When asked why the interest rate in Brazil is higher than in other countries, my answer usually involves asking why, despite such high rates, domestic demand has such a strong performance.
In fact, over the past six years, the average GDP growth slightly exceeded the 4% rate, a decent pace, but far from exciting. On the other hand, domestic demand expanded at a rate of 5.5% per year, while its private component (consumption and investment), which is more sensitive to interest rates, increased at a rate that exceeds 6% per year!
If it is true, then, that the interest rate in Brazil is an anomaly compared to international standards, it is no less anomalous the domestic demand’s response to such rates, which in any other country would be sufficient to cause economic contraction. Thus, if we can find the answer to the latter (domestic demand at high rates), we should be able to solve the first issue (the high rates).
Part of the answer – perhaps not the most important – is reflected in the low savings rate in Brazil, which in recent years was around 17.5% of GDP. In comparison with 2002-03, the savings rate increased by only about 1.5% of GDP despite extraordinary gains in terms of trade in the period, which I estimate to have reached almost 4% of GDP. Therefore, we can conclude that most of the gains made from high commodity prices has become additional expenditure, reflecting a growth model that focuses on consumption which is financed by the expansion of government transfers and credit.
That being said, if we compare two identical economies, but with one of them having government stimulus to consumption, it should be clear that the interest rate must be higher in the economy with government incentives.
In fact, if the real interest rate was equal in both economies, inflationary performance would be very different. On one hand, domestic demand would grow more in the economy with incentives. On the other, reflecting the lower savings and thus investments (since there are limits to the external deficits), the potential growth of this economy would also be lower than that of her twin. To keep inflation stable, therefore, such an economy would have to live with a higher interest rate. But how much higher? It remains a mystery.
What I find to be the most intriguing about the strong domestic demand despite high interest rates in Brazil is the way we define and set these interest rates.
In general, when comparing the Brazilian rate to other countries one thinks of the Selic (1-year) rate as the only relevant rate. However, there is a segment of the credit market in Brazil that is virtually insensitive to the market’s interest rates. The direct credit (“credit direcionado”) in Brazil (which includes the BNDES, as well as housing and agriculture/rural credit programs) offers interest rates that are not affected by monetary policy and are, in fact, usually well below the Selic rate.
Additionally, despite the vigorous expansion of the free credit over the past two years (about 20%, adjusted for inflation), the direct (government) credit grew at an even faster pace (40% above inflation). Thus, the direct credit represents something like 36% of total loans in Brazil, compared to 28% in mid-2008, an extremely relevant phenomenon considering its high and increasing share of credit in Brazil. In fact, this share is about to become even larger given that BNDES should have an amount of R$ 65 billion for loans at its disposal (R$ 20 billion accumulated from 2011 plus an additional, recently announced R$ 45 billion), an equivalent to 15% of its loan portfolio.
There is, therefore, a considerable stimulus coming out of direct credit. Hence, we can conclude that, under these conditions, the effect of the Selic on our domestic demand is lower than it would be in the absence of the direct (government) credit. Or in other words, if everything else remains constant, the central bank (BC) will need to keep interest rates higher if it wants to get the same demand growth.
Similarly, because the direct credit rates do not change in response to the Selic, in order to control the expected high inflation, the BC will also need to increase interest rates higher than it would in the absence of direct credit if it wants to adjust its policy.
In light of this reasoning, the existence of a segmented (direct) credit market, where interest rates are considerably lower than the market’s, explains the strength of domestic demand even at interest rates that are considerably higher than international ones. And it is also the most logical explanation for the future persistence of such “anomaly”.
If these assumptions are true, what policies are needed to bring the real interest rates in Brazil closer to international levels?
First of all, the reduction of public expenditure. According to the International Comparison Program (ICP), Brazil has the second highest level of public spending as a percentage of GDP among countries with US$ 100 billion + GDP, a fact that undoubtedly plays a central role in explaining the low domestic savings. Secondly, direct credit programs would have to undergo considerable changes. It would not be necessary to eliminate it, but the subsidies implicit in its rates would have to be extinct. This way, the direct (government) credit interest rates would rise, but the Selic rate would fall, benefiting (us) the “mortal” borrowers (including Treasury) at the expense of the “immortal” subsidized borrowers.
In another universe, perhaps, this conclusion is sufficient for such a policy to be adopted. But in this one, however, it is a sign that this change should be even more unlikely that the reduction of government expenditure. It is also a sign that, despite the government’s complaints, the interest rates in Brazil may remain among the highest in the world.
Alexandre Schwartsman, PhD in Economics from the University of California, Berkeley, and former BC director of International Affairs, is associate director of Schwartsman & Associates.