MNI INTERVIEW: BCB To Ease Gradually As It Assesses War- Pires

The Iran war's impact on the global economy is clearly inflationary but the Central Bank of Brazil wants time to assess the effects on its own economy, and will temper the pace of easing for now, former secretary of economic policy at the Ministry of Finance Manoel Carlos Pires told MNI.

The BCB last month cut its official Selic rate by 25 basis points to 14.75%, but this is still a high level, noted Pires, adding that such tight policy will tend to lead over time to rising indebtedness and default, and difficulties for otherwise healthy companies in obtaining financing.

"The Copom is facing a significant dilemma. Interest rates have been very high for a long time, with the real rate above 10%. This begins to generate effects that go well beyond simply slowing economic activity to curb inflation,” said Pires, now a researcher at Fundação Getulio Vargas, in an interview.

"My impression is that the Copom decided to slow the pace of rate cuts to gain time and better assess the effects of the war," Pires said.

TERMINAL RATE

If the war ends soon, the central bank would return to its original easing plan, he stressed, though the terminal rate of the cycle will depend on how the conflict evolves.

"If the effects of the war begin to materialize, it will most likely end the easing cycle earlier than previously planned."

What matters most is the signal the BCB sends going forward, Pires said.

"The baseline scenario is for gradual cuts, while the monetary authority better assesses how these various economic forces will combine to produce a given outcome, whether higher inflation or economic slowdown."

GOVERNMENT RESPONSE

On the political front, Pires said the government’s response, including subsidies and tax breaks, as well as an export tax on companies benefiting from the oil price surge, has been appropriate so far, and faster than its response to the 2022 energy shock, even if it is difficult to determine whether the fiscal windfall will be sufficient, as this will depend on the magnitude and duration of the war. (See MNI INTERVIEW: Iran War Fuels Brazilian Fiscal Risks)

The government is also negotiating temporary exemptions from the ICMS value-added tax collected by Brazil’s states. However inflationary pressures tend to reduce a government’s popularity, making this a delicate moment, especially in an election year, even if the cause of the shock is external to Brazil, he said.

"Brazil produces more oil than it consumes, so the macro effect is positive, but highly asymmetric," said Pires. "Most of the population does not feel this benefit, but it feels the impact of higher inflation. So the government needs to act to mitigate these effects, particularly in fuels.”