Opinion – Solange Srour: International reserves, insurance or threat?

In the last few weeks, we have had news about the elaboration of two apparently independent proposals.

The first refers to the establishment of a target for international reserves. An optimal level would be established, probably below the current one, with fluctuation bands. In practice, such a measure would limit the Central Bank’s direct action in the foreign exchange market with the purchase and sale of dollars.

The second deals with a new fiscal framework: the use of the debt/GDP ratio as an indicator of the necessary fiscal adjustment. The pace of expenditure growth would be determined depending on the ranges of this ratio. Although not explicitly, the projects are quite interconnected. If the sale of reserves is used to reduce gross debt and this is chosen as a metric for the new fiscal rule, then room will be opened for further growth in expenses.

Reserves should be seen as insurance that the country acquires against potential shocks that destabilize capital flows and generate exchange rate instability. The economic literature is full of studies on what would be the optimal level of reserves, which fundamentally depends on the country’s tolerance for external risks and the cost of carrying such insurance. This cost is heavily impacted by the differential between domestic interest rates and the interest rate obtained by investing reserves in the international market.

In Brazil, this differential has never been small. What happens is that the public sector is financed by local (higher) interest rates, but accumulates assets remunerated by international (lower) interest rates, causing a fiscal worsening.

There is no doubt that, when compared to our international peers, Brazil stands out as one of the countries with the highest level of reserves and the highest cost. The question we must ask ourselves is whether these factors are sufficient to determine that we should have fewer reserves.

Between the end of April and the month of September 2015, the dollar went from R$3 to more than R$4. From January to May 2020, we saw the US currency rise from R$4 to almost R$6 On both occasions, we had more than US$360 billion in reserves and made significant interventions to contain disorderly movements in the exchange rate.

But if the reserves were not enough to avoid significant depreciation, wouldn’t it be better to reduce their level and incur a lower fiscal cost? Here comes the counterfactual: what would have been the depreciation of our currency in these two situations without high reserves?

The fact is that the sustainability of our public accounts does not make us less vulnerable to external shocks. From 2015 onwards, we have advanced a lot with the approval of the spending cap and a robust pension reform, but we are always flirting with attempts to reverse the achievements achieved. Interrupting the fiscal consolidation process with the pandemic is justifiable, but the same cannot be said in relation to the weakening of the institutionality of the fiscal rule in the post-pandemic period. Today it seems easy to change the Constitution if the objective is to increase spending. That is, if, with high reserves, we are susceptible to changes in external mood, worse without them.

A lower public debt resulting from the sale of assets does not change the fact that we currently have a structural primary result, that is, without atypical revenues and expenses and discounting the effects of the economic cycle, below what would be necessary to guarantee its sustainability. If debt adjustment is not made via sustainable growth or lower break-even interest, it will rise again. Reducing public debt through the sale of reserves would only reduce the urgency of carrying out reforms that address the heart of the problem: rigidity and high mandatory spending.

Giving up insurance to make the fiscal framework more flexible creates insecurity regarding the sustainability of our debt, and most likely, the medium-term effect will be a higher break-even interest rate and a more depreciated exchange rate. The sale of reserves for debt relief can be counterproductive if done before a sustainable fiscal adjustment.

While we await the new fiscal framework, ideas of an alternative use for reserves pose a threat, going against their insurance role. It has not been a short time since we debated the use of reserves to capitalize public banks, create funds to finance social programs or to guide gasoline prices. These are the ideas that force us to have and pay dearly for high insurance, which is not so effective when we need it.