MNI INTERVIEW: Brazil Risks Fiscal Dominance-Ex BCB Deputy

MNI (BRASILIA) - The Central Bank of Brazil is likely to hike by another 50 basis points at its next meeting in December, but an over-expansionary fiscal environment could mean that rate rises will soon be insufficient to quell inflation, the BCB’s former deputy governor for economic policy Sergio Werlang told MNI.

"Copom might continue raising rates, probably by another 50bp at the next meeting, but I believe that at some point, especially with the new board composition next year, someone on the board might start to question its effectiveness. Because I believe that even with a significant increase, the BCB wouldn’t be able to bring inflation to target," Werlang, now a professor at Fundacao Getulio Vargas, said in an interview.

"Some are talking about an interest rate of 15% for inflation around 4.5%, which doesn’t seem reasonable," he added. The Central Bank of Brazil decided to hike its official Selic rate by 50 basis points to 11.25% last week, accelerating the pace of tightening while remaining data-dependent for future steps.

MONETARY POLICY WEAKENING

"I believe that monetary policy is losing some of its potency due to the fiscal situation. It’s not that we’re already there, but we’re approaching what’s known as fiscal dominance, where raising rates becomes counterproductive for lowering inflation," Werlang emphasized. (See MNI INTERVIEW: BCB To Keep 50BP Pace in December -Goldenstein)

Although Werlang considers the BCB’s 3% inflation target to be too low, he recognises that to change it would require a major fiscal adjustment to be implemented simultaneously.

"To reach the target, the interest rate would need to be so high that the debt-to-GDP ratio would keep rising. This is usually counterbalanced by a contractionary fiscal policy, which is the opposite of what we’re seeing. Fiscal policy is very expansionary now," he noted.

The former BCB deputy governor highlighted that it is possible the measures still be announced by the government may improve the outlook, but that would require a change to the trajectory for public debt, which is currently equivalent to 78.27% of GDP.