Lula declares war on the Central Bank: what are the consequences for Brazil’s economy?

By Célio Yano

The repeated criticism from President Luís Inácio Lula da Silva (PT) on the performance of the Central Bank (BC) may generate an effect contrary to what he defends, according to economists.

By attacking the basic interest rate, defined by the monetary authority, and even questioning the agency’s independence, the tendency is that the nominal interest rates, practiced by the market, go up even more.

By anticipating an interference of the State in the conduct of the Central Bank’s monetary policy, the financial institutions seek to protect themselves from a likely scenario of greater inflationary pressure.

The results are more limited access to credit, lower consumption, and lower economic growth rates.

Last week, Lula’s criticism of the Central Bank, the interest rate, and the current inflation targets made during an interview on RedeTV caused rates on interfinancial deposit (DI) futures contracts to soar.

For example, the DI maturing in January 2025 advanced from 12.97% to 13.275% in a single trading session on Friday.

In the interview, Lula even said he intends to reassess the Central Bank’s autonomy after Roberto Campos Neto’s term as the head of the institution ends in 2024.

“I want to know what the independence [of the Central Bank] was for. I will wait for this citizen [Campos Neto] to finish his mandate so that we can evaluate what the independent Central Bank has meant.”

Futures interest rates ended up retreating to previous levels on Wednesday (8) after the Minister of the Secretariat of Institutional Relations, Alexandre Padilha, stated that there is no discussion at the Planalto to change the legislation that guarantees the independence of the Central Bank or the inflation targets.

On Tuesday (7), in a lecture, Campos Neto defended the agency’s autonomy.

“The main reason for the Central Bank’s autonomy is to disconnect monetary policy from the political cycle,” he said.

“The more independent you are, the more effective you are, the less the country will pay in terms of the cost of the inefficiency of monetary policy.”

CENTRAL BANK AUTONOMY IS ONE OF BOLSONARO AND GUEDES’ LEGACIES

The autonomy of the Central Bank was formalized by a law passed in February 2021 and is considered one of the main victories in the economic area obtained in Congress by the government of former president Jair Bolsonaro (PL) and former minister Paulo Guedes.

With the law, the Central Bank is no longer linked to the Ministry of Economy (currently the Ministry of Finance) and is now classified as an autarchy of a special nature, characterized by the “absence of being linked to a ministry, of tutelage or hierarchical subordination”.

In addition, the text established four-year terms for the president and the eight directors of the Central Bank, not coinciding with the terms of the President of the Republic.

Although the Executive branch head still nominates them, the names are now subject to approval by the Senate.

When the law was discussed, the PT already opposed the measure.

After the approval, the party even filed, along with the PSOL, a direct action of unconstitutionality (ADI) in the Supreme Court (STF), questioning the legitimacy of the rule.

The legends argued that the autonomy of the Central Bank “removes the authority of the elected government over a central instrument for defining economic policy and interferes in the coordination of the implementation of this policy, reducing its effectiveness by diluting the responsibility for its results”.

The Supreme Court rejected the ADI by a score of 8 to 2.

LULA’S STATEMENTS PUT PRESSURE ON THE MARKET, AND THE RESULT COULD BE EVEN HIGHER INTEREST RATES

Economist Bruno Mori, founding partner of the consulting firm Sarfin, explains that the definition of a high level of the basic interest rate is the main remedy to contain consumer price inflation.

“The main function of the Central Bank is to protect the currency, which means that it has to defend its purchasing value, or, in other words, to bring inflation to the pre-established target. It is less subject to political interference when it has this legal autonomy”, he says.

The independence of the agency in relation to the government guaranteed that the volatility of financial assets was lower in 2022 than in other presidential election processes, says the economist.

The market estimates that the Broad Consumer Price Index (IPCA) for 2023 should be 5.78%, according to Monday’s edition of the Focus Bulletin, which consolidates projections from market analysts every week.

The inflation target set for the year is 3.25%, with a tolerance of 1.5 percentage points more or less – a range between 1.75% and 4.75%.

On February 1, after maintaining the Selic at 13.75%, the Central Bank’s Monetary Policy Committee (Copom) hinted that it might sustain them at this level for quite some time – perhaps until the end of the year, as interpreted by part of the market.

For the president, the inflation target should be higher, allowing the Central Bank to maintain a lower interest rate.

“Why not make it 4.5%, as we did? At this instant, we need to know the following: the Brazilian economy needs to grow again. And we need to make income distribution; we need to make more social policies,” Lula said in an interview with Globonews in January.

“The consequence of him talking about tolerating higher inflation is even higher interest rates,” says Mori.

“The fact that interest rates are high in Brazil does not correlate with the autonomy of the Central Bank, quite the opposite,” says Raphael Vieira, co-head of investments at Arton Advisors.

“An independent Central Bank ends up detaching itself from the political scenario and looks effectively, within the economy, at what benefits or harms the expectation and anchoring of inflation,” he says.

He recalls that Campos Neto was highly praised for his performance in the post-pandemic economic recovery and for anticipating price shocks.

He started the cycle of interest rate hikes much earlier than other countries, including developed economies.

“I think that this discussion is much more of a trial balloon for the government to obviously not attack the main point, which is the containment of public spending and to effectively look more diligently at controlling inflation in the country,” he opines.

For Jason Vieira, chief economist at Infinity Asset, Lula seems to be focused on “undoing the legacy of the last two mandates,” indicating that pragmatism did not work and revanchism should guide decisions from now on, regardless of whether this legacy was positive or not.

“Thus, even if he had been in power for 14 years, [adding up the periods of the Lula and Dilma Rousseff’s PT governments,] the current president does not seem to understand that interest rates are not a cause, they are a consequence and that, therefore, the government doing its ‘homework,’ ‘its part’ in the economy, is literally the best way to give the Central Bank room to cut interest rates freely and unimpeded,” the economist wrote in a report for investors.

With information from Gazeta do Povo