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Brazil's Real Plan
On July 1, 1994, Brazil implemented the last, and to date, most
successful of its economic stabilization programs to end inflation.
Nearly three years later, the Real Plan was intact, far outliving
its ill-fated predecessors. By late 1996, inflation by some measures
approached an annual rate of less than 20 percent, a remarkable
achievement in an economy that a few years earlier would have regarded
even a monthly rate at this level a triumph. The new monetary unit
created by the plan, the real (pl., reais ; for value of the real
, see Glossary), actually appre-ciated against the dollar in the
months after its creation.
The design and implementation of the Real Plan also distinguished
it from the earlier plans, and may help explain some of its success
in its first years. Unlike the earlier plans, it did not depend
on a general price and wage freeze to stop inflation. At the heart
of the new plan was the de-indexation of the Brazilian economy,
which was accomplished in part by converting salaries and a number
of other prices in the months preceding the implementation of the
Real Plan into Real Value Units (URVs), which were then linked to
the United States
dollar. After July 1, 1994, prices in URVs were converted into
reais , which began officially at par with the dollar, but traded
at a premium in the open market. Although the new plan made no guarantees
of automatic price and wage adjustments to compensate for inflation,
few restrictions were placed on employers and employees in private
wage negotiations.
Although some observers characterized the Real Plan as a form of
"dollarization" of the Brazilian economy, in which prices
and wages that previously had been indexed to inflation were now
linked to a foreign currency, there was a significant difference
between Brazil's approach and that of countries like Argentina,
which attempted to stabilize the value of their currencies through
a formal and legal link to the dollar. Brazil did not make such
a commitment, and despite the stability of the real against the
dollar throughout the first year and a half of the Real Plan, there
was a widespread expectation that the real eventually would depreciate.
This exchange-rate policy and the expectations that accompanied
it had significant consequences for the domestic Brazilian economy.
Expectations of an eventual depreciation of the currency, coupled
with the short-term stability of the exchange rate and much greater
mobility of financial capital between Brazil and world financial
markets led to a strong appreciation of the real and painfully high
domestic real interest rates. Lenders required interest rates that
would protect them against a possible depreciation. With prices
stable or even falling for some products, borrowers could not repay
in currency that had lost its value through inflation, as they were
accustomed to do in earlier years.
International enthusiasm for the Real Plan, reinforced by its apparent
success in its first year, led to the resumption of large-scale
flows to Brazil, permitting the government to maintain its policy
of approximate exchange-rate stability. Despite the worries about
a depreciation, and several speculative attacks against the real
in its first year, the high level of capital flows to Brazil more
than financed the high level of imports stimulated by the resumption
of economic growth, leading to a sharp increase in Brazil's reserves
of foreign currency. By late 1995, they totaled more than US$50
billion.
The fall in inflation, supported in part by the strong real , led
to important changes in income flows within the Brazilian economy.
Decades of inflation had produced a large financial sector, which
flourished in part through the spread between borrowing and lending
rated in a high-inflation environment. With the fall in this revenue,
a number of financial intermediaries came under severe pressure,
despite the high real interest rates. During 1995 there were bank
insolvencies, with failures avoided by Central Bank intervention
to merge these intermediaries with stronger ones.
The fall in inflation also had consequences for Brazil's income
distribution. Lower-income groups, which had borne a disproportionately
large share of the inflationary burden because of their relatively
limited access to fully indexed savings opportunities and to the
tendency of minimum salaries and other nominal wages to lag behind
inflation, benefited significantly from the Real Plan. In the months
following its implementation, sales of consumer durables, especially
those purchased by lower-income groups, increased significantly,
leading the government in 1995 to attempt to restrict consumption
and reward saving. The rise in the real incomes of lower- income
groups produced a level and depth of political support for the Real
Plan that made it difficult for unions and other groups opposing
many of the policies of the new Cardoso government to confront the
Real Plan head on. It also may have helped the government in its
efforts to secure the support of the Congress for a number of its
proposed reforms.
The Real Plan's success in its first year strengthened the political
support that the government needed to attack the underlying fiscal
disequilibrium. By 1995 the operational budget of the federal government
was significantly smaller than it had been in earlier years, and
the attempts by some organized sectors, among them the employees
of state enterprises, to overturn many of the policies of the Real
Plan had been resisted. Further progress in reducing the pressures
on the finances of Brazil's public sector rested on the rates of
the first year of the Real Plan, as well as on the support of Congress
for the fiscal reforms proposed by the Cardoso government.
By the end of 1996, the Real Plan appeared to have succeeded in
its objective of ending decades of inflation and macroeconomic uncertainty.
It had also bought valuable time for the government to attack the
underlying fiscal imbalance that generated the inflationary pressures.
There was little time to be lost, however, and the rise in public-sector
expenditures, especially at the state and municipal levels, cast
a cloud over the prospect for the long-run success of the Real Plan.
This rise was the consequence of a number of factors, among them
the surge in costs for public-sector employees created in part by
the requirements of the 1988 constitution. In the short run, the
rise in interest costs in the first year of the Real Plan was a
heavy burden for many states and municipalities, some of which were
unable in 1995 to pay employees their full salaries. Other pressures
on the public sector included rising pension and social security
costs, caused in part by demographic trends and by the generous
promises of earlier governments to future retirees.
Data as of April 1997
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