Subsidized credit increases the basic interest rate – 06/13/2023 – Bernardo Guimarães

For the debate on the BNDES, it is important to keep in mind that subsidized credit for some increases the market interest rate, the Selic, thus making loans more expensive for others.

I explain.

The consumption of strawberries in Brazil is equal to the national production of strawberries plus the amount imported and minus the amount exported. This is an accounting relationship. It always has to.

Something similar applies to the level of investment in an economy.

The amount of investment in an economy is equal to what households save (their incomes minus consumption and taxes), plus what the government has saved (the public sector surplus), plus what we borrow from foreigners, in net terms.

Now consider a subsidized credit policy that leads to more investment by firms that would not borrow at market rates. This increase in investment must necessarily be offset by a combination of four things: (1) other companies invest less; (2) people save more; (3) the public sector deficit falls; (4) we receive more foreign capital.

I start with item (4). If Luxembourg wanted to build a new railroad with foreign financing, it would borrow from other countries without affecting its interest rate. In Brazil it is not like that. Higher debt leads to higher interest rates because it increases risk and because foreign funds will want a higher premium to have more Brazilian securities in their portfolios.

Regarding item (3), the direct effect of subsidies is to increase the public deficit. There may even be indirect effects, but not even those who defend the expansion of the BNDES believe that this would generate a surplus the size of the loans offered (under much more lenient conditions, the BNDES would already be excellent).

In short, (4) it doesn’t work without increasing interest rates and (3) it should even play against it. So, it remains for items (1) and (2) to resolve. Either there are fewer resources for other companies to invest, or families have to save more.

How does this happen?

If we need to produce more strawberries or consume less, it is the price of strawberries that goes up.

In the case of the capital market, it is the interest rate that rises to stimulate household savings and discourage investment by companies.

Thus, lower interest rates for those benefiting from BNDES loans lead to higher interest rates for others.

How big is this effect?

If small increases in interest rates generated a large reduction in household consumption or a large injection of foreign capital, investment by companies that did not benefit would need to fall a little to close the account.

However, these responses are generally not strong. Thus, much of the investment promoted by the BNDES is offset by the drop in investments by other companies.

If this is true, variations in the amount of BNDES credit should not cause major changes in the level of investments. The data are consistent with this implication.

The following graph shows BNDES credit and the level of investments in Brazil (gross fixed capital formation), both as a proportion of GDP. The size of the BNDES has varied a lot in recent decades (between 5% and 20% of GDP). The level of investments varies less and has little relation to the size of the BNDES.

This happens because subsidized credit for some implies a higher base rate. By encouraging some investments, the BNDES discourages others.

This suffices as an argument against the expansion of the BNDES, but it shows that industrial policy does not generate investments, it only allocates resources to some sectors to the detriment of others. The favorable arguments need to justify this change in resource allocation.

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