Dreaming of Brazil

Brazil's commitment to reform in the 1990s carries lessons for India

Brazil does not loom large in the consciousness of most Indians. It is celebrated for its soccer, its samba and its coffee. Some probably associate it with inflation. There is not much else.

But in reality the recent Brazilian experience is rich with lessons for India and for its role in the subcontinent. With Brazil's new President Luis Inacio da Silva (universally known as Lula) India's official guest for the Republic Day parade, it is worth recounting some lessons Brazil carries for India, and one or two that India might have for Brazil.

Brazil is the giant of South America, with a land mass slightly smaller than China (or Canada). Its exchange rate has moved around a great deal of late, such that the most recent World Bank numbers place its per capita income at $2,850 (as against India's $ 480).

With a population of 174 million, this makes Brazil's economy almost exactly the same size as India's, a shade under $500 billion, although India's is larger at purchasing power parity (PPP) prices. In the late 1990s, before the value of the Brazilian currency, the Real, plunged, Brazil's economy was valued at twice the size of the Indian economy.

Over much of the 20th century, Brazil was one of the fastest growing economies in the world, but as with much of the rest of Latin America the last two decades have been unkind, characterised by slow growth, erratic capital flow cycles, volatile inflation and unsteady exchange rates.

But as the recent celebrated Goldman Sachs article ('Dreaming of BRICs') has pointed out, Brazil (together with Russia, India and China) is one of four emerging markets that could shift the centre of gravity of the world economy over the course of this century.

Brazil's post-war economic model was quite similar to that of India. Public enterprises and development banks were accorded the leading role in the development of the country, and the economy was relatively closed to trade.

In contrast to India, though, there was little discouragement of multinationals or of the domestic private sector: these both coexisted with the giant, often very well run, public enterprises. Much of the financial sector was also in public hands; with a few exceptions, these institutions proved to be an important source of Brazil's ruin.

In contrast to India, this phase of the country's development was very successful, transforming Brazil's industrial sector, its urbanisation and its relative standing in South America. But this success ended in the 1970s, and Brazil succumbed to the Latin debt crisis, and to stagflation, in the 1980s.

The crumbling of the economy had at least one salutary consequence: it prompted the removal of the military from office. This was a gradual process, but was symbolised in a new, somewhat populist constitution adopted in 1988, which continues in force.

The interesting lessons for India lie in Brazil's attempts to refashion its economy in the 1990s. While there are lessons in many areas, I will focus on just two: trade policy (including the formation of the regional trade bloc, Mercosur); and fiscal policy and adjustment.

Brazil's trade reform is usually dated to 1991, when it undertook significant unilateral reduction in customs duties. Unlike India, where the process has dragged out over more than twelve years, and is still far from complete, the Brazilian reform was compressed into three years, and was largely complete by 1995, although admittedly at average tariff levels (around fifteen per cent) that are higher than in both South-East Asia and more committed liberalisers in South America, such as Chile.

It is important to keep in mind the political and regional context of trade reform in Brazil. Trade liberalisation was seen as a guarantee of hard-won democracy, not just in Brazil, but also in neighbouring Argentina and Uruguay.

In order to commit to the maintenance of liberal trade and democracy, as well as to encourage foreign direct investment in a large market, Brazil was (and remains) the driving force in linking Argentina, Uruguay and Paraguay into the South American common market, or Mercosur.

Mercosur has had a somewhat chequered existence, largely because of macroeconomic instability in its two main economies. Over the 1990s, at one time or other, both Brazil and Argentina have tried to peg their exchange rates to fight inflationary expectations.

Both when these exchange rate regimes survived (and the relevant currency strengthened) and when they collapsed (and the currency weakened) trade flows were dramatically affected. But the larger goals, of integrating the economies, and avoiding military conflict have largely been achieved.

In addition, the framework of Mercosur may have helped to avoid reimposition of tariffs at times of macroeconomic stress. The smaller, more open economies, led by Argentina, sometimes complain about being trapped into buying Brazil's high-cost goods (in return for assured market access), but this in turn creates some pressure for continued trade liberalisation by Brazil.

I draw three conclusions for India from this experience. The first is that we should study Mercosur carefully, because the relative roles of India and Pakistan are quite similar to those of Brazil and Argentina. The second is to question whether a trade agreement can bring about peace, as versus cementing a peace already in place.

The third is to stress the importance of low trade barriers in the core country in order to make trade with it attractive to the smaller economies in the bloc. A second broad area where the Brazilian experience deserves study, for both positive and negative lessons, is fiscal policy and management.

Brazilian revenue mobilisation, at both the central and state levels, has been strong, if inefficient. Despite this, debt growth, as in India, has been very rapid. Given Brazil's history of inflation and debt default, the government does not enjoy access to long-term funds, and can only place its debt on floating rates, or by indexing to the inflation rate or the exchange rate.

On account of this debt structure, Brazil has been prone to crisis despite having a net debt:GDP ratio of less than 60 per cent, much less than India's ratio of 85 per cent plus.

What has been impressive, though, has been the determination to address this vulnerability. The core target has been the primary surplus (the government deficit minus interest payments). This has been achieved at above 3 per cent of GDP since 1999, and has now been raised to 41/4 per cent of GDP.

Also, Brazil has fiscal responsibility legislation that applies at all levels, with criminal penalties, unlike our Act, which is largely advisory . What is impressive is that all this has been achieved within the framework of a democratic, fragmented federal system, and has been endorsed by President Lula's left-wing government.

And what lessons does India hold for Brazil? I would cite just one: the reward for honouring your debts. India has a tradition of low inflation, and of not defaulting on its government obligations. The sea of money heading toward public sector banks and government bonds testifies to the faith in government credit at all levels.

Such credibility has allowed the government to maintain an unsustainable fiscal policy for a while. Brazil provides us lessons on the long-term effects of destroying this credibility, as well as concrete examples of how decisive action can be taken, once the political will exists.

sbery@ncaer.org

(The author is Director-General of the National Council of Applied Economic Research, New Delhi. The views expressed are personal)