Brazilian rates: A race to single digits

An article in Brazil’s Valor Econômico has got economists’ pulses racing. According to Brazil’s top business newspaper, the government will send legislation to Congress that will change the country’s popular savings account system, or “poupança”.

This is a deposit scheme commonly used by lower income people that pays 0.5 per cent interest a month plus the reference rate (presently 0.062 per cent per month) and is exempt from income tax.

The problem with the fixed interest rate on the poupança is that whenever Brazil’s benchmark Selic interest rate falls significantly, investors shift their money to the poupança, leaving other financial products high and dry.

This happened during the global financial crisis when the Selic fell to 8.75 per cent.

The effect is that the poupança is seen as an obstacle to Brazil’s long-cherished ambition to lower its real interest rates, which are among the highest in the world.

Late on Tuesday, Finance Minister Guido Mantega denied the Valor article but it is well known that President Dilma Rousseff wants to see lower interest rates in Brazil.

Her government sees the eurozone crisis and the ensuing global slowdown as a chance to try to bring rates down. The central bank has already cut the Selic by 100 basis points in the past two months. So tinkering with the poupança at this juncture would make sense from the government’s point of view.

Only many economists do not believe the government’s gamble on inflation – that it will continue to fall in line with a deteriorating global outlook – will succeed. This from Nomura’s Tony Volpon:

    The government’s strategy is in effect an attitude of “let’s get there first and then we will see what we will do to hold down inflation”. We believe this will ultimately not work, and we also forecast Selic to rise later in the year. Nonetheless we believe the news today is another signal that bringing Selic to single digits is now not so much a target of monetary policy, but a much more important “decision of state”, a major policy imperative of the Dilma Rousseff government.

In Brazil, it seems monetary policy has become a race to get rates down into the single digits. But it is anyone’s guess whether the Selic will be able to get to the finish line before its old enemy — inflation – catches up.