Latin Finance - May 2008 - 76

arminio fraga No Room for Hubris by Dan Shirai W hen Arminio Fraga became president of Brazil’s central bank nearly 10 years ago, the country was reeling from a decade marked by hyperinflation, multiple currency plans and a series of global financial meltdowns, including one that started at home. Along with several other government and private sector officials, the executive – who previously worked at Salomon Brothers, as well as with George Soros – helped patch up some gaping holes in the economy, setting it on a path to calmer waters, where institutions would be rebuilt and fortified for the next phase of development. Fraga, who today runs Gávea Investimentos, a Rio-based asset manager with $3.6 billion under management, charts a brief history of Brazil and identifies the challenges the country still faces. Brazil is more open and increasingly capitalist, according to Gávea Investimentos’ Arminio Fraga. But it remains chaotic and is unlikely to grow at Asian rates. very fat cost structures and we had a banking crisis in 1996-1997. The government responded swiftly through the PROER program and the crisis was addressed in a pretty timely fashion. But as we approached the end of the 1990s, we realized we also had a major fiscal problem. Our primary budget was in a deficit and interest rates were sky-high. Before the 1998 elections the government announced a budget tightening of four points of GDP. The promise was kept, a Fiscal Responsibility Law was sent to congress and fiscal discipline has been maintained until now. Lastly, also in 1998, in the aftermath of the Russia and LTCM crises, it became clear that the fixed exchange rate we had used to stabilize inflation became overvalued and that also had to change. In January 1999 the markets forced the real to float. Where was Brazil 20 years ago? This has been a very interesting period in our history. Twenty years ago you had a country in default, dealing with hyperinflation. We as a country were struggling, really, and not growing. And we were looking back at the miracle years – from the 1950s through the 1970s – trying to reconnect with the kind of growth we were used to, and not being able to do that. It took us a while to come to the conclusion that that model had really run its course, and that the import substitution, big government approach, particularly in the 1970s, wasn’t working. We started to borrow a lot to keep things going. Inflation also started to creep up, on its way to hyperinflation. But because we had done so well for a few decades it wasn’t easy to change. We struggled for about a dozen years and finally in the early to mid-1990s things started to turn. Need to do better, and more: Arminio Fraga administration. Privatizations also started then. With the arrival of President Cardoso, Brazil began shifting into a period of stabilization under the umbrella of the Real Plan. After inflation was finally wiped out in 1994, the country moved further ahead with significant privatization and global integration on the investment side. We also started to take more seriously the major challenge we faced in education. Back then about 20% of our children were not in school, whereas today we can say that most of them are enrolled, which is a very important change that bodes well for the future. After stabilization, it also became clear to us that we needed to address three very important macro issues. First was our banking system. After inflation disappeared it became clear the banks had What were some of the things you worked on when you first became president of the Central Bank? I joined the government in February of 1999. We decided to keep a floating exchange rate so as to avoid the frequent balance of payments crises of the past. As a result we had to look for a new inflation anchor and our choice was to introduce inflation targeting. So that was the first time Brazil had a floating currency and inflation targeting – and those two go hand in hand. Now when we look back, we see that Brazil finally had a proper macro regime in place, with a sound fiscal policy, a floating exchange rate, inflation targeting and healthy banks. This regime has survived the political transition of 2002, which was What were the first steps of this turn? Brazil started by opening the economy on the trade side in the early 1990s, still under the [President Fernando] Collor 76 LATINFINANCE May 2008

Latin Finance - May 2008

Table of Contents for the Digital Edition of Latin Finance - May 2008