies. The monetary correction mechanism was instituted by law No. 4356/64 with the establishment of ORTNs. Law No. 4380/64 established the National Housing Bank, which became the leading institution of the Housing Financing System (SFH), composed of real estate loan companies, savings and loan companies, and the federal and state savings banks. The introduction of the monetary correction mechanism helped rehabilitate the public debt as a noninflationary instrument for financing budget deficits. Savings deposits with monetary correction that would finance SFH loans grew rapidly from 1970 onward. Last, the investment banks were authorized to attract resources via fixed-term deposits with monetary correction.

The creation of various compulsory saving mechanisms also dates from this time. In 1967, enterprises began withholding 8 percent of wages to be invested in the Guarantee Fund for Time of Service (FGTS), essentially an unemployment and retirement insurance fund, whose resources were allocated to the BNH. In 1971, enterprises were required to withhold 0.75 percent of their turnover for the Social Integration Program (PIS), which guarantees the employee a remuneration of 3 percent a year over the monetary correction, the BNDES being responsible for the use of these resources.

The 1964–65 reform favored the accumulation of financial assets, whose balance as a percentage of GDP rose between 1965 and 1975 from 23.9 percent to 32.8 percent, the level to which it has only recently returned. Even this percentage is not significant if it is compared internationally; in some European countries with the same per capita income the rate is as high as 100 percent. The increase took place despite the decline of monetary assets from 20.6 percent to 13.1 percent of GDP, thanks mainly to the growth in indexed assets—passbook savings accounts, fixed-term deposits, and federal public debt—which led to nonmonetary assets rising from 3.2 percent to 19.7 percent during this period. The gradual and persistent decline of the stock of money after the reform is attributed to not only the growing complexity of the market but also to inflation, which rose from 20 percent a year during the 1967–75 period to 40 percent in 1976–79, then to 100 percent during the 1980–82 period, and finally to 200 percent in 1983–86 (see Table 1).

Table 1.

Principal Financial Assets

As a percentage of GDP

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Note: Balances at June 30, from 1970; until 1965 as reproduced in A. Lemgruber, Un Análisis Cuantitativo del Sistema Financiero (Rio de Janeiro: IBMEC, 1978).

Held by the public.

With the change in the currency unit in February 1986 (the cruzado plan) there was a sudden rise in monetary assets, as inflation fell from almost 14 percent a month to about 1.5 percent. Indexation was suspended, being kept only for passbook savings accounts. Currently, most fixed-term deposits and government securities are negotiated at nominal rates with maturities no longer than 60 days.

Saving in Decline

The evolution of the financial assets in the hands of enterprises and individuals is a slender indication of aggregate savings. Compulsory saving, new stock subscriptions, and investment funds and the savings of enterprises (retained earnings), government saving (current account surplus), and external saving (current account balance) must also be considered. On the basis of the national accounts, it is possible to obtain a gross capital formation series broken down by source and uses, which clearly shows the colossal fall in savings recorded since 1980.

Gross capital formation reached unprecedented levels close to 30 percent of GDP in the mid-1970s thanks to the very positive contribution of government saving (direct administration), state enterprises, and foreign savings. This composition did not fundamentally change until 1979, when, faced with the second oil shock and high international interest rates, the Government refused to make a compensatory readjustment.

When the international Financial market was paralyzed in 1982, gross capital formation fell to 16.9 percent and is currently holding at this level, with some difficulty, exclusively through the contribution of private sector saving. Government savings and foreign savings disappeared a long time ago. The effect of this state of affairs on investment is obvious. The Government, either directly or through state enterprises, reduced its investments, and even the private sector did the same, to levels about half of those recorded halfway through the previous decade (see Tables 2 and 3).

Table 2.

Sources of Gross Capital Formation

In billions of current cruzeiros

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Source: National Accounts: SEST and Central Bank—the sum of the lines differs from gross capital formation because of changes in the current cruzeiro. Until 1980, national account figures are as reproduced in L. Lago and others, El Combate de la Inflación en el Brasil (Rio de Janeiro: Paz e Terra, 1984). Note: SP = private sector savings; SE = state enterprise savings; SG = government savings; SX = external savings.
Table 3.

Uses of Gross Capital Formation

In billions of current cruzeiros

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Source: National Accounts: SEST and Central Bank—the sum of the lines differs from gross capital formation because of changes in the current cruzeiro. Until 1980, capital account figures are as reproduced in L. Lago and others, El Combate de la Inflación en el Brasil (Rio de Janeiro: Paz e Terra, 1984). Note: IP = private sector investments; IE = state enterprise investments; IG = government investments.

Investment Peaks

Three investment peaks followed by stabilization crises have taken place in Brazil since the Second World War. The expansionary Government of Getúlio Vargas was followed by a short contraction in 1954–55, under Ministers Gudin and Bulhōes. At the end of the decade, there was a colossal expansion in investment during the Kubitscheck Government financed in the final analysis through the monetization of the public deficit, as the financial and capital markets were just getting under way. After a brief contractionary and expansionary period under Jânio and Goulart, respectively, there came the fiscal and monetary contraction that went hand in hand with the strategic plan of action of Castelo Branco’s Government, conducted by the Campos and Bulhoes duo. The present banking, financial, and tax structure and the increase in investment that took place in the following years are due to the basic reforms introduced during this period.

The modernization of the institutions simultaneously produced more voluntary saving, an increase in autonomous investments, and fiscal surpluses in the current account. It is true that after 1969 the Costa e Silva Government opted for a gradualistic policy in the struggle against inflation, which meant the generalization of the indexation process through which the ORTN turned into a second unit of account in Brazil. While on the one hand indexation initially made it easy to go along with inflation and forestalled capital flight, on the other hand it consolidated currency issue as a way of financing the public deficit.

The possibilities for reducing the monetization of deficits were abandoned after the first oil shock. Faced with the wide availability of external financing, the Government tried to raise the level of public investment (II PND). It stimulated attraction of external loans directly by state enterprises or indirectly via the financial system. The result was that Brazil absorbed the external shock with these loans, reduced the growth rate to a certain extent, doubled the rate of inflation, increased public and private investment, financed the current account deficit, and even accumulated reserves.

Since 1979, Brazil has been undergoing a stabilization crisis the consequences of which are still unforeseeable. Faced with two unfavorable external shocks (oil prices and interest rates), inflation running at over 50 percent, and dwindling reserves, the recently elected Figueiredo Government opted for an expansionary fiscal and wage policy (subsidies for agriculture, substitution of imported energy, and six-monthly wage readjustments above the level of inflation), and a contractionary monetary policy (domestic credit controls), with the object of continuing to attract external resources and substituting imports without reducing the level of activity.

A combination of ill-chosen initiatives—a maxidevaluation followed by prefixed exchange rates and monetary correction at unrealistically low levels—accelerated inflation and further damaged the balance of payments. When prefixings were suspended, a fiscal contraction followed, and then reversed itself during the period leading to the 1982 elections. When the external debt refinancing process was suddenly broken off, Brazil moved into the severest recession in its history. In 1983, a new maxidevaluation and wage restraint raised the exchange/wage ratio to close to 70 percent.

As a result of these measures, inflation climbed to a new level (200 percent annual), and Brazil generated a trade surplus that since 1984 has allowed it to keep the current account balance in equilibrium, with full payment of external debt interest, without new money. Driven by export growth, and more recently by an expansionary fiscal and monetary policy, Brazil began to grow again, but inflation did the same. This growth probably lacks internal sustainability, as since the beginning of the decade investment in Brazil has been inadequate and the instruments of Financial intermediation, capital, and public-deficit financing are essentially the same as they were twenty years ago.

Deficit Financing

For a given level of inflation and use of capacity, there are three main definitions of deficit: deficit in the meaning usually employed, that is, the public sector borrowing requirement, which is measured by the difference between the total use of current and capital resources of the government and its ordinary revenues. This concept is particularly useful as an indicator of the government’s tax burden on the financial market. The nonfinancial deficit, also called primary deficit, is simply the public sector borrowing requirement less public debt interest payments. This is frequently used as an indicator of the government’s pressure on aggregate demand. Last, we have the deficit that is of particular interest in examining the government’s contribution to aggregate savings, that is, the current deficit. This deficit is measured by subtracting capital expenditure from the public sector borrowing requirement.

We can conclude from a superficial examination of the figures that the deficit recently stabilized at between 6 percent and 8 percent of GDP and that the nonfinancial deficit and the current deficit are close to zero. There are no reliable estimates, but there is no indication that the public sector borrowing requirement has been very different in the past. At the same time, data suggest that until 1980 the nonfinancial deficit was positive, since public debt had not reached its present proportions: the financial charges component was less of a burden on government expenditure than it now is. Consequently, at that time, the fiscal pressure on the level of activity was meaningful, and particularly so on investments. However, as we saw earlier, the current deficit was negative during the previous decade, which suggests that the Government was financing a good part of its investments from its own resources (generated by current revenues). Thus at that time, the Government’s contribution to aggregate savings was not to be disdained.

The public deficit measured indirectly as the difference between (federal, state, and local government) public sector debt balances from one year to the next, plus currency issue, plus seigniorage excluding inflation on debt service, amounted to 0.8 percent of GDP in 1982 (a 5.5 percent basic increase and 9 percent increase in debt), 6.5 percent in 1983 (1.7 percent basic increase and 4.8 percent debt increase), 6.2 percent in 1984 (2.7 percent basic increase and 3.5 percent debt increase) and 8.7 percent in 1985 (2.7 percent basic increase and 6 percent debt increase). Public debt rose from 27.2 percent of GDP in 1981 to 50 percent in 1985, and currently, 55 percent of the debt is external (mainly federal state enterprises), 25 percent consists of federal government bonded debt, 10 percent is federal state enterprise debt with the domestic financial system, and 10 percent the debt of states and municipalities. As indicated, the deficit is largely financed by the inflation tax, despite which the debt/GDP ratio continues to rise. There are also circumstantial economic reasons for the existence of a higher-than-desired debt. The fact is that the economy has been operating beyond the level of full employment since mid-1986, Furthermore, with the change in the monetary unit and the consequent remonetization of the economy, the Government will have to replace currency issue with net placements of securities in new credit operations.

Monetization of deficit has always been a widely used procedure in Brazil. The creation of the Central Bank in 1964 did not prevent the Banco do Brasil from continuing to operate as a monetary authority through the so-called conta de movimento, to which until quite recently the negative sum of the asset and liability operations of the subsidized credits was debited. Also, with the growth of the public enterprise sector, the federal budget gradually declined, because these entities today control resources three times larger in absolute terms. Last, with the transfer in 1982 of the federal public debt to the Central Bank (Complementary Law 12/72), the atrophy of the fiscal budget was complete.

This situation started changing slowly in 1979 when the Secretariat for Control of State Enterprises (SEST) was created, along with the Planning Secretarial of the Presidency of the Republic. SEST now consolidates the balance sheets of 179 enterprises in the federal state production sector (SPE), although fewer than half a dozen (PETROBRAS, ELETROBRAS, TELEBRAS, VALE, RFFSA) are of major importance. SEST also consolidates the budget of the social welfare system (SINPAS). Until last year the budget for the official banks—Banco do Brasil, BNDES, Savings and Loan Bank, BNH, and so on—was included in the SEST global expenditure program. However, it was not made public in 1986.

From 1985 the federal budget included a provision for fiscal expenditures that had previously come under the monetary authorities—subsidies to agriculture, exports, and financial charges on bonded debt. Recently the rediscount facility (conta de movimento) of the Banco do Brasil was frozen and the Banco do Brasil was formally separated from the Central Bank: its deposits no longer form part of the money supply and are now subject to a legal reserve requirement. The subsidies administered by the Banco do Brasil will be financed by the recently created Secretariat of the Treasury under the Ministry of Finance. Despite these praiseworthy innovations, one cannot ignore the fact that the “credit budget” and the public debt are still essentially administered by the Central Bank. It should also be remembered that the federal budget is sent to Congress on the last day of August, while that of the state enterprises is submitted on the last day of the year. Consequently, over and above a shortfall in the coverage of these budgets, there is an obvious gap between the dates on which they are presented.

Despite everything, the Sarney Government is not overawed by the size of the deficit. It complies with the changes already made in the budget process and suggests that the recently created compulsory “loan” (in fact a subscription) on the purchase of fuels and the sale of vehicles, together with a new tax on travel abroad, will suffice to finance the deficit henceforth. The cruzado plan, which confined itself to knocking three zeros off the old currency, and to converting wages and contributions by half, financial contributions by their maximum value, and fixed contracts in nominal terms by their discounted value according to the official conversion table, would be sufficient to eliminate inflation, and even indexation.

The indexation process is not without complications. As we have seen, it played an indispensable role in restoring the credibility of public credits after 1964 and in making long-term loans and the housing financing system possible. Once generalized throughout the economy, indexation with high inflation rates means the automatic monetization of part of the public deficit. The government cannot drastically reduce indexation while inflation remains in three figures; public financing cuts would generate colossal adjustments in the distribution of income and would not prevent inflation stabilizing, even at high levels. But, with the change in the monetary unit and low inflation, let us say 20 percent annual, the financing cuts could make indexation redundant. The Government has not yet made any attempt along these lines and, on the contrary, is trying to make the freeze redundant by means of messianic appeals for increased output.

Mobilization of Savings

The economic policy of the Sarney Government has not been clear and firm enough to reverse the decline in savings and stimulate investment to increase capacity. The President, supported by a fragile coalition of parties, has been unable to adopt the unpopular measures that seem inevitable if the economy is to be rehabilitated on a sustainable basis. The stabilization crisis, which began toward the end of 1980, may continue despite the dizzy growth of the last two years. A stop-and-go policy has prevented structural reforms from taking place since 1979. This Government took over in March 1985 with an economy already on the road to full recovery, real wages increasing faster than productivity, and external restrictions (oil prices, dollar and interest rates) moving in a favorable direction.

Despite the rhetoric, the Government postponed the debate on the more pressing reforms and embarked on a markedly expansionary policy from August on. The monetary reform did not change this situation and, on the contrary, stimulated demand through real wage increases and price freezes, many of these set at below the average variable cost. Small and medium-scale enterprise owners, whose products are not easy to control, are occupying the position of the traditional firms. The production of consumer durables grew through July by 30 percent over the same period in the previous year, but intermediate goods did not exceed 8 percent. Stocks are low, and in order not to lose the market, many firms are raising wages even higher with a view to holding on to their workforce. Here there are problems both of maladjusted relative prices, and of excess demand, characterized by the increasing prevalence of speculation, shortages, deterioration of quality, or the “disguising” of products to get around the freeze. Meanwhile, the official indexes do not reveal this inflation.

Once the process of remonetizing the economy was exhausted, and with reluctant acceptance of the diagnosis of a feverish condition, the Government in July issued a range of fiscal measures to keep under its administration approximately 2 percent of GDP during the following 12 months. The compulsory “loan” will be used in the National Development Fund (FND), together with any yield there may be from a limited number of selected public enterprise shares and new uses of the pension funds of state enterprise officials. The implementation of these measures was marked by inertia and confusion. For a start, a compulsory subscription, which may or may not have residual value, was called a loan. Furthermore, as it is a “loan,” the official inflation indexes do not take into account the price increases of fuels and vehicles, thus creating a monthly 2 percent to 3 percent lag of these indexes against the others, with negative repercussions on the financial market and on the Government’s own credibility. These problems would not have arisen if the Government had openly confessed that demand was over stimulated and that conventional measures (tax increases, placement of securities, and reduction of expenditure) would have to be adopted to finance and/or reduce the deficit.

In the past, periods of high investment were possible thanks mainly to forced saving (currency issue), and external saving (loans), apart from domestic saving protected by indexation of the financial market and the balance sheets of enterprises. Capital flight did not become a serious problem, as it did, for example, in Mexico and Argentina, because in Brazil, exchange and monetary policies, in general terms, kept real interest rates positive. Currently, these requirements are seriously compromised. The monetary reform is not allowing the deficit to be financed through currency issue at the same rate as hitherto, at least for the time being. External savings, in the form of new loans, essentially depend on the general condition of the economy and on an ambitious renegotiation program which in turn depends on the success of the cruzado plan. To erase the memory of inflation, the Government prohibited indexation of the balance sheets of enterprises and of almost all securities on the financial market; as it is known that the projected inflation rate is not less than (let us say) 20 percent annual, the distortions that these measures introduce in saving, investments, and the placement of resources are evident.

The most significant changes announced or actually undertaken by this Government (freezing the conta de movimento, budget unification, creation of the Secretariat of the Treasury, setting up the FND, creation of Central Bank bills, etc.), are partial and consequently insufficient, in view of the magnitude of the problems that have to be faced. They are not part of a plan to cover all the Government’s financing and resource use needs. In this sense, they do not break with the inertia of recent years in fiscal and monetary affairs, and the Government is having to adopt stopgap measures that revolve around the general problems but do not solve the fundamental issues of reducing the public deficit and of stimulating savings and investment.

Currently, most state enterprise prices are totally out of phase (50 percent below 1980 prices), and they cannot invest as much with their own resources as they would wish. They even transfer a large proportion of their financial costs to the Banco do Brasil and to the BNDES. These banks guarantee the financial charges of the state enterprises but transfer the account to the Central Bank which is relieved when the Treasury declares a compulsory “loan” and compensates it—albeit partially—for these expenditures. The contradictions of the Housing Financing System are also well known—a decade of inequality between price indexes, wage changes, and monetary correction of savings passbooks and the symmetry of the system for making services and the debit balance current—gave rise to uncovered liabilities in the system of about US$20 billion, which will become due in the next few years. The continuing lack of transparency in the public sector accounts is thus notorious.

Some not inconsiderable disadvantages of this state of affairs are the discrepancies and uncertainties about the ideal compensation policies. These distortions originate not only in the diversity of viewpoints regarding the behavior of the economy and the probable incidence of specific measures, but also particularly, in the case of Brazil, in the lack of reliable information. For example, only recently, the Government admitted that, far from disappearing, the public deficit, excluding inflation, is running at about 5 percent of GDP. Even so, doubts remain about this estimate itself.

One crucial element in calculating the deficit is the choice of transactions to be included in the calculation. If this universe is limited to the federal government, the following budgets can be distinguished: the fiscal budget per se, employment funds (FGTS, PIS/PASEP, FND), the funds for direct distribution (SINPAS, FINSOCIAL, PIN/PROTERRA), those of public service enterprises (ELETROBRAS, TELEBRAS, RFFSA, etc.), those of public enterprises (PETROBRAS, VALE, SIDERBRAS, etc.), those of the official banks (BB, CEF, BNH, BNDES) and any funds and programs still administered by the Central Bank. The fiscal budget and the budget of the SEST seem generally to be in balance, as the former does not include all of the expenditures which are a central government responsibility—essentially the financing requirements of official banks, whose expenditure program takes up almost 10 percent of GDP. The SEST covers part of its deficit with a capital increase supplied by means of fiscal resources.

With an overall view of the fiscal accounts, it is possible to avoid taking casuistic measures and plan for institutional reforms. For example, to reduce the deficit it would be inadvisable to raise (let us say) income tax, even though it represents over half of the federal revenue. Given the considerable segmentation of the Brazilian public sector, a linear cut of 10 percent in its total expenditures would be equivalent, from a financial point of view, to a 100 percent increase in income tax. Furthermore, in Brazil, income tax is essentially an indirect tax; 40 percent of collections come from enterprises (IRPJ), 20 percent from interest and dividend remittances abroad and 20 percent from financial market yields, taxed exclusively at source. Consequently, in order not to further penalize middle-class wage earners and consumers, a tax reform that would broaden the concept of income and include all sources of income in the individual return, would be a prerequisite to raising the income tax.

The Government possesses an ever-dwindling range of instruments to reduce the deficit and stimulate investments, other than the publication of yet more packages of measures or sheer direct intervention. Recently, with the intention of extending the deadline for financial operations concentrated in the under-60-days range, the National Monetary Council decided to tax heavily short-term operations by individuals and nonfinancial enterprises. There is a growing expectation that between the November elections and the end of the year, the Government will promote a new package of fiscal measures. This climate is clearly not compatible with renewed investment. The prerequisites for establishing confidence in the financial and capital markets include the revision of the short-term fiscal and monetary policy, the launching and consolidation of institutional reforms and the renegotiation of the current external debt on a permanent basis.

The new set of fiscal measures should include an explicit statement of, and a once-and-for-all answer to, the question of financing and reducing the public deficit. With regard to outflows, the Government should not shy away from announcing cuts in expenditures and increases in taxes and tariffs. Obviously this calls for unpopular measures, such as the managed unfreezing of prices and the revision of the wage “trigger” (automatic readjustment of wages whenever inflation reaches 20 percent). The strict monetary policy recently re-adopted should be continued in order to keep real interest rates at levels no lower than 10 percent or 12 percent a year. Furthermore, the monetary authorities would reduce uncertainties if they could agree to set their monetary expansion targets, even though this may be difficult because of the current confusion about the budget. The return of indexation for placements and contracts of more than one year is indispensable to reactivate long-term investment. It will no longer be possible to put off fixing an exchange devaluation policy.

Until the various budgets are standardized, simplified, and submitted simultaneously to Congress, budgetary programming will not be taken seriously. A tax reform to broaden the bases of the main taxes (the income and value-added taxes), would allow the present excessive number of parafiscal taxes and contributions to be reduced (single taxes, FINSOCIAL, PIS/PASEP, PIN/PROTERRA, Wage-Education, etc.). An effective separation of the Banco do Brasil and the Central Bank will take place only when a federal credit budget is instituted (consolidation of the financial programming of official banks) with prior provision of noninflationary resources. The administration of bonded and financial public debt, which is currently a federal responsibility, should be transferred from the Central Bank to the Secretariat of the Treasury, and the systems (SFH) and enterprises that are verging on bankruptcy should be capitalized, privatized, or simply dissolved. A realistic tariff policy would help reduce subsidies and raise the investment capacity of the state productive sector.

With an annual inflation rate of 20 percent, an extension of the floating rate mechanism for credit operations of more than one year, which is what the Government seems to want, does not seem possible. Consequently, there should be several instruments together to attract financing. Pre-fixed interest on very short-term operations (LBC), should form part of the Central Bank’s portfolio in managing the liquidity of the system. Floating interest rates for maturities of up to 360 days and the monetary correction of interest would be the basic rule for operations with maturities of more than one year. Currently, the tax bite is one of the main cost elements of loans; taxing at source could be lower and compulsorily considered as an early return. The expansion or contraction of each of these market segments will naturally depend on business trends, the level of inflation, and the actual conduct of fiscal and monetary policy.

Financial intermediation outside banks (bonds without specific guarantee, “commercial paper”) or even the involvement of banks in business intermediation (mergers, expansion, and associations) and in advising enterprises, have not been sufficiently developed in Brazil. Nevertheless, if there is a new rise in investment, these nontraditional sectors and the capital market should have an historical opportunity to increase their share of the market. The easy phase of large investments in import subsitution seems to be over—Brazil imports barely 3 percent of GDP, excluding oil. The transition to mature industrialization will call for the large-scale absorption of imported technology, a process that depends on competitive and decentralized investment methods.

The consolidation and renegotiation of the external debt must be preceded by the restructuring of the liabilities of the highly indebted enterprises. Part of this debt, which in some enterprises takes up 90 percent of their liquid assets, would be capitalized with the Treasury, which will take over the burden of financial charges to creditors. (In fact it has already done so in many cases.) It would then be necessary to restructure on a longer term (let us say 25 years) the maturities of the principal of a large proportion of this debt. The interest would be paid in full, but on the understanding that at least half would be reinvested in Brazil. The exchange devaluation policy would explicitly strive to maintain the par value, which has not happened, while not neglecting the evolution of the balance of payments. Renegotiation of the debt, fiscal adjustment, and institutional reforms would be prerequisites for attracting risk capital on a large scale, financed through domestic and foreign savings.

Comments

Aldo A. Arnaudo

The decline in investment and voluntary (private) saving ratios is the main concern of the paper. The 1980s have seen a substantial drop in investment expenditure per domestic unit of production as compared to the previous decade. A similar development can be observed in Argentina. The two countries’ experience seems to indicate that this decline is connected with external debt service payments rather than with the suspension of foreign capital inflows, a phenomenon that would also explain the sharper drop in the figures for Argentina.

Investment is financed by private savings, by the savings of state enterprises (depending on the tariffs for public services), government savings (depending on taxation), and foreign savings, practically nonexistent at present. If the private savings ratio were raised it would be possible to increase investment and the main restriction on “most Latin American countries, … the scarcity of voluntary resources for long-term investment” (p. 180) would disappear. An orthodox Keynesian position would conclude that this is impossible, but social behavior as regards savings is quite complex and has been shown to be affected by the institutional framework.

Longo outlines the mechanisms used in his country to stimulate private savings, setting forth the instruments and their results. It is not my intention here to discuss these experiences, but rather to make a comparative analysis between Argentina and Brazil and to consider some vital aspects to guide future action.

Gross Capital Formation and Sources of Financing

Percentage of GDP, averages

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Data are from Tables 2 and 3 of the paper under review.

Ministry of Economy and Finance, Informe Económico—Resena Estadística, 1981, Part I, Table 1.

D. Heymann, “Alta Inflación y Estabilización de Choque en la Argentina” (mimeographed, 1986, Appendix, Table 1.

As distinct from total gross investment and the other entries.

M. A. Broda, Política Monetaria y Fiscal desde el Plan Austral; series of seminars of the Economic Research Center of the Torcuato Di Tella Institute, 1986, Statistical Appendix, Table 1.

Ibid., (3) Table 8.

Own calculation.

A comparative study gives the impression that in both cases the same financial phenomena produced similar results, even though they did not occur at the same point in time. There are at least six phenomena that can be compared, and which are dealt with below.

The first comparison is the existence of a central monetary authority whose functions include administering the financial assets of society. In Argentina, the Central Bank was organized in 1935 and had already been through the phase of having its deposits nationalized (1946–57) before the creation of its counterpart in Brazil in 1964, although the process was completed only very recently, when the Banco do Brasil relinquished its money creation operations. Taking the last twenty years, the monetary authorities of the two countries do not seem to have exerted much influence on the public to adopt given financial assets and, more seriously, did not possess the political independence to stand up to requests for monetary financing of the public sector deficits and the granting of various subsidies not channeled through the government budget.

Second, in Brazil, the investment banks were institutionalized in 1964, as part of the financial reforms of that year, and soon after it became possible to undertake indexed operations (or operations with monetary correction, according to the Brazilian terminology). In Argentina, although this was provided for in the 1968 legislation, only in 1974 was this process regulated, and it did not in fact come into operation because in 1977 the principles of the system of financial universality were introduced, under which any (banking) institution can undertake whatever asset and liability operations it wishes.

Third, indexation of financial operations was introduced in Brazil in 1964 with satisfactory results that led to a growth in the financial assets/output ratio (p. 182; cf. table, above). In Argentina there have been minor and sporadic attempts at indexation. The most important took place at the same time as a substantial increase in the rate of inflation, and lent themselves to “speculation” (in the sense of the substitution of money in day-to-day transactions), so that their adoption acquired the unfavorable connotation that it still has.

Fourth, a massive housing financing program was begun in Argentina in 1946 and lasted almost a decade. It used loans from the monetary authority, taking advantage of the fact that there was no fiscal deficit because of higher rates of collection of tax from the recently expanded social security system. In Brazil, a similar experiment took place from 1964 onward with the SFH system. It provided special subsidized financing—for this is what it becomes when differential monetary correction indexes are used. With the present difficulties in the Brazilian system caused by the partial indexation of loans, it is not unusual that in the long run they should lead to the elimination of the system, as happened in Argentina in the mid-1950s.

Fifth, the systemic decline of money (M1 = money in circulation + demand deposits) as part of financial assets is observable both in Argentina and Brazil, and is undoubtedly due to inflationary conditions, substitution by other assets with a positive (or less negative) yield, and technological innovations.

Sixth, also common to both countries is the coupling to the financial system of a complex mechanism for subsidizing borrowers, either in the form of interest rates set very much below the market rates—with the subsequent implicit tax on the depositor—or by rediscounts at preferential interest rates—financed by the monetary authority, and so on.

The usual method of measuring the degree of financial saving in an economy is the ratio between the aggregate of financial assets (stock) and the national product (flow). On the basis of this parameter—quite apart from the value it has in developed countries—Longo is a little pessimistic (p. 183), as in Table 1 he indicates that the value achieved in the decade after the financial reforms of 1964 remained stable from 1975 and, after deteriorating, “only recently returned” (ibid.). The desirable upward trend in private savings has not been maintained, especially now that the possibilities of government and foreign savings have been exhausted. The figures for Argentina would give an even more pessimistic impression: from values close to those Brazil had in 1965 and 1975, in recent years the figures amount to barely half of Brazil’s.

However, in the present case, the ratio between a stock (financial assets) and a flow (national product) in an inflationary economy is affected by the presence of negative real interest rates, which means that the increase produced by new financial savings may be insufficient to restore the real value of already existing assets. This situation would not occur if all financial assets were indexed, because they would automatically be adjusted to a growing level of prices. Furthermore, the systemic decrease in M1 in terms of the national product introduces a downward bias. These difficulties make an alternative measure advisable, such as the (annual) growth of financial assets—flow—in relation to the national product, and its separation into those that do not yield interest (M1) and those that do (the difference between M2, M3 or whatever denomination is used, and M1). This correction would be less indispensable in an economy in which indexed assets predominated (Brazil) than in one where they are virtually nonexistent (Argentina).

If it is postulated that for reasons of monetary illusion, indivisibilities, lack of other alternatives, or reasons as yet unclear, there is positive financial saving with reasonably negative real interest rates, the above pessimistic position should be altered. A careful examination of Argentine statistics, taking into account changes of financial assets over time, would indicate that financial saving can increase through the liberalization of the financial markets and a closer linkage between nominal interest rates and the pace of inflation.

There are two extreme solutions to the problem of increasing real interest rates: to liberalize the markets and allow them to fix the nominal interest rates, or to introduce indexation of financial assets. When the nominal prices of goods and services are fixed by credit-taking entrepreneurs according to the “full-cost” principle (fixed margin over variable costs) and the financial charges are part of the cost, the risk of future inflation remains with the creditors (depositors or holders of financial assets); the reverse is true when operations are indexed and subject to positive real interest rates.

On the basis of the Argentine experience, unrestricted liberalization of the financial markets at a time of high inflation has the following main effects: (a) it increases short-term financial assets; (b) they become the only placement; (c) the mechanisms for extending terms on the basis of use of short-term interest rates (floating rates) are disastrous; (d) it leads to greater discrepancies between lending and borrowing interest rates and growing inefficiency in the financial system. The current evolution of the Brazilian system toward (nonindexed) deposits at a maximum of 60 days and the introduction of charges on very short-term deposits as a means of discouraging them is probably analogous to the phenomena experienced in Argentina.

From the above discussion, it can be inferred that the indexation of financial assets is more beneficial than liberalizing the financial markets as the rule seems to be that the latter measure encourages short-term assets whereas the former encourages long-term assets. The most recent stabilization plans in both countries showed considerable aversion toward indexation, which was blamed for much of the inertial inflation. Even if we accept this diagnosis, the indexation of financial assets, as well as the development of institutions that undertake this kind of operation, is a vital condition for increasing long-term assets—or at least for keeping them at their present level—in countries with a long history of inflation.

The traditional argument between those who support the segmentation of the financial markets between long-term and short-term and those who support a unified market has not been resolved and is now coming up again. There is no reason to incline one way or the other without knowing the circumstances of each case. A certain degree of segmentation can be brought about through the institutions and regulations if it is desired to stimulate the long-term market, and consequently make economic development easier. Putting aside any more thorough consideration of the capital market, the existence of a secondary market in indexed assets would be a good complement to the measures mentioned.

Despite all this, it would be difficult to make the indexation of financial assets advantageous without any restrictions at all. The experience of Brazil and Argentina counsels certain conditions: (i) inflation should be relatively low (under 50 percent per annum, let us say) to prevent indexed assets being used as means of payment, (ii) the fiscal deficit should be low to avoid crowding out the private sector and because it is unlikely (as Friedman would have it) that indexation would act to reduce it, (iii) there would be just one correction index to avoid hidden subsidies that frequently occur when there are several of them.

Last but not least, the combination of a financial system and subsidy mechanism gives the worst of both worlds, a point that must be borne in mind in the future when contemplating any reform intended to modernize the financial system.

Pedro A. Palma

These comments will not be a criticism of Longo’s paper but rather a supplement to it, trying to establish some similarities and differences between the case of Brazil and that of Venezuela in regard to the behavior of such variables as savings and private investment, fiscal deficit and its financing, interest rates, external debt service payment commitments, and so forth, which are analyzed in Longo’s paper.

I believe that this comparative analysis should start by establishing some of the differences and similarities that exist between the two economies under review. One of the main differences lies in the behavior of inflation, which in the Venezuelan economy has traditionally been low. Indeed, during the period 1960–72, the average year-on-year increase in consumer prices was only 1.6 percent. While this situation changed during the years of the oil bonanza (1974–77), inflation still remained low during this period (8.5 percent per annum), partly owing to the price controls and abundant state subsidies but mainly to the massive increase in imports, which made it possible to keep under control the price increases on tradable goods, despite the sustained high growth of demand during those years.

In the second half of 1979 and during 1980, Venezuela suffered the highest inflation rate in its recent history, over 20 percent. This was due to price liberalization combined with speculation, deliberate wage increases, very low labor productivity, and external upward pressures created by high interest rates and higher international inflation. From 1981 onward, there was a deceleration in the pace of price increases, which was sustained for several years. Even after the progressive devaluation of the bolivar that took place once exchange controls were established in February 1983, inflation remained moderate, despite the fact that the official exchange rate underwent a devaluation of about 75 percent over a three-year period, and that the free rate has depreciated substantially more severely.

The table that follows shows the very different behavior of inflationary pressures in the two countries.

This modest inflation has meant that Venezuela has not experienced the indexation processes so typical of the Brazilian, and to a lesser extent, the Argentine and other Latin American economies.

Percentage Change in Consumer Prices in Brazil and Venezuela

Percentages

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Sources: Central Bank of Venezuela; and International Monetary Fund.

Average year-on-year changes.

Turning now to an analysis of the similarities between the two economies, mention should first be made of the drop in savings, and above all in private investment, which have taken place in Venezuela as in Brazil, in the last few years. During the period of the oil bonanza, real expenditures in capital formation, both public and private, increased rapidly, with an average year-on-year growth rate between 1975 and 1977 of 36 percent for the former and 23 percent for the latter. However, since the end of the 1970s, a radical change has taken place in this trend in the case of real private investment, which did not grow in 1978, and then underwent a sustained and abrupt contraction. Indeed, in the period 1979–83, it fell to a year-on-year rate of 26 percent.

This decline was due to a series of events, both domestic and foreign. The former includes overinvestment during the oil boom period, when new centers of production were created and others expanded, in the belief that the growth in demand in those years would continue uninterrupted for a long period of time, and that consequently the private productive sector would have to prepare itself to meet this increased demand. However, the completion of these investments coincided with the stagnation and subsequent contraction of private consumption which followed the bonanza, causing many enterprises to have to work at 40 percent or 50 percent of their installed capacity. This contributed substantially to the abrupt contraction in investment.

Likewise, the high world interest rates in 1979 and the early 1980s, together with the expectations of devaluation in Venezuela in 1978 and the first half of 1979, and also in 1982 and early 1983, due to the weakening of the oil market, all had an adverse effect on investment and private savings. These circumstances stimulated the outflow of capital from Venezuela, a process that was unimpeded due to the lack of restrictions on foreign exchange and the overvalued fixed exchange rate, which existed at this time, contrasting with the exchange controls and the regular minidevaluation process that Brazil had adopted.

Private savings also underwent a sustained contraction once the oil boom was over. This applies particularly to personal savings, as a result of the drastic decline in real disposable personal income and in particular the real average wage, which amounted to somewhat more than 25 percent between 1979 and 1985. This has resulted in a reduction in the average propensity to save, to such an extent that by our own estimates, these savings could presently be equivalent to 2 percent of disposable personal income, which contrasts with the level reached by this ratio at the end of the oil boom period when it was about 14 percent.

The contraction of investment, combined with the decline in private consumption as a result of Venezuela’s reduced purchasing power, generated an economic recession which lasted for the seven years 1979–85, during which period real non-oil gross domestic product contracted at a year-on-year average rate of 1.1 percent, and the level of unemployment increased substantially.

All this led the Venezuelan authorities to define growth as the principal objective, which is also the economic policy recently applied in Brazil. Thus, in 1985, the Government announced its intention of implementing an expansionary fiscal policy, in order to stimulate economic activity through additional spending plans for capital formation above the budgeted levels. This policy began to be implemented in the last quarter of 1985. It has produced the desired results in its initial phase, as we have seen some recovery in the level of economic activity during the months it has been in force.

Paradoxically, the start-up of this expansionary expenditure policy actually coincided with the collapse of prices and the decline in value of oil exports, which in Venezuela’s case led to an equivalent contraction in public sector revenue, and in particular central government revenue, the main contributor to which is the oil industry itself.

The introduction of this fiscal policy, combined with the fall in oil revenues, will obviously generate a disequilibrium in the public budget that will have to be financed. In the first phase (1986) the main source of deficit financing was public savings previously accumulated during the adjustment period 1984–85, together with additional resources obtained and saved by some state enterprises, in particular the nationalized oil industry after an adjustment in the official exchange rate from Bs 4.30 per U.S. dollar to Bs 7.50 per U.S. dollar, which generated additional revenue in bolívares for this industry, thus improving its cash flow and allowing it substantially to increase its deposits in the Central Bank. These resources are now being used to finance the public deficit.

However, the fact that there is little likelihood of oil exports increasing significantly in the short run raises a number of questions regarding the possibility of maintaining this expansionary fiscal policy in the years to come.

In Venezuela, the origins of the current public deficit lie in the sudden reduction in export revenue, over which it had no control. This distinguishes it from Brazil and Argentina and from many other Latin American countries, where the budget disequilibria derive from the rigidity of ordinary revenues, traditionally of domestic origin, combined with a sustained expansion of expenditure.

The question is what to do in light of the above: the choice is between attacking this deficit generated by a sudden drop in external revenue by means of a contraction in domestic expenditure, thereby keeping the budget in equilibrium and living with the consequences, or alternatively, trying to keep the public sector in a deficit situation in order to limit the dampening effect of the reduction in export revenue, thus avoiding a recession even deeper than the one we have had over the past eight years.

I believe that in the case of Venezuela the more logical choice is the second, because when oil prices collapsed we had abundant reserves in the public sector, as well as a very high level of international reserves, equivalent to over 24 months of imports of goods. Likewise, the trade surplus was in excess of US$8 billion and the current account surplus exceeded US$3 billion. It is reasonable to hope that if world prices for hydrocarbons fluctuate between US$13 and US$15 per barrel during the next few years, it will still be possible to preserve favorable trade balances somewhat in excess of US$2 billion and manageable current account deficits.

At all events, a decision of this kind is no easy task, because apart from the economic complexities involved, there are political and social factors intimately related to the economic policy alternatives. Similarly, it should be emphasized that the decision taken in the fiscal and monetary sphere must be just one aspect of the overall economic policy to be defined and implemented.

The direction the Venezuelan Government has decided to take on the fiscal side is to pursue the expansionary expenditure policy within the appropriate limits, trying at least to stop any major decline in real domestic expenditure.

Because of this, it is necessary to estimate the deficit financing requirements that will arise in the next several years and on that basis to decide what action to take. In this regard, on the one hand, the fact that ordinary revenue has been limited by the decline in oil exports and, on the other, the growing needs of domestic expenditure, are evident. Hence the need to limit external expenditure to the extent possible by postponing external debt amortization payments and by reducing the differentials on interest, while at the same time making serious efforts to make best use of the depleted resources through reorganizing expenditure and increasing its efficiency. In other words, an overall fiscal reform similar to the one proposed by the Fiscal Study and Reform Commission should be introduced, covering not only tax issues but also expenditure, indebtedness, budget, planning, as well as administration, inspection, and control of the respublica.1

If the depressed oil price situation and the low level of savings in the public sector persist, it will become imperative to find alternative sources of financing to cover the deficits for the years to come. As regards next year, apart from some funds still available being transferred to the Treasury, approval has been given to some changes in tax laws such as the Income Tax Law and the Stamp Tax Law, which increase collections from these sources, and the possibility is being studied of amending the law on the Central Bank and the General Banking Law, in order to expand the capacity of the institute of issue and other financial institutions to purchase government obligations.

If oil export revenue does not show signs of an upturn by 1988, and if the decision not to change the present par value is still in force, thus preserving an overvalued exchange rate that does not correspond to any economic reality, then the pursuance of an expansionary public expenditure policy could generate undesirable competitive pressures on the financial market, which in turn would lead to a scarcity of borrowable resources, due to the public sector’s need for resources to cover its deficit, given the limited access to foreign savings and the low level of domestic savings that would then be available to it.

This leads to the conclusion that in the current scenario, the public sector will not have sufficient resources to stimulate economic activity so as to beat the recession on its own. Hence the need to define and introduce without delay a coherent overall economic policy with a medium- and long-term horizon, that will not only improve the financial situation of the public sector but will also create the necessary circumstances for sectors other than the government sector to take the necessary action with a view to reaching the common goal of reviving the economy.

I have outlined below some of the most important variables or actions (apart from those already mentioned), that should shape such an economic policy, in an attempt to identify the ways in which they resemble, and differ from, Longo’s proposals regarding Brazil. The first difference comes in the recommendations on fiscal and monetary-policy, as Longo favors introduction of restrictive policies, making the possibility of stimulating economic activity wholly dependent on private investment. While this recommendation is made against a background of high levels of growth in the Brazilian economy, I believe we should not lose sight of the fact that implementation of such contractionary policies would have recessionary effects, or would at least lead to a slowdown, which could in turn limit the possibilities of private investment and consequently the growth potential of Brazil. However, this recommendation is made in a situation in which growth of private consumption is of such proportions that, apart from creating disequilibria in Brazil’s external transactions, it is generating growing inflationary pressures, which are precisely the ones that they are seeking to control.

On the other hand, as I have already explained, I believe that in Venezuela’s case, the implementation of moderately expansionary fiscal and monetary policies is justified, because they would at least avoid a sharp contraction of financial resources in light of the drastic decline in oil revenues, because otherwise recessionary pressures could return, and could reach unsustainable limits.

Turning now to the points on which the recommendations agree, I believe that in Venezuela it is becoming vital to introduce a dynamic exchange policy such as has been applied in Brazil for some time now, by means of which, after a devaluation of the commercial bolívar, regular adjustments of the exchange rate would be made to keep Venezuelan products competitive with foreign products. Furthermore, Longo’s observation regarding Brazil does not apply to Venezuela, where there is a high import substitution potential which, if the conditions were right, could lead to considerable investment which would contribute not only to improving the balance of payments but also to stimulating economic activity.

Given that Venezuela is a country with no tradition or experience of exporting, I do not think that in the short run much hope can be placed in this area, particularly in the present world circumstances in which every country is seeking to export while at the same time keeping its imports down to a minimum. There is, nonetheless, a high export potential in some areas where there is an obvious comparative advantage and where results can be achieved in a relatively brief period of time. This applies to numerous primary products, such as petrochemicals, aluminum, steel, and so forth, and to tourism.

It is important to remember that the introduction of such an exchange policy would have significant repercussions on government finance in Venezuela. However, it would be a serious error if exchange decisions were taken to achieve this objective, rather than with a commercial purpose. Similarly, it must be borne in mind that, given the fact that the public sector is an exporter and the private sector is an importer, the devaluation of the bolívar would mean the transfer of resources from the private to the public sector, which would mean that these exchange adjustments would have a restrictive effect equivalent to that of an indirect tax. Hence the importance of the fiscal expenditure policy being very well planned, so that it can ensure that the additional resources obtained from the private sector can be channeled toward those activities that it is wished to stimulate.

Another essential aspect of this coherent overall policy that should be introduced in Venezuela, and one that fits in with Longo’s recommendations for Brazil, is the fixing of positive and realistic real interest rates, which would stimulate domestic savings, thus generating a greater capacity for domestic financing. In this way, the pressures on the financial markets that would appear as a result of competition between the public sector and the private sector to capture resources would be reduced. Consequently, the very limited approach used so far in fixing interest rates, whereby they are established according to how world market interest rates behave, without taking into account domestic inflationary pressures, should be abandoned. This approach has led to negative real interest rates, which not only discourage domestic savings but also promote the outflow of capital.

Last—without intending to declare this comparative analysis complete, for it could be substantially expanded—I agree with Longo’s recommendation that an extension of the amortization terms on external debt should be negotiated. In the specific case of Venezuela, this is of crucial importance, as apart from freeing resources for domestic expenditure, the contraction in oil exports, and their possible stabilization at current levels makes it necessary to increase efforts to reduce the deficit in the nonmonetary capital account, which would be the decisive factor regarding the size of the overall balance of payments deficit in the years to come. Hence the need to link foreign debt service to commitments to new lending by creditor banks, to be used to finance viable projects, and to make conditions suitable for stimulating foreign investment.

1

See Fiscal Study and Reform Commission, La Reforma del Sistema Fiscal Venezolano (Caracas, 1983).

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Cover External Debt, Savings and Growth in Latin America
External Debt, Savings and Growth in Latin America
Papers Presented at a Seminar Sponsored by the International Monetary Fund and the Instituto Torcuato di Tella, held in Buenos Aires on October 13-16, 1986
ISBN:
9780939934959
Publication Date:
15 Jan 1987
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9780939934959.071
Pages:
227