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Brazil Exchange Rates and Foreign Trade
Exchange Rates and Foreign Trade
The single most important policy tool for influencing Brazil's balance
of payments is the exchange rate.
Brazilian exchange-rate policy has evolved over the past several
decades. Policy makers and Brazilian exporters believed that trade
flows in the 1960s and 1970s were most effectively managed through
trade policies such as tariffs (see Glossary), import controls,
or export incentives. Beginning in the 1980s, they began to recognize
that balance of payments adjustments may be more efficiently pursued
using the exchange rate, rather than tariffs, subsidies, and direct
controls on trade. This evolution in thinking reflects in part the
increasing skepticism among many Brazilians, both economists and
policy makers, about the government's ability to maintain external
balance using trade policy without creating severe economic distortions.
Even more important, however, was the exchange-rate experience
of the early 1980s. Following the onset of Mexico's debt crisis
in 1982 and the resulting inability of Brazil to continue to finance
its current-account deficit through external borrowing, the cruzeiro
was devalued sharply against the dollar in February 1983. Unlike
the earlier "maxidevaluation" of December 1979, which
was soon undermined by rapid increases in internal cruzeiro prices,
the real depreciation of the cruzeiro resulting from the 1983 adjustment
was maintained for the next several years. Exports increased substantially
in 1983 and 1984, and the value of imports fell by over US$5 billion
between 1982 and 1984. Although some of this decline resulted from
the fall in petroleum prices from their record levels in 1981, the
response of the trade deficit to the large and sustained real depreciation
of the cruzeiro provided clear evidence that Brazil's external adjustment
problem could be addressed through exchange-rate policy. The experience
of the early 1980s, in fact, led to the recognition that Brazil's
real problem was not the private sector's lack of response to the
exchange rate, but the inability of the domestic economy, particularly
the public sector, to generate the net saving that is the counterpart
of a current-account surplus.
Brazil's success in moving the current account into surplus after
1982 implied a corresponding adjustment in either net private saving
(private saving minus private investment) or in public-sector saving
(tax receipts and other public revenues minus public expenditures).
Because net public-sector saving actually deteriorated in the 1980s,
the burden of adjustment fell on the private sector, particularly
on investment. The dramatic fall in investment after 1982 had important
consequences for Brazilian competitiveness and hence for the potential
benefits that Brazil would derive from trade reform.
Thus, the experience of the early 1980s suggests that the Brazilian
economy had responded to real exchange rates (see Glossary) that
facilitated external adjustment, but the policy also reduced domestic
private investment and future economic growth. In retrospect, the
delay among policy makers in using the exchange rate as the primary
tool for achieving external balance is surprising. Their approach
may have been influenced in part, however, by the success of the
"crawling-peg" policy instituted in August 1968. This
policy consisted of small but frequent adjustments in the nominal
exchange rate in line with Brazilian inflation and price changes
in Brazil's major trade partners, primarily the United States. It
ushered in a long period of real exchange-rate stability, broken
only a decade later by the December 1979 devaluation. The crawling-peg
policy was a marked improvement over the earlier exchange-rate regime,
in which the combination of domestic inflation and a nominal exchange
rate fixed for long periods of time resulted in large fluctuations
and uncertainty about the real exchange rate. The real rate may
in fact have been too stable, however, leading Brazil to delay the
appropriate exchange-rate response to the external shocks of the
1970s.
A rise in the real exchange rate represents an increase in Brazilian
price competitiveness in international markets. Such an increase
in price competitiveness could be caused by a depreciation of the
cruzeiro against the dollar, a rise in United States prices, or
a fall in Brazilian prices. A slowing of inflation in the 1970s
made Brazil more competitive, while the rapid acceleration of inflation
in the second half of the 1980s substantially eroded Brazil's price
competitiveness. Unlike other episodes in which the actual effects
of a devaluation were rapidly undercut by Brazilian inflation, the
1983 real devaluation was maintained through frequent adjustments
in the nominal exchange rate, sufficient to maintain Brazil's price
competitiveness in international markets until the 1986 Cruzado
Plan froze the nominal exchange rate (see fig. 11; table 12, Appendix).
A number of implications for Brazil's balance of payments policy
are clear from exchange-rate trends and movements in the current
account. First, by the 1980s it was clear that Brazilian trade flows
were strongly responsive to the real exchange rate. If "elasticity
pessimism," which hypothesizes that trade responses to relative
prices are low, was ever justified in the Brazilian case, those
days were long past. Since the late 1960s, Brazil has ceased to
be a developing country in terms of its trade flows. Traditional
primary products, such as coffee, cocoa, or sugar, in recent years
have accounted for less than a third of the value of Brazilian exports.
The increasing importance of manufactured exports, as well as the
variety of local import substitutes, makes Brazil's trade balance
responsive to real exchange-rate changes. This responsiveness removes
one of the traditional justifications for extensive tariff and import
restriction policies and for administrative intervention in trade
to attain external balance. The evidence of the past several decades
suggests that Brazil can attain external balance without extensive
market intervention, however harsh the domestic effects of external
adjustment.
Second, the introduction of a degree of indexation of the nominal
exchange rate in the form of the crawling-peg policy has permitted
the external sector to avoid some of the consequences of domestic
inflation that would otherwise have produced much more severe external
payments crises. Real exchange rates remained relatively stable
for a decade after the policy's introduction in 1968. Unlike several
other Latin American countries such as Argentina, Brazil avoided
the sharp swings in the real exchange rate resulting from domestic
inflation and infrequent adjustment of the nominal rate. When Brazil
departed from this pattern, as it did in 1986 during the Cruzado
Plan, policy makers soon learned that this was a mistake. Subsequent
stabilization plans, even if they were failures for other reasons,
at least did not succumb to the temptation to use the exchange rate
as an anti-inflationary weapon.
Finally, and perhaps more negatively, Brazilian exchange-rate policy
transformed Brazil's external adjustment problems of the early 1980s
into more intractable domestic balance problems in the early 1990s.
Contrary to the initial expectations of many observers, Brazil was
able to solve its external balance problem after the 1982 debt crisis
with surprising speed. The cost was a sharp increase in the demand
for domestic saving to replace lost foreign capital inflows. With
little increase in net public-sector saving or in private-sector
gross saving, investment fell substantially, undercutting the growth
of the Brazilian capital stock and the economy's potential growth
in competitiveness.
Data as of April 1997
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