Faced with sluggish GDP growth, Central Bank slashes interest rate by 0.75 percentage points to 9.75% per year

The Monetary Policy Committee (“Copom”) at the Central Bank was under pressure after the announcement earlier in the week that GDP growth was a weak 2.7% for 2011. The pressure increased when it was seen that the industrial sector’s feeble performance was responsible (industrial production was down 2.1% in January, compared to December 2011, and down 3.4% compared to January 2011; and a breakdown of 2011 GDP growth showed that the farm sector grew 3.9%, services were up 2.7%, but industry as a whole only up 1.6%)

Last night, by a 5 to 2 vote, Copom decided to lower Brazil’s benchmark interest rate, known as the Selic (“Sistema Especial de Liquidação e Custódia”), by an unexpectedly large 0.75 percentage points. Although Brazil has the world’s highest interest rate, the market had almost unanimously forecast a cut of only 0.50 percentage points (the two votes contrary to the 0.75 percentage point increase were in fact for a reduction of 0.50).

Just exactly how much main street economic influence the Selic has is controversial. Conventional wisdom says a lower basic interest rate boosts consumption by benefiting the consumer, investments by benefiting the businessman, production by benefiting businesses and is good for sustainable economic growth.

However, a lower Selic undercuts investment yields in general and means lower returns on government bonds.

On the other hand, it will discourage Brazilian banks, businesses and individuals from borrowing money abroad at low interest rates and bringing it home to put on hot money markets, as well as stemming the “monetary tsunami” of foreign hot money flowing into Brazil seeking high returns that president Dilma Rousseff has complained about.

Yet, the fact is that there is an enormous disconnect between the Selic and the interest rates the Brazilian financial system charges. According to the Consumer Protection Foundation of São Paulo (“Procon-SP”), the average interest on a personal loan at seven of the city’s largest banks is 5.8% per month (in other words, monthly interest runs around half the annual Selic). The only thing worse than that is the interest on an overdraft allowance (“cheque especial”): a whooping 9.53% per month.

As soon as the Copom decision to reduce the Selic was announced, the country’s largest state-run bank, Banco do Brasil (“BB”), released a note with new rates for individual and corporate loans. The BB admits that its interest rates, along with those in the rest of the Brazilian financial sector, are disproportionate with regard to the Selic, but points out that the present reduction is the fifth since July 2011, and that its interest rates are the lowest on the market. According to the note, for example, interest on Crédito Benefício loans will fall from 2.31% to 2.27% per month, while BB Crediário loans will go from 3.35% to 3.31% per month.