Brazil: changing sides in currency war

Another day, another macro-prudential measure from Brazil. On Thursday night Guido Mantega, finance minister, announced a doubling in the tax due on personal loans, from 1.5 to 3 per cent a year.

Measures like this have let Brazil reduce its reliance on high interest rates, formerly its only weapon against inflation. The trouble with high rates is they drive the currency higher and that hurts competitiveness – hence the whole currency war.

But you can’t have everything, and with inflation pushing higher Brazil appears to have decided that the strong BRL is its friend, after all.

First, a quick glance at Thursday’s measure. With consumers paying 238.3 per cent a year for credit card debt, it’s hard to see how an extra 1.5 points will make much difference. But as Tony Volpon at Nomura points out, the measure may curb supply of credit (rather than demand) because wider spreads provoke more defaults, so banks may lend less.

In any event, it doesn’t look like this will slam the brakes on consumer credit, currently expanding at a rate of 22 per cent a year – the government reckons 12 to 15 per cent would be “adequate”.

And what about inflation? The central bank’s latest weekly survey of about 100 market economists has it above 6 per cent by year-end. The survey’s “top 5″ best-rated economists say it will be 6.4 per cent. Not only is inflation way above the government’s 4.5 per cent target. It is threatening to breach the upper limit of its 2 percentage point tolerance.

The government has been right to look beyond interest rates for ways to fight inflation. Now, it seems, its reach has embraced the currency itself. On Thursday – after Wednesday night’s surprisingly weak “currency measures” – the real burst through the R$1.60 barrier against the US dollar and kept right on going. It now looks likely to settle into a new band of R$1.55 to R$1.60 – not far from where it was in pre-crisis days. So far, the government has not reacted.

What’s the pay-off? The government has three macro priorities: low inflation, investment, and competitiveness.

All of those can be addressed by micro-prudential measures: overhaul the tax system and the labour code, improve public education, etc, etc. Fat chance.

If you limit yourself to monetary policy and macro-prudential measures, you can’t have all three. Give up the fight against inflation, and you have a popular revolt. Give up on investment, and the World Cup and Olympics will be a disaster for a start – and never mind all the other infrastructure needed irrespectively.

Give up on competitiveness – well… Who will be hurt? What commodities exporters lose on the currency, they regain in part from rising prices. What manufacturers lose in competitiveness, they regain in part on the components they import.

A stronger real will hurt, no doubt about that. But perhaps not that much. In the fight against inflation, it is the government’s friend. And right now, the government needs all the friends it can get.