By mid-2023, the basic interest rate should reach the most contractionary level in 20 years, since the beginning of the first Luiz Inácio Lula da Silva government (2003-2006), according to estimates by the macroeconomic research area of Banco Santander.
The more contractionary the interest rate level is, the greater its effect of cooling economic activity by making credit more expensive, discouraging consumption. In contrast, an expansionary level means a boost to demand.
Santander’s calculation considers the difference between the real and neutral interest rates. The first is measured by expectations for the base rate (Selic) and for inflation 18 months ahead, a period that encompasses the maximum effect of monetary policy —that is, the impact on the economy of interest rates set by the Central Bank.
For the neutral interest rate, which in theory does not stimulate or contract demand, the fixed value of 4% per year estimated by the monetary authority is considered.
According to the projections of the Santander team, the above-neutral rate, which indicates the effect of monetary policy on the economy, was at 4.8% per annum in December 2022 and should reach 5.7% in June and July of this year. This is the highest level since the 6.5% reached in July 2003.
The increase occurs because, even with the Selic maintained by the Copom (Monetary Policy Committee) at the current 13.75% per year in this period, there is a drop in inflation estimates for the 18 months ahead. As a result, the real interest rate rises, and the level of monetary tightening becomes stronger. In 2003, the Selic rate reached 26.5% per year.
“If the BC has an ex-ante real interest rate [“olhando para a frente”] above the long-term structural rate [a taxa neutra]is contributing to pull the handbrake on aggregate demand”, says Mauricio Oreng, superintendent of macroeconomic research at Santander.
To measure the effect of monetary policy on the economy, economists use the ex-ante real interest rate, “looking forward”, which better reflects the cost of taking out credit, for example. Another way to calculate the real rate is “looking back” (ex-post), by the difference in interest rates and inflation in the last 12 months, given that it is more used in evaluating investments already made.
In Santander’s main scenario, the BC should start cutting the Selic rate in August, which would also start a reduction in the level of monetary tightening on the economy in the following months. In December 2024, the end of the term of the current BC president and the date of the bank’s last projection, the base rate would be at 9% per annum, a level that is still slightly contractionary for the economy.
Despite the level of monetary tightening, the BC itself projects that inflation in 2023 will remain at 5%, above the tolerance limit of 4.75%. This would be the third year in a row that the target has been exceeded. For 2024, the institution projects a price index exactly in the middle of the 3% target.
Real swear ‘out of purpose’
In his first statements after taking office, Minister Fernando Haddad (Finance) stated that Brazil has the highest interest rates in the world in real terms, at a level “out of place”.
By Santander’s calculation, the real interest rate was at 9% per annum at the end of 2022 and should reach 9.9% in June and July of this year. This is the highest level since mid-2006, also in Lula’s first term, when the indicator was at 10% a year.
The effect of the real rate on inflation also depends on the neutral interest rate, which is estimated by the market at 4.5% per year, according to a survey carried out by the BC with economists. Some analysis houses estimate that the indicator may be closer to 5%. In this case, the effect of the basic rate on the economy, throughout this semester, will be smaller. It will still be at the highest levels since 2003.
The minister attributes the problem of high interest rates to measures taken by the previous government to stimulate the economy with a view to the re-election of former President Jair Bolsonaro (PL). According to Haddad, it is necessary to seek an understanding between the fiscal authority and the Central Bank.
The economic team is studying measures to reduce the deficit in public accounts this year. Expenditure containment helps to reduce demand pressures, which facilitates the fall of inflation and allows to cut interest rates more quickly.
Mauricio Oreng, from Santander, says that the trajectory of the basic rate until 2024 indicates a very restrictive monetary policy and that the possibility of the Central Bank raising interest rates again is not in the bank’s scenario, as part of the market has projected.
On the other hand, the Brazilian economy is slowing down, but it remains close to its growth potential. In this scenario, economic stimuli and uncertainties about fiscal policy make it difficult to fight inflation.
“It’s a very tight monetary policy stance. The big question is whether this tightening is enough to bring inflation to the center of the target,” says Oreng.
‘Bolsonaro’s great legacy’
The Minister of Finance spoke several times about the need to have credible fiscal rules and said that, in the first weeks of the government, the necessary measures will be presented to restore the confidence of investors and citizens.
He returned to the subject on Tuesday (3), in an interview with the Brasil 247 website. According to Haddad, the measures taken during the election period left a R$300 billion shortfall in public accounts and led the country to have “the highest real interest rate of the world today”. “This is Bolsonaro’s great legacy,” he said.
The minister said that Brazil has an inflation rate lower than that of the US and Europe, but with the highest real interest rate on the planet. “Look at the paradox we are experiencing, a completely anomalous situation. Comparatively low inflation and an inappropriate real interest rate for an economy that has already been slowing down,” he said.
The statement was understood as a criticism of the Central Bank.
The Central Bank has said that, despite the economic slowdown, other risks to controlling inflation remain. Among them, the tax issue. Market projections for price indices in this and the coming years are on an upward trajectory.
Roberto Campos Neto has a term as BC president until the end of 2024. President Lula will appoint two new members to the institution’s board of directors in March this year and another two in January 2024.
Only from 2025 onwards will those appointed by the current government become the majority in the Copom, as provided for in the legislation that gave autonomy to the institution. The collegiate is formed by the president and eight directors.
Glossary
Basic interest rate
The Selic rate is the reference for other interest rates in the economy. This is the average rate charged in negotiations with securities issued by the National Treasury, registered daily at Selic (Special System for Settlement and Custody).
real interest rate
It considers a nominal rate, the Selic, for example, discounting inflation
ex ante real rate
Calculated looking forward (expected rate), based on projections for interest and inflation. It is the most relevant for monetary policy, as it influences future investment and consumption decisions
ex-post real rate
Calculated looking backwards (verified rate), based on interest and inflation over the last 12 months, for example. Serves to evaluate an investment already made
Neutral rate or structural interest rate
The one that keeps inflation on target and GDP growth equal to its potential. It can only be obtained from estimates.
Effective real interest rate
Difference between the real rate and the neutral rate. When the effective real interest rate is positive (real rate above the neutral one), the monetary policy is contractionary: it contains economic activity and contributes to the reduction of inflation. If it is negative (real rate below the neutral rate), it boosts economic activity and contributes to rising inflation
Copom (Monetary Policy Committee)
Body of the Central Bank, formed by its president and directors, which defines, every 45 days, the basic interest rate of the economy, the Selic
IPCA
Indicator measured by the IBGE that serves as an inflation target. The goal is defined by the National Monetary Council, a body that includes the BC, the Minister of Finance or Economy and other members of the economic team. The target for 2023 is 3.25%, with a limit of 4.75%. For 2024 and 2025, the expected target is 3%, with a limit of 4.5%
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