In Dilma Versus Banks, Round One Goes to Government

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Nothing animates Brazilian opinion quite so much as cash -- and the current battle over interest rates between the government and the banks is no exception.

Add to this Brazil's tradition of sky-high interest rates, and bad memories of hyperinflation in the 1980s, and the result is a lot of emotion and rhetoric.

The central bank has been systematically cutting interest rates since August 2011, when it reduced the benchmark Selic rate from 12.5 percent to 12 percent; it's now at 9 percent.

On May 3, the government announced another bold move: cutting the guaranteed return on traditional savings accounts, which were first established 150 years ago. More than $200 billion is deposited in 100 million of these tax-free, government-backed accounts, most of which are held by middle-class and low-income savers. The return on these accounts had been set at 6.17 percent a year, plus a variable reference rate.

The government wants to further reduce the Selic to boost growth, but it feared that further cuts would drive investors out of government bonds and into the savings accounts. Under the reform, new savings accounts will return only 70 percent of the Selic if it falls to 8.5 percent or lower.

It was a typically convoluted Brazilian solution that media outlets painstakingly tried to explain to readers, with varying degrees of success. But the decision was mostly well received.

An editorial in the business daily Valor Economico called it "a daring move, but with a political risk calculated to the millimeter" that "opened the path to a more accelerated reduction in interest rates." The paper added:

The change in savings was necessary, the government justified, to permit the reduction of rates. New cuts in the Selic would reduce the gains of investment funds and of government bonds and there would have been a migration of money to savings if the rule hadn't changed, running the risk of unbalancing the system.

In an op-ed in the same day's paper, Andre Perfeito, chief economist of Gradual Investimentos, described how he had e-mailed President Dilma Rousseff in early 2011. The subject line of his e-mail, he said, was "Operation Valkyrie"-- referring to the failed attempt to assassinate Adolf Hitler. In it he laid out his strategy to "knock interest rates to civilized levels," beginning with a reduction in the savings rate, which he attacked metaphorically:

To kill a dictator is easy, what's really difficult is to end a dictatorship. It's time for an Operation Valkyrie in these tropics.

Dilma soon upped the ante. In a prime-time television address on the eve of the annual Workers Day holiday, she portrayed the savings-account reform as part of her larger efforts to improve conditions for workers.

Part of this battle is the government's effort to reduce interest rates. The Brazilian economy will only be fully competitive when our interest rates, be that for the producer, be that for the consumer, equal the rates prevailing in the international market.

Then she laid into private banks for charging high rates on overdrafts, credit cards and especially loans.

The banks can't keep charging the same rates to companies and to consumers while the basic Selic rate falls … The financial sector can't explain this perverse logic to Brazilians.

The Brazilian banking federation Febraban responded in its weekly report. It was written by the association's chief economist, Rubens Sardenberg, who "questioned the effectiveness of the official measures to stimulate lending and boost the economy," according to the O Globo newspaper. Banks were already worried about loan defaults, Sardenberg wrote, and many expected the Selic to rise again in 2013. He added the memorable phrase: "You can lead a horse to the edge of the river, but you can't force it to drink the water."

(Febraban later said Sardenberg's report didn't reflect its official position.)

That attitude didn't go over well, either with Dilma's government or the public. Interlocutors for the president reacted with irony, O Globo reported. One unnamed technician said: "You can't force a horse to drink water, but it can also die of thirst."

Valor Executive Editor Cristiano Romero weighed in on the controversy May 9:

There has never been seen, in the country's recent history, such a big effort by the government as what is being done now by President Dilma Rousseff to reduce basic interest rates and bank rates. The moment, apparently, allows for audacity.

Romero laid out the reasons why: less inflation in Brazil, falling commodity prices, poor economic performance in Europe, a weak recovery in the U.S., and Brazil's recent decline in industrial production. Meanwhile, retail sales are growing, and the gap between demand and what the domestic industry can supply is being filled by imports.

But Romero warned that the market is growing suspicious of inflation, with forecasts for 2012 and 2013 worsening in recent weeks. He added:

Expectations are not mere opinions. They are an important component of inflation ... For the strategy of interest-rate reduction to be successful, the government and the central bank will have to convince the market that the path chosen is consistent and the best approach for the country, and not the result of a political desire to lower interest rates by force and force economic growth at any cost, even at the expense of inflation above the target of 4.5 percent. If the expectations don't improve, inflation tends to increase, which will jeopardize the strategy of accelerated interest-rate reductions.

In short, the market -- not the press or the banks -- will be the final judge of Dilma's daring policies.

(Dom Phillips is the Rio de Janeiro correspondent for World View. The opinions expressed are his own.)

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