The Legacy of the Real Plan: a stabilization without economic growth? Fernando Ferrari-Filho* “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes” John Maynard Keynes 1. Introduction After many frustrated attempts at stabilization policies in Brazil during the 1980s and 1990s1, the Real Plan is considered the most successful plan of economic stabilization that Brazilian economy had concerning its prime objective: the reduction and control of inflation rate. The figures about inflation rate show the success of the Real Plan: in June 1994, one month before the introduction of real as legal tender, the annual inflation rate was around 5,150.00%, while in December 2000 the inflation rate in the last twelve months was, approximately, 10.0%2. Although the price stabilization represents the incontestable success of the Real Plan, it fails when we look at the performance of Brazilian economic activity throughout the period of real: from 1994 to 2000, the average growth rate of GDP was only 3.0% per year, very similar to the average growth rate of GDP of Brazilian economy in the 1980s – by the way, this decade was considered the “lost decade” by Brazilian economists – that was 2.9% per year3. The poor performance of GDP during the period of real can be explained by the fact that the Real Plan was conceived as a stabilization plan without proposing any strategy for medium and long run development. For us, the stability of the currency makes sense only if it aims at developing the production, circulation and distribution of the economic activity. In other words, the price stability cannot be considered the final step of the economic stabilization; on the contrary, the price stability is just a condition to develop the economic activity in the medium and long run. This paper aims at analysing the reasons of successful – that is to say, the reduction and control of inflation rate – and unsuccessful – it means the disequilibria of fiscal budget and balance of payments of Brazilian economy – of the Real Plan. After analysing these disequilibria, the paper shows that the fiscal imbalance and the deficit of the balance of payments impose some constraints concerning the recovery of Brazilian economic growth in the medium and long run. Going in this direction, the paper is divided in three sections. It begins in * Professor of Economics at the Federal University of Rio Grande do Sul, Research Fellow of CNPq and Flemings Visiting Fellow in Economics at the University of Oxford’ s Centre for Brazilian Studies. 1 The Cruzado Plan, in 1986, Bresser Plan, in 1987, Verao Plan, in 1989, and Collor Plan, in 1990, are some example of these frustrations. 2 These inflation rates were calculated according to IGP-DI/FGV. See Table 1. 3 These average growth rates of GDP were calculated according to Table 2. 2 section 2 by bringing back the logic and theoretical framework of the Real Plan. Section 3 shows the management, by monetary authorities, of economic policy during the period of real and its impact on real variables of Brazilian economy, before and after the Brazilian currency crisis, in January 1999. The last section, considering that the inconsistency of macroeconomic fundamentals impose serious restrictions to assure the increasing of Brazilian economy in the medium and long run, presents some policy recommendations – let us call them as economic growth target – able to restore the macroeconomic balances, indispensable to maintain the inflation under control and, at the same, assure the economic growth and social development of Brazilian economy for the next years. 2. The logic and theoretical framework of the Real Plan The Real Plan, developed and implemented by the former Minister of Finance of Itamar Franco government and the current President of Brazil, Fernando Henrique Cardoso, diagnosed that the Brazilian inflation rate was related to the public deficit and the general indexation of the nominal contracts of the economy4. Considering this diagnosis, the Real Plan aimed to create a new framework for economic management to change (i) the style of fiscal policy and (ii) the monetary regime. Thus, the economic stabilization was developed in three steps: first, the Government adjusted the short-term fiscal deficit; secondly, the monetary authorities introduced a price index to stabilize the relative prices of the economy; and finally, the monetary reform was implemented – real as legal tender. What was the short-term fiscal adjustment? In a context in which (i) the privatisation program was extinguished by Itamar Franco government and (ii) the constitutional reforms were not approved by representatives in the National Congress5, the monetary authorities could not operate the structural fiscal reforms. Then, they decided to be very “original”: a short-term plan of fiscal austerity was implemented – that is to say, fiscal measures were adopted to aim at cutting expenditures – and, at the same time, the Government created a tax over financial transactions to increase the fiscal revenue. At the end of 1993, this short-term fiscal adjustment, called Emergency Social Fund, was approved in the National Congress. As a consequence, in June 1994, one month before the monetary reform, the primary fiscal surplus was equivalent of 2.6% of GDP, as well as the nominal public deficit – the overall result of operational and primary fiscal of Union, States and Municipalities and the public enterprises’ surplus – was balanced. 4 On one hand, it is important to say that the main cause of the public deficit was its financial component due to the necessity of paying high interest rates to economic agents as a condition of postponing the debt public. In other words, it means that the primary result of public sector – the difference between the current expenditures of Union, States and Municipalities and the tax revenues of them – was balanced. On the other hand, the idea of relating inflation with the general indexation of nominal contracts of the economy was elaborated and discussed in the 1980s, as well as it basically supported the Plano Cruzado and Plano Bresser. According to this idea, if there is not a price shock in the economy – such as, demand push or supply cost – the current inflation is determined only by the past inflation. 5 By the way, the privatisation and deregulation programs and the institutional reforms, such as administrative and Social Security, would continue and be approved in the Fernando Henrique Cardoso government. 3 The second step of the Real Plan was characterized by the introduction, in February 1994, of the Unit of Real Value (URV) as standard of monetary value, while the cruzeiro real continued to be used as legal tender. The URV, an average index of some representative inflation indexes of Brazil – IPC/FIPE, IPCA/IBGE and IGP-M/FGV – aimed to push the economic system to find a sustainable price set, essential to remove the indexation process of all nominal contracts of the economy. It is important to emphasize that the success of this step of the Real Plan occurred because, contrarily other Brazilian plans of economic stabilization, the URV was introduced in a context in which the market mechanisms were totally respected. The last step of the Real Plan made, in July 1994, the URV as legal tender. In other words, the monetary reform was introduced: the real replaced the cruzeiro novo as medium of exchange, unit of account, standard of deferred payment and store of value. Moreover, the Government established two nominal anchors: monetary and exchange rate. Focusing on the monetary anchor, the monetary authorities established some targets to expand the money supply, more specifically to control the high-powered money. The exchange rate anchor was characterized by the following systematic: the Central Bank of Brazil would control the maximum price of the exchange rate – one real could not be superior to one U.S. dollar –, while the exchange rate market would establish the buying price of the exchange rate. To sum up, the exchange rate anchor would be used to reduce and control the inflation rate, while the strategy of monetary anchor would be to contain the impetus of the economy. As the next section shows, the monetary anchor, after the Mexican crisis, would be also used to finance external imbalances. 3. The announcement of a devaluation process? As is well known, the Real Plan was successful in bringing quickly inflation down6 and, as a result, in the short run the demand was expanded – basically durable-goods. Tables 1 and 2 show the performance of inflation rate and growth rate of GDP, ex ante and ex post the Real Plan. According to Table 1, there is no doubt about the success of the Real Plan: from July 1994 to December 2000 the inflation rate was 149.8%; it represents an average inflation rate, during this period, of 1.18% per month. This figure is very representative when it is compared with the average inflation rate during the six months before the real that was 43.2% per month. Considering Table 2, in the beginning of the Real Plan, more specifically in 1994 and 1995, the average growth rate of GDP was 5.0% per year, while, between 1990 and 1993, the average growth rate of GDP was only 1.3% per year. The conjunction of bringing inflation down and provoking demand expansion, at least in the short run, forced the Government to slow down the economy, by controlling domestic credit and increasing real interest rate. The consequence of a high real interest rate was the entrance of short-term capital inflows7. Thus, the nominal exchange rate became overvalued.