Source: http://worldcityweb.com/home/MIA/publications/magazine/21/674/

Brazil: Money matters

by Walter Molano

Working from Karl Rove’s playbook, President "Lula" da Silva tries to foster an "ownership society" to ensure his re-election in 2006.

Price stability was Brazil’s primary objective during the latter part of the 1990s. After the hyperinflation of the 1980s and early 1990s, Brazil’s main goal was to reduce inflation. The Real Plan was successful in stabilizing prices. It was followed by inflation targeting, which restrained Brazil’s inflationary pressures after the maxi-devaluation of 1999. However, the emphasis on price stability forced policymakers to sacrifice growth. Brazil’s GDP growth rate averaged 2.2 percent between 1990 and 2004. At the same time, income distribution deteriorated.

It was clear that, once price stability was achieved, something had to be done to improve income levels. However, the government faced a dilemma. Given the experiences of the past 30 years, it knew that expansive monetary and fiscal policies would fan the simmering embers of inflation. Massive investment in education and infrastructure would help, but it would take a generation to reap the rewards. With elections held every four years, politicians would never capitalize on the benefits. Therefore, something else had to be done. This is where Lula took a page out of Karl Rove’s handbook.

The theory of “ownership society” is based on the hypothesis that societies will vote to maintain the status quo when they have a large financial stake in their community. The theory postulates that “financial ownership” aligns the interests of voters and current policymakers. In the United States, the notion is manifested in home ownership. Given that homes represent a large portion of Americans’ wealth, voters will choose politicians who maintain the value of their homes or enhance them. In other words, they will become more conservative. This does not mean that the society has to become “right wing,” as it did in the United States. It means that the electorate will conserve the status quo. In the United States, the status quo happened to be a right-wing government, but a leftist government could easily exploit the concept. Many political analysts believe that the tenets of “ownership society” shaped U.S. economic policies during President Bush’s first term, and they were vital in his re-election campaign. Therefore, it is not surprising to see that Lula is taking steps to apply the concepts to Brazil.

Unfortunately, consumer credit in Brazil is virtually non-existent. Given weak bankruptcy laws, bank lending is nil. Brazil’s mortgage market is tiny. Most cars are paid for in cash, and credit card rates are exorbitant. Only the largest corporations and the top income levels have access to credit at competitive levels. Members of the middle class have limited access to credit, but usually at triple digit rates. The lower income stratum has no access to credit. Therefore, the development of an ownership society in Brazil was going to be difficult.

However, there was a loophole. For the past decade, public sector workers could pledge part of their wages to banks in order to get preferential rates. Public sector workers would register the loans with their employers and the government would discount the installment payments from their paychecks in order to send it to the banks. Given that it is virtually impossible to fire any public sector worker, particularly in Brazil, the banks had the security they needed to provide financing at much lower rates.

The microfinance program was one of the most popular perks for government employees, and it expanded throughout the federal system. It was first developed for the military, but public sector labor unions throughout Brazil were soon clamoring for the program. The microfinance program was so popular that in October 2004, the government decided to expand it to pensioners by allowing them to deduct loan installments directly from their pension checks.

The program was a coup for Lula. Even though his Workers’ Party, the PT, was mired in a shroud of controversy, Lula’s popularity is starting to rise. By providing financial resources to a large segment of Brazil’s society that never had access to credit, Lula is creating his own version of an “ownership society” and this may be the key to his re- election in 2006.

Consequently, the drive to expand credit may shape Brazil’s macroeconomic policies. This may be the main reason why the COPOM, which sets interest rates, is starting to soften its stance. Most Brazilians believe that the monetary adjustment is coming to an end, even though the central bank will continue to miss its inflation target.

We believe that the new emphasis on credit expansion will provide an unexpected boost to the level of economic activity. Brazilians expect that the social security program will increase credit by $10 billion, but the economic effects will be multiples higher. As a result, the new micro financing programs will reshape the face of Brazil’s economic policies and determine the political landscape in 2006.