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Brazil Exchange Rates and Foreign Trade

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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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