The danger lurking in Brazi’s shadows

As investors, finance ministers and lenders prepare to decamp from the snowy streets of Calgary after the Inter-American Development Bank’s annual general meeting, there is one topic everyone agrees on, and one that they do not.

The first is the cold. As the head of Canada’s central bank put it: “You have to be either very brave or very committed to come to Canada in the winter.” The second is Latin America’s so-called “macro-prudential policies”, the new hot topic of global finance.

It is an ugly term that covers all manner of measures – from increases in bank provisions to capital controls – that Brazil, especially, is using to help slow its booming economy, although not without controversy.

Brazil says such policies are a pragmatic response to US quantitative easing that has flooded the world with international liquidity and pushed up its exchange rate to near-intolerable levels.

Many investors, though, believe Brazil is using them as a substitute for further spending cuts and higher interest rates. Brazilians retort that the first is politically painful, and the latter would only force its exchange rate higher still. That is why it has gone macro-prudential. Not all investors are convinced. Some have even dubbed Alexandre Tombini, the head of Brazil’s central bank, “Mr Pombini” – a pun on the Portuguese word for “dove”.

One way to cut through the intellectual controversy, though, is to make the following conceptual point. Macro-prudential measures are designed to strengthen the banking system. If boosting reserve requirements and loan-to value ratios also slow down the economy, that is well and good. But it is a handy by-product; not the policies’ main point.

The reason for this distinction is as simple as it is important. Macro-prudential measures only address the formal banking system. What they do not do is curb credit from the “shadow banking” system.

Brazilians, for example, spend an estimated one fifth of disposable income on debt payments. (By contrast, US households at the peak of their credit boom spent about 15 per cent.) Some of that debt is held by Brazilian banks, which are currently growing lending at a 20 per cent annual rate. But some of it also stems from debt taken out directly at shops via consumer credit instalment programs. Such lending largely escapes the macro-prudential net.

Nor do macro-prudential measures address the increasing amount of cheap money that Brazilian corporates are raising abroad via dollar bond issues. In January and February, for example, they raised two and half times what they did last year. One way or other, that credit creation finds its way into Brazil’s economy. Some of it funds the investment the country so desperately needs to improve its infrastructure. But some of it also funds an increasingly frivolous consumption boom.

For cynics, this is further evidence that the apparent strength of Brazil’s economy is just the result of another steroid-like credit boom which will end in tears as all credit booms do – most spectacularly in the US.

But that is unfair. The US was remarkably complacent during the run up of its credit boom. Brazil, by contrast, is active on many fronts. It is cutting spending. It has raised interest rates. And it has deployed “macro-prudential” policies too.

Will this Brazilian style policy-miscegenation see the country successfully muddle through and avoid an eventual bust? In Calgary the feeling was “yes” despite the many huge unknowns – such as commodity prices, future US interest rates, the possibility of a eurozone bust, and the dangers that may lurk in the shadows too.