The best defense against the crisis is for Brazil to announce primary result and spending targets, says Arminio Fraga – 03/16/2023 – Market

Economist Arminio Fraga, former president of the Central Bank, sees no risk that the weaknesses that haunt financial institutions in the United States and the European Union can be identified in the Brazilian banking system.

“Outside contamination is not the main risk factor here,” he says. “No one is ever armored. But I don’t believe that this sector can succumb to a banking crisis. The banks here in Brazil are more capitalized. One has the impression that big blunders like the one we saw in the United States don’t happen here. That’s my view. assessment.”

Fraga, however, claims that the economic cycle is not comfortable in Brazil. “Several companies depend on financing for working capital, and they are suffering a lot. Some are even proving to be unviable.”

In his assessment, it will be easier for the Central Bank (BC) to act in this more adverse environment, following a possible reduction in interest rates, if the government of Luiz Inácio Lula da Silva (PT) is more agile in presenting definitions for what considers the core of the problem in Brazil: fiscal fragility.

“I would say that here, although we are not facing a bank run —this is my expectation—, we have a very fragile macroeconomic situation, with interest rates already very high”, says Fraga. “It is clear that high interest rates are a problem, and it is not new. But the cure for this condition is fiscal.”

Arminio reinforces that although attention has been turned to the elaboration of new fiscal rules, the priority is the disclosure of the primary result and public expenditure parameters for the coming years.
“With or without a framework, the government has to announce the main parameters”, states Fraga.

We were already feeling credit risk, there was a loss of confidence and, in the last week, banks with problems. Are we facing a risk of multiple crises? Yes, but we need to look at the geography of the thing. Outside, we have a very delicate situation, and the central banks have already warned that they are going to come in with heavy artillery. In general, this at least gives time. You need to find out how much leverage you have in the system. In the real estate sector, which was the biggest problem in 2008, it is believed that you have less leverage.

What’s new from the Bank of California [o Silicon Valley Bank, que faliu na semana passada] is that they had a huge position of rate mismatch. In other words, they captured short-term deposits and invested them in the long term. They broke, from what you hear, because of that. It was a tremendous shave by bank managers and regulators, who also did not see this. It wasn’t a loan portfolio that was difficult to value. It was pretty easy.

Abroad, the central banks were chasing the losses with inflation. It was a gamble they made. They were afraid and now comes the bill. The credit crunch is factored into central bank calculations. There is always the risk of what we can call financial dominance, that is, the central bank eases inflation a bit so as not to tighten the credit world too much. That’s the state of the art out there.

It’s in Brazil? Here is different. There is also an inflationary issue, and it is not just a supply shock — and even if it were, the Central Bank has to, at the very least, take care of the secondary effects of the shock. In our case, most experts feel there is also a demand element.

The BC had been working in this area and, suddenly, the issue of credit also arises here. It’s not a big surprise, given that interest rates went from 2% to 13%, but it’s still a subject to watch.

At the same time, this fiscal issue is also up in the air here and what the government is going to do.
At first, he’s very focused on designing a framework to replace the others that didn’t hold up. But I think that, at this moment, more important than redesigning a framework —which is, of course, relevant— is to announce very clear targets for the primary balance and, who knows, even for spending, over the next three years.

This would be the most forceful and clear step, in my view, and not a discussion of a very sophisticated framework, based on the positions of the government as a whole, including the President of the Republic, that this fiscal issue is or is not very relevant , or is a gross exaggeration. But there is certainly no great appreciation for this topic outside the Ministry of Finance, for the time being.

Here, what would tend to calm things down would be precisely to give the BC more space to work — and the only way to do that is to resolve the tax issue. That’s it, or it would have some impact on credit as well. A freer BC, or one that doesn’t have to carry a heavier piano than it should, can work the theme a little better.

Mr. Do you think the government is taking too long to present the targets? A little. But it is not unusual for a government that is coming to take a little while to get into gear. It doesn’t worry. What worries is this feeling that a framework will solve the matter. Will not. What will solve it is for the government to present its commitment. Then things calm down.

It is already said that the Fed, the American central bank, can review interest rates. For what mr. I mean, is it more difficult for this to happen here until the tax issue is resolved? There is always — let’s put it this way — a component of risk aversion. However, in our case, we are facing a banking system —as far as one can see, and I tend to agree— that is solid, and a reasonably closed economy.

We have more of a general psychological risk component, fueled by issues that are not just psychological. Contamination from outside is not the main risk factor here.

It is important to differentiate the international framework from ours. In the international context, we have governments and banks, most of which are considered solid and have reasonable room for manoeuvre. I would say that here, although we are not facing a bank run —this is my expectation—, we have a very fragile macroeconomic situation, with interest rates already very high. It is clear that high interest rates are a problem, and it is not new. But the cure for this condition is fiscal.

Does the government, then, need to announce the framework with the parameters soon? Forget the framework. The framework may even take a while. With or without framework, he has to announce the main parameters. Deep down, they are going to give the following signal: look, we are going to make an attempt —because nobody really believes it— to resurrect the Fiscal Responsibility Law, the spending ceiling, in a credible way, within a commitment, of a government which is now starting, which has everything to make an investment in the medium and long term. Then the situation tends to calm down.

If there is a huge crisis in the world — I am not ruling it out, but it is not the most likely scenario — then Brazil will suffer, there is no way to avoid it. But as always, our biggest problems are in here.

Mr. mentioned the issue of shaving. BlackRock CEO Larry Fink said that part of what we see now is the result of the glut of cash in recent years. Mr. Do you agree that the environment made institutions be permissive and lenient with financial rules? For sure. This is something recurrent in the financial history of peoples and part of a natural cycle that attracted several scholars, such as Irving Fisher, Hyman Minsky and Ben Bernanke himself. The subject is known, but the solutions have proved difficult, as we are seeing.

I think it’s time to review the rules. Many things understood as dogma can be revised, such as the issue of deadlines. Bank borrows short and lends long, but this cannot be interpreted with all that flexibility. The system needs to rethink this. Banks themselves are already subject to various obligations in terms of liquidity. Normally, they don’t carry very long credits on their balance sheets. You don’t see infrastructure financing on banks’ balance sheets. That goes to investors with adequate liabilities, like insurance companies and pension funds. It’s not that nothing has been done.

However, the fact is that we are experiencing this crisis with symptoms very similar to those of others. There has been a bank run as long as there has been a bank. This is nothing new in itself. What’s amazing is that it wasn’t managed well. The answers aren’t easy, but there are a lot of good ideas, and it’s time to sit down and discuss them.

Mr. mentioned that he is not afraid of a banking crisis in Brazil. I imagine it’s because of the size and solidity of the institutions, and even because of their concentration. There is also no risk for smaller and younger institutions. Are digital banks, fintechs, shielded? Armored no one is ever. But I don’t believe that this sector can succumb to a banking crisis. Banks here in Brazil are more capitalized. One has the impression that big blunders like the one we saw in the United States don’t happen here. That’s my assessment.

And what is the scenario for companies in general? What is said is that credit restrictions are strong and some companies are at their limit. That’s another story. The economy, in addition to the supply shock, warmed up. BC tightened. Many companies rely on financing for working capital, and they are suffering badly. Some are even proving unviable. This is a typical economic cycle issue and not a major systemic crisis..

What is your perspective for the Copom meeting? I avoid this question openly, also because I am a manager. I believe that BC’s method of work is good. It’s getting right. You can make a mistake here and there, but the Copom meets frequently and they correct it, if necessary. The system is good. He has difficulties when the supervisor is not good. There complicates.

RAIO-X – Arminio Fraga, 65

Economist from PUC-Rio (Pontifical Catholic University of Rio de Janeiro) and PhD in the area from Princeton University, he is a founding partner of the management company Gávea Investimentos. He was managing director of Soros Fund Management, the investment company of businessman George Soros (1993 to 1999), and president of the Central Bank of Brazil (1999 to 2002). He participated in the foundation and chairs the boards of the IEPS (Institute of Studies for Health Policies) and the IMDS (Mobility and Social Development Institute)