Brazil is South America’s largest economy. The Southeast of Brazil, centered around the state of São Paulo, is the main pole of economic growth and contains the largest number of industries. São Paulo state by itself accounts for approximately 35 percent of the country’s gross domestic product (GDP), which roughly equals the GDP of Argentina.
Brazil’s economy has enjoyed prolonged periods of strong economic growth; however, high inflation has been an ongoing problem. In times of both low and high growth, inflation has been an integral part of Brazil’s economic life since the 19th century. The late 1980s and early 1990s saw inflation at new heights as it remained for several years at over 1,000 percent per year. The following tables gives the annual inflation rates for 1987-95 and the estimated rate for 1996.
Since 1985, the government has implemented five separate programs to break the inflationary cycle. All of the these plans, previous to the current Real Plan, failed after a short period of initial success.
Source: Central Bank of Brazil
The 1994 Real Plan, named after the new currency it ushered in, the real, was introduced by the then Minister of Finance, Fernando Henrique Cardoso, and brought him to the Presidential Palace in the elections held in the fall of 1994.
The economic reform package known as the Plano Real has succeeded in providing much needed stability to the Brazilian economy since its introduction on July 1, 1994. The plan reined in uncontrolled government spending and reduced monthly inflation from 50 percent in June 1994 to around 2 percent a month later. One year after the introduction of the Real Plan, inflation was reduced to an average monthly rate of 2 percent.
However, after the initial economic stabilization, new inflationary pressures began to surface. Economic growth reached 5.6 percent in 1994, the highest since 1986. The return of consumer credit and the reduction of inflation encouraged spending and caused inflation to inch upward again. At the same time economic growth surged forward threatening to overheat the economy. January 1995 retail sales in São Paulo jumped 30 percent. Energy consumption was also growing at higher than expected levels.
Fearing that the economy was overheating, the Cardoso Administration took austerity measures to contain consumption and prevent inflation from rekindling. A credit restriction and anticonsumption package implemented in 1995 held back economic growth. Nevertheless, GDP growth still reached 4 percent in 1995. The plan also succeeded in keeping down inflation. At 23.1 percent, inflation in 1995 was lower than expected. The Bank of Boston estimates a 14.7 percent inflation rate for 1996, with GDP growth of 3.2 percent.
The new currency, the real, was originally valued on par with the dollar, but soon appreciated. In order to support the new currency, the Central Bank raised interest rates. Years of trade surpluses soon came to an end as Brazil’s exports suddenly became more expensive in overseas markets. By the end of 1994, the over-valued real peaked at 83 cents to the dollar. In response to the pressures of apparent overvaluation of the real, the Central Bank widened the exchange-rate band from 88-93 cents to 91-99 cents. By August 1995, the real had fallen to 94 cents. Following action by the Central Bank in January 1996, the real fell to 98 cents. The initial strength of the Brazilian currency tipped Brazil’s trade balance into the red for the first time in 1995.
After years of trade surpluses exceeding $10 billion, Brazil ran a trade deficit of $3.1 billion in 1995. However, because of the declining value of the real, Brazil is expected to have a trade surplus of $2 billion for 1996.
Inflation and Indexation
A key element in perpetuating Brazil’s inflation, as well as an essential instrument to cope with it, has been a widespread system of indexation covering virtually all of the economy, including salaries and contracts. A key factor in the initial success of the Real Plan was a wage pact with government workers and labor unions which eliminated automatic monthly increases. In July 1995, President Cardoso started a gradual dismantling of the indexation system by prohibiting indexation clauses in salary contracts, allowing salaries to be determined by negotiation between the parties in the labor market. Over the past year, President Cardoso has consolidated the wide array of indexes. Quarterly adjustments in taxes, according to the Ufir index, are scheduled to become biannual in 1996. Moreover, under the new law, adjustments for inflation in contracts cannot be made for periods of less than a year.
One of the main long-term challenges facing President Cardoso is to lower Brazilians’ expectations of inflation. It is necessary to alter the inflationary culture to follow signals of the market, in terms of productivity, demand and cost of inputs, instead of habitually raising prices, particularly in response to price increases in completely unrelated goods.
The most immediate threat to the Real Plan would be a sustained trade deficit combined with substantial amounts of portfolio investment covering the difference in the current account, as in the case of Mexico. The Brazilian situation is significantly different from Mexico’s though. For example, certain luxury goods have seen their tariff rates increase substantially. Cardoso has been acting forcefully to reduce the trade deficit and appears to have succeeded. Brazil’s willingness to let the real devaluate at a controlled pace should dispel any trade deficit worries for 1996.
The following are major basic economic indicators for Brazil as of end year 1995.
BRAZIL in Brief:
Geography: Approximately 8.5 million square kilometers.
Fifth largest country in the world.
26 states and 1 federal district.
Economic power concentrated in the Southeast.
Major Cities: São Paulo, Rio de Janeiro, Belo Horizonte, Salvador.
Population: 160 million people.
26 : 74 ratio of rural to urban dwellers.
50 percent under the age of 20 years.
Religion: 90 percent Roman Catholic.
Illiteracy Rate: 10 percent in South East. 15- 20 percent in Northern regions.
Time: -3 hours from GMT.
Currency Unit: Real (Approximately $0.98).
GDP: $613 billion (Approximately $3,835 per capita).
External Debt: $114 billion (Approximately 25 percent of GDP).
Debt service payments: 4 percent of GDP and 42 percent of export earnings.
Exports: $53.1 billion
Imports: $41.5 billion
Currency Exchange: $13.6 billion surplus
Total US Exports: $7.3 billion (23.4 percent of total Brazilian imports).
Major Trading Block: Southern Common Market (Mercosul: Argentina, Brazil, Uruguay, Paraguay).
Average Import Duty: 14 percent
Social Stratification: Uneven
Monthly Earning percent of the population
Less than 1 minimum wage 16.1
Between 1 and 2 times wages 21.2
Between 2 and 3 minimum wages 12.2
Between 3 and 5 minimum wages 17.6
Between 5 and 10 minimum wages 5.3
Between 10 and 20 minimum wages 7.5
More than 20 minimum wages 5.0
Source: Brazilian Institute of Geography and Statistics (IBGE)
Note: The minimum wage is currently stipulated as R$100 or approximately $102