The Impact on Brazil of The Impact on Brazil of the Global Financial the Global Financial

CrisisCrisis

John WilliamsonJohn WilliamsonSenior FellowSenior Fellow

Peterson Institute for International Peterson Institute for International EconomicsEconomics

Finance versus the Real Economy?Finance versus the Real Economy?

Gloom and doom in the financial sectorGloom and doom in the financial sector Versus continuing prosperity in major parts Versus continuing prosperity in major parts

of the real economyof the real economy Export sectors in the USExport sectors in the US Emerging marketsEmerging markets Primary product exportersPrimary product exporters Brazil as an exampleBrazil as an example Reverse-coupling thesisReverse-coupling thesis

Strengthened Fundamentals in Strengthened Fundamentals in BrazilBrazil

Low inflation countryLow inflation country Large primary surpluses and an expected Large primary surpluses and an expected

overall fiscal surplusoverall fiscal surplus Falling public sector debt/GDP ratioFalling public sector debt/GDP ratio Elimination of dollar-denominated debt Elimination of dollar-denominated debt

from the public sectorfrom the public sector Current account surpluses for 5 yearsCurrent account surpluses for 5 years Low ratio of external debt to exports or Low ratio of external debt to exports or

GDP.GDP.

September 2008: Financial CrisisSeptember 2008: Financial Crisis

Sudden change of viewSudden change of view Loss of US housing wealth since end-2006: c. Loss of US housing wealth since end-2006: c.

$6 trillion $6 trillion Loss of world equity wealth since the end of Loss of world equity wealth since the end of

2007: c. $20 trillion2007: c. $20 trillion Assuming 4% spending from wealth, and US Assuming 4% spending from wealth, and US

has half the world’s housing wealth, this will has half the world’s housing wealth, this will reduce demand by about $1,300 b.reduce demand by about $1,300 b.

AndAnd demand is cut by lack of access to credit, by demand is cut by lack of access to credit, by an unknown sum.an unknown sum.

Impact on BrazilImpact on Brazil Principal channel for world recession to impact Principal channel for world recession to impact

Brazil is via current account:Brazil is via current account: Lower prices of primary productsLower prices of primary products Lower demand for differentiated productsLower demand for differentiated products

About 50% of Brazil’s exports are primary About 50% of Brazil’s exports are primary products and the rest differentiated products and the rest differentiated (manufactured) products(manufactured) products

How large and how permanent will the decline in How large and how permanent will the decline in primary product prices prove?primary product prices prove?

Decline in Decline in realreal likely to temper the loss of likely to temper the loss of markets for manufactured exports.markets for manufactured exports.

Two Measures of the History of the Two Measures of the History of the Brazilian REERBrazilian REER

Brazilian Real REER, Citigroup measure1980 - September 2008

0

20

40

60

80

100

120

140

160

180

Jan-

80

Jan-

82

Jan-

84

Jan-

86

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Brazilian Real REER, JP Morgan measure1970 - September 2008

0

50

100

150

200

250

Jan-

70

Jan-

72

Jan-

74

Jan-

76

Jan-

78

Jan-

80

Jan-

82

Jan-

84

Jan-

86

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Contagion via the Capital AccountContagion via the Capital Account

Brazil still a major net debtor, especially short-Brazil still a major net debtor, especially short-term, even though it has not recently had to term, even though it has not recently had to borrow muchborrow much

So a capital outflow is still possible and still has So a capital outflow is still possible and still has major consequences:major consequences: Less FDI—modest and delayed effect on investmentLess FDI—modest and delayed effect on investment Portfolio equity outflow—large, rapid effect in reducing Portfolio equity outflow—large, rapid effect in reducing

Bovespa, thus Brazilian consumption, and reducing Bovespa, thus Brazilian consumption, and reducing realreal, thus increasing inflation, thus increasing inflation

Fewer loans for Brazilian companies—threat to Fewer loans for Brazilian companies—threat to investment, exports, production.investment, exports, production.

PolicyPolicy

Accept the decline in the Accept the decline in the realreal but aim to limit but aim to limit overshootovershoot

Don’t ditch inflation-targeting, but reformulate Don’t ditch inflation-targeting, but reformulate objective to prevent objective to prevent second-round effectssecond-round effects of the of the depreciation on inflationdepreciation on inflation

Replace missing foreign credits by an expansion Replace missing foreign credits by an expansion in domestic creditin domestic credit

Join (if invited) in a concerted fiscal expansion Join (if invited) in a concerted fiscal expansion with with temporarytemporary measures. measures.