Inflation Fighter

Brazil’s Henrique Meirelles keeps a lid on prices.

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In 1994, Henrique de Campos Meirelles, then president of Bank of Boston’s Brazilian subsidiary and a pillar of the São Paulo financial establishment, made an unusual overture. He organized a meeting between a half dozen top executives of multinational companies and Luiz Inácio Lula da Silva, a left-wing presidential candidate whose opposition to privatization and calls for tougher tax enforcement and renegotiation of Brazil’s foreign debt aroused fear and loathing among the country’s business elite. The executives spent six hours with Lula and his aides discussing politics, economic policy and the future of Brazil — and disagreed on practically everything. But Meirelles found the meeting useful all the same. “I think that I understood them much better, and they understood us much better,” he recalls. “There was clearly an open mind on his part particularly, really an interest in understanding — even if we disagreed.”

Today the seeds that were planted in that meeting are paying big dividends for Brazil. When Lula finally won the presidency on his fourth attempt, in 2002, he surprised many of his supporters by choosing the conservative Meirelles to be governor of the Banco Central do Brasil. And Meirelles’s determined anti-inflation policies — staunchly backed by Lula, it’s worth noting — have played a critical role in maintaining Brazil’s financial stability and fostering the country’s powerful economic expansion. Confidence in Brazil’s policymaking institutions, particularly the central bank, contributed significantly to the recent upgrade of the country’s credit rating to investment grade, says Lisa Schineller, a sovereign analyst at Standard & Poor’s in New York. “Lula understands that low inflation is very important,” she tells Institutional Investor. “Central bank independence will prevail, assuring that the actions needed in monetary policy will be taken. This supported the upgrade.”

Meirelles can’t afford to rest on his laurels, though. Despite his impressive record on inflation, Brazil, like many other emerging-markets countries, faces intense price pressures that could erode the economic gains of recent years. Rising international demand for food and fuel, increasing government spending and buoyant domestic demand — retail sales were up 10.5 percent in July from a year earlier — are all driving prices higher. The year-on-year inflation rate rose to a four-year high of 6.37 percent in July, near the top of the target range of 2.5 to 6.5 percent. A July central bank survey of 100 economists found that they expect inflation to reach 6.54 percent in 2008, which would make this the first year since 2003 that the central bank missed its target.

The central bank governor aims to prove those economists wrong and reaffirm his anti-inflation credentials. “We saw risks tilting toward inflation, and some of the reasons are international and some are domestic, because there is a high level of domestic demand,” Meirelles told II in a recent interview at his home in São Paulo. “We are taking measures to balance our economy and do our homework.” In late July, a few weeks after that interview, Meirelles led the central bank’s Monetary Policy Committee in raising the benchmark overnight lending rate, the Selic, for the third time in four months — on this occasion by 75 basis points, to 13 percent. It was the biggest rate hike in more than five years, underscoring both the severity of the inflation threat and Meirelles’s determination not to fall behind the curve.

The move helped boost the real against the dollar and won praise from analysts and investors. “By front-loading the interest rate adjustment, they send a strong signal to the market that they will do whatever it takes,” says Alberto Ramos, senior economist for Latin America at Goldman, Sachs & Co. in New York. Economists’ average projection for inflation this year dipped to 6.34 percent, according to the central bank’s late August survey.

Recent declines in oil prices and signs of a slowdown in food price inflation are also encouraging some economists to believe the worst of the threat may be passing. “Our feeling is that inflation is beginning to come down, and we are going to close the year within the target,” says Alvaro Bandeira, chief economist at brokerage Ágora Corretora in Rio de Janeiro. “I don’t think things are grave. The central bank is acting in good time.”

Inflation is a global problem, reflecting the sharp rise in energy and commodity prices in recent years. The pressures are particularly high in emerging markets because of the breakneck pace of growth in many of those economies. Inflation is currently running at year-on-year rates of 7.1 percent in China, 11.05 percent in India and 15.1 percent in Russia, for example, and central banks in all three countries have been ratcheting up interest rates in recent months. In its revised World Economic Outlook, released in July, the International Monetary Fund raised its forecast for inflation in developing economies by 1.5 percentage points, to an average of 9.1 percent for 2008. “The top priority for policymakers is to head off rising inflationary pressure, while keeping sight of risks to growth,” the Fund said in its report.

In this environment Brazil has done better than most emerging economies in keeping a lid on prices, thanks to nearly 15 years of reform efforts. After a long run of hyperinflation that saw the inflation rate peak at more than 3,000 percent in 1990, then–Finance minister Fernando Henrique Cardoso oversaw a package of reforms in early 1994 that all but eliminated the government’s budget deficit and introduced a new currency, the real, that was pegged to the dollar. The so-called real plan slashed inflation from 1,340 percent in 1994 to 46 percent the following year, and helped Cardoso win the presidential election in October 1994.

In 1999, Meirelles’s predecessor at the central bank, Armínio Fraga, adopted an inflation-targeting regime modeled on the Bank of England’s policymaking process, which sets a target rate for inflation and gives the bank an exclusive mandate to achieve that target. Since January 2003, when Meirelles took over as central bank governor, he and his team have reduced inflation, which was 12.53 percent in 2002, to a low of 3.14 percent in 2006 and 4.46 percent in 2007.

Thanks in good measure to this success, confidence in Brazil’s economy has surged. Foreign direct investment doubled in 2007, to $34.6 billion. Those inflows, combined with rising prices for many of Brazil’s agricultural and mineral exports, have pushed growth — which averaged only about 2 percent in the 1990s — up to about 5 percent.

“The good news is, this is very healthy growth for the first time in Brazil because it’s anchored on very solid fundamentals,” Meirelles tells II. “With stability and the commitments the central bank has shown to inflation control, the level of business and consumer confidence is high, the inflation expectation for the years ahead, in spite of this difficult international scenario, is on target.”

Success brings its own challenges, though. Robust growth is straining the country’s capacity in terms of infrastructure and the number of skilled professionals; it is also adding to upward pressure on prices. The central bank’s high interest rates, although a valuable tool in fighting inflation, have propelled a 17 percent appreciation of the real against the dollar over the past year, a move that is sucking in imports and putting a damper on Brazil’s manufactured exports. Economists expect the country’s current account, which showed a modest $1.5 billion surplus in 2007, to register a deficit of about $20 billion this year.

Brazil’s inflation-adjusted interest rates, at nearly 7 percent, are among the highest in the world. In addition to the buoyant economy and a history of hyperinflation, strong growth in government spending helps keep rates high, analysts say.

Although Lula has avoided the kind of inflationary fiscal policy that some observers had feared before the 2002 election, his administration has increased spending to 26.2 percent of gross domestic product in 2007 from 22.7 percent in 2002. The government has increased the number of civil servants and military personnel by 24 percent in the past six years and increased the minimum wage at a faster pace than the rate of inflation. The president has also committed to ramping up spending on roads, hydroelectric plants and other infrastructure.

“Once again, the central bank has to overwork to compensate ‘underwork’ on the fiscal side,” says Gustavo Franco, who was governor of the central bank from 1997 to 1999 and now is head of Rio Bravo Serviços Financeiros, an asset management firm in Rio de Janeiro. Some critics blame Finance Minister Guido Mantega for running a loose fiscal policy, but when asked about any differences with Mantega, Meirelles is tactful. “In the modern world it is natural to have different vantage points between the central bank and the Finance minister, and sometimes they have different priorities,” he says.

The widespread availability of government-subsidized credit also plays a role in the high level of official interest rates. Fully 58 percent of all lending to business, by Meirelles’s calculation, is made at below-market rates. Banco Nacional de Desenvolvimento Econômico e Social, the government-owned development bank, provides the bulk of those subsidized credits. Another government-owned lender, Banco do Brasil, provides cheap credit to the agricultural sector. Such lending “means the central bank rate has to work overtime to get the job done,” says Fraga, the former central bank governor who now heads a Rio de Janeiro–based hedge fund, Gávea Investimentos.

Meirelles remains determined to do that job, judging by the central bank’s recent rate hikes. He pledges to bring inflation down to 4.5 percent, the middle of the target range, by the end of 2009. In overseeing the bank’s Monetary Policy Committee, which sets the Selic rate, Meirelles is “playing more of a leadership role” lately than he did in his early years, says Christopher Garman, director for Latin America at Eurasia Group, a consulting firm. The July rate hike was a unanimous decision, according to the minutes of the meeting.

The biggest asset Meirelles has in pursuing his anti-inflation campaign is the unequivocal support of Lula. The president frequently voices his desire to keep a lid on prices, most recently at a June celebration of the country’s credit rating upgrade. “Controlling inflation will continue to be a priority for my government,” he said.

Meirelles welcomes the support and praises Lula for recognizing that preserving workers’ purchasing power is consistent with his long-held political views. “He kept his basic beliefs, which are his commitment to the workers, job creation and income distribution improvement, and he’s delivering on those,” Meirelles says.

Associates attest to the strong bond between the two men. In an e-mail former Finance minister Antonio Palocci recalls the key role Meirelles played in maintaining economic stability at the start of Lula’s first term. “From the outset, President Lula authorized Meirelles to conduct monetary policy with autonomy, which facilitated things,” he says. “Today, the relationship of Meirelles and President Lula is one of great trust and understanding.”

The fact that Meirelles manages to work so well with the president is striking, considering their different backgrounds. Lula grew up poor, didn’t learn to read until he was ten years old and quit school after the fifth grade. He started working at age 12 as a shoeshine boy and eventually became a lathe operator and then a union leader before helping to found the Workers’ Party in 1980.

Meirelles is the son of a well-to-do lawyer from the central state of Goiás; his uncle was state governor. After graduating from the Universidade de São Paulo with a degree in engineering, Meirelles got an MBA from the Universidade Federal do Rio de Janeiro. In 1974 he joined Bank of Boston as a director in its Brazilian leasing subsidiary, then rose steadily through the ranks to become president of the bank’s Brazilian unit in 1984. A dozen years later he went to Boston as president and COO of parent BankBoston Corp., making him the first Brazilian to achieve such a lofty post in international banking. When the bank merged with rival Fleet Financial Group in 1999, Meirelles was named president of global banking at the new FleetBoston Financial.

Although a financier by profession, Meirelles takes a keen interest in social issues, which may explain his rapport with Lula. At BankBoston he raised funds for Viva o Centro, an initiative to revitalize São Paulo’s dilapidated downtown by restoring historic buildings. He also supported a project aimed at reuniting Brazilian street children with their families; his involvement began shortly after his 1994 meeting with Lula, when he was approached by Aloízio Mercadante, a longtime Lula confidant and now senator.

Meirelles left Boston in 2002 to return home and run for a seat in the Chamber of Deputies on the ticket of the centrist Brazilian Social Democracy Party, headed by then-president Cardoso. Although Lula defeated the PSDB’s José Serra for the presidency, Meirelles prevailed in his race against a rival from Lula’s Workers’ Party. He declined to take up his seat, however, after the president tapped him for the central bank post.

Meirelles plans to run for office in Goiás in 2010, although he hasn’t indicated whether he will seek a congressional seat or the governorship. Some observers and friends think he harbors presidential ambitions, but Meirelles refuses to discuss his future in politics. “I think the position of governor of the central bank is not compatible with political campaigning,” he tells II.

For now, Meirelles has a tough enough job on his hands.



Eye on the Target: An Interview with Brazil’s Meirelles

Henrique de Campos Meirelles has had some tough tasks in his five and a half years as governor of Banco Central do Brasil, prime among them fighting inflation and restoring confidence in the country’s economy. A former head of global banking at FleetBoston Financial, he has developed a close relationship with Brazilian President Luiz Inácio Lula da Silva. As inflation has crept up, the central bank has raised its benchmark Selic interest rate three times, most recently in July, by a larger-than-expected 75 basis points, to 13 percent, earning praise from the International Monetary Fund for sending a strong message that inflation will not be allowed to run amok. Meirelles discussed these and other issues when he spoke, in English, for more than an hour with Institutional Investor Contributing Editor Lucy Conger in the dining room of his home in Chácara Flora, an elegant, wooded suburb of São Paulo.

Institutional Investor: You’re managing inflation in very different circumstances for Brazil — not at a time of crisis but while the economy is growing at a strong pace and the currency is appreciating. What are the challenges of

dealing with inflation in this environment?

Meirelles: I think it’s the role of any central bank to fight the secondary effects of imported inflation, let’s call it. We cannot accommodate the second-round effects of the price increases in commodities. Wholesale price [increases] are now at double-digit levels as a result of increases in [the costs of] food and oil. We are taking measures to prevent the pass-through. That’s a challenge, but it’s everyone’s duty to do that. In terms of the first-round effect, that has to be taken care of by monetary authorities, because if everyone thinks it’s someone else’s problem, we’ll have a problem. Fortunately, that’s not the case. I am confident that central banks all over the world are going to keep their commitments to the inflation targets.

How is Brazil’s situation different from that of other major emerging-markets countries?

I think quite clearly we saw risks tilting toward inflation, and some of the reasons are international and some are domestic, because there is a high level of domestic demand, and we are taking measures to balance our economy and do our homework.

Does the level of Brazil’s domestic debt, currently about 50 percent of GDP, concern you?

The number we think is more relevant is the net debt. Why the net? Because it’s important to subtract the international reserves. The net debt is about 42 percent [of GDP], down from 56 percent at the peak. Projections are that the debt is going to drop to about 40 percent as a result of the primary surplus being delivered over the last years. We do think the lower the debt, the more efficiently the whole system is going to work.

The monetary base has been expanding at about a 20 percent annualized rate. Do you need to reduce the rate of expansion, and if so, how and when might you do that?

We are an inflation-targeter. We don’t target the monetary aggregate, but we watch it carefully; that’s a good indicator. That’s the result of stabilization of the Brazilian economy. The inflation expectation is on target for ’09, ’10, and that was unheard of in the Brazil of the past decades, particularly when we are facing inflationary pressure. That means predictability; that means higher credibility. Again, we watch very closely the estimates for future inflation, and we act on those.

President Luiz Inácio Lula da Silva has been consistent in endorsing the fight against inflation, which surprises some, given his leftist background. Why does he feel this way, and what is his dialogue with you?

One thing is important to understand about President Lula: He was a union leader and had most of his career as a union leader during the period of hyperinflation. President Lula experienced personally the cost for the worker of high inflation, how difficult it is to preserve the purchasing power of the average citizen. He’s very sensitive to that point. He was very wise to realize very quickly how lower inflation — brought about by the austere monetary policy — is increasing the purchasing power of the average worker and working families. In one of my latest meetings, when I met with a group of federal deputies of PT [Lula’s Workers’ Party] at Congress, I said, “Who said loose monetary policy and high inflation is a leftist policy?” I think that our policy of making sure inflation is low and maintaining workers’ purchasing power is a leftist policy.

You have pointed out that Brazil doesn’t have an independent central bank. Do you think autonomy is needed? And what would be required in the political process to achieve it?

Legal autonomy would require a bill approved by Congress. It would provide economic agents and the markets with more confidence about central bank commitment in the future for keeping the value of the currency. I think there would be an advantage in the overall level of interest rates and risk in the market. I don’t see that happening soon. I think it’s a question that’s going to take a few more years of a stable economy providing good results and growth. Brazil had the longest period of hyperinflation in recent times; there is a very high level of suspicion about monetary affairs, and Congress feels its mission is to watch the central bank very carefully and be able to take any action. I think it’s a question of an evolutionary process.

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