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Roubini at Odds With Fraga Over Budget Cut Plan: Brazil Credit

New York University Economist Nouriel Roubini
New York University Economist Nouriel Roubini. Photographer: Goh Seng Chong/Bloomberg

Nouriel Roubini, the New York University economist who predicted the global financial crisis, says Brazilian Finance Minister Guido Mantega’s proposal to stem currency gains by cutting spending is flawed.

Brazil, which has struggled alongside developing nations from South Korea to Chile to halt currency gains, plans a “strong fiscal move” to curb demand and cool inflation, paving the way for the central bank to trim interest rates, Mantega said Jan. 4. Lower rates will curb foreigners’ demand for fixed-income assets and help brake a two-year, 37 percent rally in the real, Mantega said, echoing an argument made by economists including former Brazilian central bank President Arminio Fraga.

Roubini says the move may backfire, luring more foreign capital instead of less, because spending cuts will reduce the budget deficit and bolster the country’s creditworthiness. Lower government expenditures will also stem the country’s record current account deficit, helping buoy the real, he said.

“I am not convinced by the argument,” Roubini said in a Jan. 7 telephone interview. “If you are fiscally sound, then you are even more appealing as a country and more money can come.”

The real climbed to a 28-month high of 1.6435 per dollar last week as Brazil’s benchmark 10.75 percent lending rate lured investors seeking an alternative to near-zero rates in the U.S. and Japan. Foreigners poured a record $62 billion into Brazilian debt and stocks in the first 11 months of last year, up from $46 billion in 2009, according to the central bank. The currency traded at 1.6889 as of 11:26 a.m. New York time.

Derivatives Trading

Brazil’s inflation-adjusted benchmark rate of 4.8 percent is the second highest after Croatia, according to all economies tracked by Bloomberg.

Budget cuts will allow the central bank “to reduce rates in the country at the right time,” Mantega told reporters in Brasilia on Jan. 4. There’ll be “less arbitrage operations between rates abroad and our rates,” he said.

He declined to provide details on the planned cuts.

President Dilma Rousseff authorized the country’s sovereign wealth fund to trade currency derivatives yesterday, the latest step by the government to slow the advance and shore up exporters. Mantega told reporters yesterday in Brasilia that he doesn’t expect the wealth fund to lose money if it wagers against the real because he’s “sure” the rally is ending.

Foreigners’ Tax

The central bank implemented last week a reserve requirement on short dollar positions in a bid to discourage investors from betting on real gains. The central bank also bought $41 billion in the foreign-exchange market last year, up from $24 billion in 2009, to weaken the currency. In October, Rousseff’s predecessor, Luiz Inacio Lula da Silva, tripled a tax on international investors’ purchases of fixed-income assets to 6 percent.

The real’s 37.1 percent surge since the end of 2008 is the second biggest in emerging markets after the South African rand. Its 110 percent advance since Lula took office in 2003 is the biggest in the world. Brazil made investment grade for the first time in 2008, receiving a BBB- rating, one step above junk, from Standard & Poor’s.

Fraga, who’s now chairman of BM&FBovespa SA, the owner of Latin America’s biggest exchange, has been a leading voice among economists from banks including Goldman Sachs Group Inc. who say that Brazil should cut spending to slow foreign investment in the fixed-income market and halt the rally.

Twin Deficits

The budget deficit widened to the equivalent of 2.7 percent of gross domestic product in the 12 months through November from 1.6 percent two years earlier after Lula boosted spending and cut taxes to bolster Latin America’s largest economy amid the global recession.

Roubini predicted the banking crisis that sparked the worldwide recession and recommended investors sell shares before the Standard & Poor’s 500 Index tumbled from its 2007 record. He missed the 13 percent rally in the S&P 500 last year, saying in July that the market would fall amid sluggish growth.

Brazil’s widening budget gap helped push the current account deficit, the broadest measure of trade, to a record $49 billion in the 12 months through November.

Fraga said in an Oct. 18 interview in Naples, Florida, that budget reductions will help “create the conditions for interest rates to go down.” He didn’t respond to a telephone call and e-mail message seeking comment yesterday.

Traders are betting that rates will rise further in 2011 as the central bank seeks to cool the fastest expansion in two decades and drive the annual inflation rate down from a 25-month high of 5.9 percent.

‘Ambiguous’ Effect

Yields on Brazil’s interbank rate futures contract due in January 2012 fell 5 basis points, or 0.05 percentage point, to 12.23 percent today, a level indicating traders expect policy makers to raise borrowing costs by about 225 basis points to 13 percent by the end of the year. The central bank lifted the benchmark rate 200 basis points in 2010 from a record low of 8.75 percent.

The extra yield investors demand to own Brazilian dollar bonds instead of U.S. Treasuries narrowed seven basis points to 166, according to JPMorgan Chase & Co. data. The cost of protecting Brazilian bonds against default for five years rose two basis points yesterday to 112, according to CMA prices.

Paulo Leme, Goldman Sachs’s chief Latin America economist, said in a telephone interview from Miami yesterday that Brazil may struggle to slow real gains if international prices for its commodity exports keep rising. Still, he said, reining in government spending and credit growth would help the country “find a more neutral interest rate which is less attractive” to overseas investors.

Roubini said he has doubts about the proposal.

“Because if you do further fiscal consolidation, your country’s sovereign risk premium will fall,” said Roubini. “Then inflows may become even larger. The net effect is ambiguous.”

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