Inflation Targeting: Brazil’s Experience
Seminar on Inflation Targeting
Bank Al Maghrib
Rabat, Morocco
April 4, 2007
Paulo Vieira da Cunha
Deputy Governor
BAM/IMF April, 2007
1
Outline
I.
II.
III.
Overview
Institutional Structure
Issues
A.
B.
C.
D.
Shocks & Expectations
Increasing Predictability
Reducing External Vulnerability
Reducing Fiscal Vulnerability
BAM/IMF April, 2007
2
I. Overview: Inflation Targeting Has Worked
BAM/IMF April, 2007
3
History
• INFLATION TARGETING was introduced in June 1999 at a time of
great macroeconomic uncertainty — but of low inflation
• It followed critical economic reforms
– Fiscal Responsibility Law
– Social Security Reform (partial)
– Privatization of SOE’s
– Trade and Capital Account Liberalization
– Restructuring and Recapitalization of Private Banks (PROER)
– Closure and/or Divestiture of Public Banks (PROES)
BAM/IMF April, 2007
4
1999: The New Macroeconomic Regime
Floating
Exchange
Rate
Inflation
Targeting
Solid Fiscal
Anchor
BAM/IMF April, 2007
5
Targets vs. Consumer Inflation
18
15
Market
Expectation
% p.a.
12
Feb 07
3.02
9
6
3
0
99
00
01
02
03
04
05
06
Jan
Mar
07
08
BAM/IMF April, 2007
6
Volatility of Inflation, GDP & Policy Rate
GDP
Inflation
Period
Selic (Policy) Rate
Mean S.D.
C.V.
Prior to IT
4T94 – 2T99
10,4
9,9
95%
2,0
6,3 311%
35,4
14,1 40%
IT
3T99 – 4T06
7,5
5,6
74%
2,5
3,5 139%
18,4
2,9 16%
Mean S.D. C.V.
Mean S.D. C.V.
IT (excluding external shocks: 3T01 a 2T03)
3T99 – 4T06
6,0
3,3
IT (post external shocks)
3T03 – 4T06
5,4
2,3
55%
3,2
3,1
96%
17,5
2,2 12%
42%
3,3
3,0
90%
17,4
2,5 14%
BAM/IMF April, 2007
7
Predictability of Monetary Policy
8
7
6
decision –
expectation (t-3)
5
4
3
decision –
expectation (t-1)
2
1
0
-1
-2
-3
Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Mar
01 02 02 02 03 03 03 04 04 04 05 05 05 06 06 07
Shaded areas: cycles of rate hikes
BAM/IMF April, 2007
8
SELIC (Policy) Rate
Average value
prior to IT regime
%
40
Average value
during IT regime
30
20
10
96
97
98
99
00
01
02
03
04
05
06
07
BAM/IMF April, 2007
9
Real Income & Inflation “Surprises”
13
1149
IPCA (–) 12mo forward IPCAexp
9
1107
7
1086
Real income (IPCA deflator)
5
1065
3
1044
1
1023
1002
-1
981
-3
960May
02
Dec
02
Jul
03
Feb
04
Sep
04
Apr
05
Nov
05
Jun
06
Jan-5
07
IPCA <
expectations
3 momovavg R$
1128
11
IPCA >
expectations
1170
BAM/IMF April, 2007 10
Credit to the Private Sector vs. Inflation
Total Credit/GDP
13
34
285
Market Expectations
for Inflation
12 Months Ahead
11
9
8
7
10
30
% of GDP
% p.a.
% p.a.
10
300
12
12
11
Credit
Average Tenure
26
9
Market Expectations
for Inflation
12 Months Ahead
270
255
8
7
Days
13
240
6
6
225
5
5
4
4
210
22
Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan
Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan
02 02 03 03 04 04 05 05 06 06 07
02 02 03 03 04 04 05 05 06 06 07
BAM/IMF April, 2007 11
Risk and Investment
138
4Q06 2000
Investment
(LHS)
1700
1990=100
133
1400
128
1100
123
EMBI+ Br (Q-2)
(RHS)
118
500
113
108
1Q
00
800
Basis points
143
1Q
01
1Q
02
1Q
03
1Q
04
1Q
05
1Q
06
200
2Q
07
BAM/IMF April, 2007 12
300
30%
200
20%
100
10%
0
Market capitalization - US$ billions
Jan/2007
40%
Jan/2006
400
Jan/2005
50%
Jan/2004
500
Jan/2003
60%
Jan/2002
600
Jan/2001
70%
Jan/2000
700
Jan/1999
80%
Jan/1998
800
Jan/1997
US$ billion
Stock Market (Bovespa) Capitalization
0%
Markets capitalization (% of GDP)
BAM/IMF April, 2007 13
GDP Growth
2007 Projection:
4.1%
160
156
Average Growth
2004-2007: 3.7%
s. a., 1990 = 100
152
148
144
140
136
132
128
Average Growth
1999-2003: 1.8%
124
120
1Q
99
1Q
00
1Q
01
1Q
02
1T
02
1Q
04
1Q
05
1Q
06
1Q
07
4Q
07
BAM/IMF April, 2007 14
Target & Model-Generated Forecasts
IPCA Inflation: 12mo forward
9
Target
“Market” Scenario
“Reference” Scenario
8
1
7
1
6
1
%
Forecasts
5
1
4
3
2
Jan
06
Jun
06
Nov
06
Apr
07
Sep
07
Feb
08
Jul
08
Dec
08
BAM/IMF April, 2007 15
Policy Rate: Expectations 6-mo Forward
15.2
14.6
% p.a.
14.0
13.4
12.8
12.2
11.6
Mar
06
Apr May Jun
06
06 06
Jul Aug Sep Oct
06
06
06
06
Nov Dec Jan Feb Mar
06
06 07
07 07
BAM/IMF April, 2007 16
II. Institutional Structure
BAM/IMF April, 2007 17
Key Parameters
National Monetary Council
sets the Inflation Target (Headline CPI-IPCA)
June of each year for 2 years ahead
Central Bank is charged with its
attainment
Band of ± 2% w/o escape clause
The Monetary Policy
Committee (COPOM) sets
the policy interest rate
(SELIC)
The policy rate affects
inflation expectations and
actual inflation, with a lag
BAM/IMF April, 2007 18
Institutional Structure of IT
National
Monetary
Council
• President Appoints
Members of Monetary
Council
• Policy Targets
Agreement
• 2 yr Rolling
Forward Targets
President
of the
Republic
• President Nominates
Governor and Board of
Directors
Governor
Senate
Board of Directors
Also sit as members of
Monetary Policy Committee
COPOM
Public
Markets
• Confirms Presidential
Appointments
• Committee hearings
BAM/IMF April, 2007 19
% a.a.
10
9
8
7
6
5
4
3
2
1
0
Advanced economies
Romênia
Turquia
Indonésia
Reino Unido
Canadá
Israel
Nova Zelândia
Suécia
Noruega
Austrália
Islândia
Coréia do Sul
Eslováquia
Tailândia
Peru
Polônia
Chile
Rep Tcheca
México
Hungria
Colômbia
Filipinas
África do Sul
Brasil
Inflation Targets & Bands: 2006
Midpoint of target range
Emerging market economies
BAM/IMF April, 2007 20
III. Issues
BAM/IMF April, 2007 21
A. Shocks & Expectations
BAM/IMF April, 2007 22
Price, Supply & Political Shocks: 2001-02
• Domestic & external shocks:
– Energy Crisis
– Argentina-I
– Argentina-II
– Brazil’s “fear of the left” political & risk aversion crisis
• Sudden stop in external capital flows and aversion to claims
denominated in local currency
• Increase in country risk
• Exchange rate depreciation
• Pass-through to inflation (aggravated by backward-looking
price setting rules for administered & regulated prices)
• Inflation at 7.7% in 2001 and 12.5% in 2002, missing the target
ranges (4% + 2% in 2001 and 3.5% + 2% in 2002).
BAM/IMF April, 2007 23
4,000
1700
3,500
BRL/USD
3,110
2,935
2,480
2,320
2,347
2,420
900
2,714
BR C-Bond
BR2040 Bond
3,000
3,342
3,806
1300
BRL/USD Rate
2100
2,378
Spread over US-TSY
Political Shock: 2002
2,500
500
2,000
jan-02 fev-02 mar-02 abr-02 mai-02 jun-02 jul-02 ago-02 set-02 out-02
Devaluation of 131%
BAM/IMF April, 2007 24
Expectations Deficit: 2002
Difference between measured expectations and the
mid-point of the Inflation Target for the year
Based on the median of the sample of market
expectations for year-end IPCA inflation
1000
Target: 3.50%
E (X): 12.52%
Actual:12.53%
800
600
400
2002
2003
200
2004
0
jan02
fev02
mar- abr02
02
mai02
jun02
jul02
jul02
ago02
set02
out02
nov- dez02
02
BAM/IMF April, 2007 25
Rebuilding Confidence: 2003-2004
•
2002: Inflation exceeded the target by a large margin
• The disinflation trajectory lost credibility
• Sharp increase in inflation expectations - medium term
•
2003: Central Bank announced an adjusted target trajectory
• The objective was to regain the lead over expectations,
smoothing the cost of disinflation:
• Adjusted targets trajectory proposed in 2003:
•
2003 
8.5% ± 2.5%
•
2004 
5.5% ± 2.5%
BAM/IMF April, 2007 26
IPCA Inflation: 2002- 2004
YoY % change based on
the 12momovavg
20,0%
Tradables
16,0%
Headline
12,0%
Core
Non-Tradables
8,0%
4,0%
jan/02 abr/02 jul/02 out/02 jan/03 abr/03 jul/03 out/03 jan/04 abr/04 jul/04 out/04
BAM/IMF April, 2007 27
Rebuilding Confidence: 2003-2004
• In Feb/2003 the COPOM increased the policy rate to 26.50% and
kept it at that level until May/2003
• Reaffirmed commitment to fiscal responsibility
• Increase in the consolidated primary surplus:
– 4.25% of GDP in 2003
– 4.50% of GDP in 2004
• Sharp FX depreciation from 1999 to 2002 produced a major
external adjustment, with a significant increase in exports
• Benign external scenario contributed to exports surge and
exchange rate appreciation
BAM/IMF April, 2007 28
Policy Rate: 2002- 2004
30,00
fev-03
26,50
25,00
20,00
set-04
16,25
15,00
10,00
5,00
0,00
jan02
abr02
jul02
out02
jan03
abr03
jul03
out03
jan04
abr04
jul04
out04
BAM/IMF April, 2007 29
Rebuilding Confidence: 2003-2004
• Inflation fell to 9.3% in 2003, from 12.5% in 2002
• It fell to 7.6% in 2004
• Successful disinflation allowed a return to the original targets
set for 2005-2007:
– Target set in 2003:
2005 4.5% ± 2.5%
– Target set in 2004:
2006 4.5% ± 2.0%
– Target set in 2005:
2007 4.5% ± 2.0%
BAM/IMF April, 2007 30
Expectations Deficit: 2003
Difference between measured expectations and the
mid-point of the Inflation Target for the year
Based on the median of the sample of market
expectations for year-end IPCA inflation
450
2003
375
300
2004
225
2005
150
Target: 8.50%
E (X): 9.22%
Actual: 9.30%
75
0
jan03
fev- mar03
03
abr03
mai03
jun03
jul03
ago03
set03
out03
nov03
dez03
BAM/IMF April, 2007 31
B. Increasing predictability
BAM/IMF April, 2007 32
Consolidating the Regime: 2005-2006
• Rapid pace of economic recovery post-2003, led by a large
surge in exports, fueled domestic demand and together the
growth in external and domestic demand threatened the
inflation target in 2005 — especially after a sudden expansion
in fiscal outlays in Q4/2004
• Consequently, starting in Sep-2004 the COPOM started on a
tightening cycle that was to last one full year to Sep-2005, with
an accumulated increase in the policy rate of 375bp
• Expectations and eventually inflation adjusted to retake the
path of the inflation target
• Inflation expectations for 2006 were contained and approached
the target. At end 2005 expectations for the next two years were
in line with the target
BAM/IMF April, 2007 33
Inflation Expectations vs. Targets
Expectation
t+1
Target
t+1
Expectation Target
t+2
t+2
1999
7,0
6,0
4,0
4,0
2000
4,3
4,0
3,8
3,5
2001
4,8
3,5
4,0
3,25*
2002
11,0
4,0**
8,0
3,75**
2003
6,0
5,5
5,0
4,5
2004
5,7
4,5
5,0
4,5
2005
4,5
4,5
4,5
4,5
2006
4,0
4,5
4,1
4,5
*CMN target: Jun/2001 (Resolução nº 2,842)
** CMN target: Jun/2002 (Resolução n° 2,972)
BAM/IMF April, 2007 34
Expectations Deficit: 2005
Difference between measured expectations and the
mid-point of the Inflation Target for the year
Based on the median of the sample of market
expectations for year-end IPCA inflation
200
160
2005
Target: 4.50%
E (X): 5.68%
Actual: 5.69%
120
80
2006
40
2007
0
jan05
fev- mar05
05
abr05
mai05
jun05
jul05
ago05
set05
out05
nov- dez05
05
BAM/IMF April, 2007 35
Policy Rate: 2005 - 2007
30,00
25,00
set-05
19,75
20,00
mar-07
12,75
15,00
10,00
5,00
0,00
jan- mar- mai- jul05
05
05
05
set- nov- jan- mar- mai- jul05
05
06 06
06
06
set- nov- jan- mar06
06
07
07
BAM/IMF April, 2007 36
Expectations Surplus: 2006
Difference between measured expectations and the
mid-point of the Inflation Target for the year
Based on the median of the sample of market
expectations for year-end IPCA inflation
40
0
2008
-40
2007
-80
-120
2006
-160
jan06
fev06
mar06
abr06
mai06
jun06
jul06
jul06
ago06
set06
out06
Target: 4.50%
E (X): 3.11%
Actual: 3.14%
nov- dez06
06
BAM/IMF April, 2007 37
Predictability of Monetary Policy
Average Deviation: Actual vs. Expected Policy Rate Changes
Lag: 1 month
1,2
Lag: 3 months
4,0
3,59
1,06
3,5
1,0
3,0
0,8
p. p.
2,5
2,0
0,6
1,5
0,4
1,05
0,23
0,2
Mean: 0,26
0,13
0,10
0,06
1,0
Mean: 1,00
0,69
0,5
0,25
0,20
0,0
0,0
Dec 01
Sep 02
Oct 02
May 03
Jun 03
Aug 04
Sep 04
Aug 05
Sep 05
Jan 07
Dec 01
Sep 02
Oct 02
May 03
Jun 03
Aug 04
Sep 04
Aug 05
Sep 05
Jan 07
BAM/IMF April, 2007 38
Real Interest Rates
Rates for the 360d Fixed-to-Float Swap – BM&F
35
30
Avg 00/03:
15,0%
25
Avg 06/07:
9,3%
Avg 04/05:
11,5%
Avg 96/99:
20
18,5%
15
10
7,9
5
Feb*
96
97
98
99
00
01
02
03
04
05
06
07
BAM/IMF April, 2007 39
C. Reducing External Vulnerabilities
BAM/IMF April, 2007 40
Exports, Imports (US$billion)
30
0
1991
1992
Imports
1993
1994
-90
1995
1996
1997
1998
Exports
1999
2000
53.0
51.1
48.0
55.1
58.2
-59.7
-57.7
-49.2
-55.8
-55.6
2001
2002
2003
2004
-73.6
-62.8
-48.3
2005
147.3
90
-107.1
2.7
137.5
118.3
96.5
73.1
60.4
47.7
-53.3
60
-91.4
-60
-47.2
46.5
43.5
-33.1
-50.0
38.6
-30
-25.3
-20.6 35.8
150
46.1
-120
30
20
10
Trade balance (US$billion)
1990
-21.0 31.6
-20.7 31.4
Trade Surplus
50
120
40
-1.2
0
2006 2007*
-10
Trade Balance
BAM/IMF April, 2007 41
Trade Balance vs. Exchange Rate
12mo forward expectations
45
3,6
Trade Balance
3,4
35
3,2
30
3,0
25
2,8
BRL$/US$
40
US$ bn
3,8
2,6
20
2,4
15
2,2
BRL/USD Rate
10
Jan
03
Jul
03
Jan
04
Jul
04
Jan
05
Jul
05
2,0
Jan
06
Jul
06
Mar
07
BAM/IMF April, 2007 42
Expectations: Trade & Current Account
Trade Balance
Current Account
16
50
46
2005
2005
2006
12
2006
US$ billion
42
38
2007
8
2007
34
4
30
0
26
22
-4
18
-8
AprJul Oct Jan AprJul Oct Jan AprJul
04 04 04 05 05 05 05 06 06 06
Dec
06
Apr Aug Dec Apr Aug Dec Apr
Oct
04
06
04
04
05
05
05
06
BAM/IMF April, 2007 43
Expectations: BRL/USD Rate
3,2
Jun 04
R$/US$
3,0
Dec 04
2,8
Jun 05
2,6
2,4
Dec 05
Jun 06
2,2
Dec 06
2,0
Dec
04
Jun
05
Dec
05
Jun
06
Dec
06
Jun
07
Dec
07
BAM/IMF April, 2007 44
REER & Commodity Prices
165
Non-oil Commodity Price Index
155
1995 = 100
138
145
123
135
108
125
Real Effective
Exchange Rate
93
Jun-1994 = 100
153
115
105
78
95
Jan
03
Jul
03
Jan
04
Jul
04
Jan
05
Jul
05
Jan
06
Jul
06
Feb
07
BAM/IMF April, 2007 45
Buildup in Reserves
Mar 07*
US$ 104.8 bi
110
99
Jan 05
US$ 54.0 bi
88
Jan 06
US$ 56.9 bi
US$ billion
77
66
55
44
33
22
11
0
Jan
Jun
Nov
Apr
Sep
Feb
Jul
Dec
May
Oct
Mar
03
03
03
04
04
05
05
05
06
06
07
*Mar 9
BAM/IMF April, 2007 46
Reduced External Liabilities
Cumulative Reduction in FX-Linked Debt and BCB’s
Accumulated Acquisitions in the FX Market since 1Q05
210
180
US$ billion
150
FX Market
FX-Linked Domestic Debt
Swap
External Debt (Treasury + BCB)
Total = $192.3bn
100.7
120
90
26.7
60
9.1
30
55.8
0
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
BAM/IMF April, 2007 47
Declining External Debt
240
45
40
190
35
30
140
25
20
90
15
10
40
5
0
Reserves/Short-Term Debt (%)
Total External Debt/ GDP (%)
50
-10
1Q
01
3Q
01
1Q
02
3Q
02
Total External Debt/GDP
1Q
03
3Q
03
1Q
04
3Q
04
1Q
05
3Q
05
1Q
06
4Q
06
Reserves/Short-Term External Debt by Residual Maturity
BAM/IMF April, 2007 48
BRL/USD Rate & Risk Spread
3.8
1400
3.6
1200
1000
Exchange Rate (LHS)
3.2
3.0
800
2.8
600
2.6
2.4
400
Embi+ Brazil (RHS)
2.2
Basis Points
R$/US$
3.4
200
2.0
1.8
0
Jan May Sep Jan May Sep Jan Jun Oct Feb Jun Oct Mar
03
03
03
04
04
04
05
05
05
06
06
06
07
BAM/IMF April, 2007 49
D. Reducing Fiscal Vulnerabilities
BAM/IMF April, 2007 50
Public Sector: Primary Surplus
5
4.3
4
% of GDP
3.2
3
2
1
0
1999
2000
2001
2002
2003
2004
2005
2006
BAM/IMF April, 2007 51
Public Debt: Stock
60
49.7%
50
% of GDP
40
30
20
10
0
Jan
-10 03
Jul
03
Selic
Jan
04
Jul
04
Fixed Rate
Jan
05
Jul
05
Inflation-Linked
Jan
06
FX
Jul
06
Jan
07
Others
BAM/IMF April, 2007 52
%
Public Debt: Composition
Share of FX-Linked Domestic Debt
42
38
34
30
26
22
18
14
10
6
2
-1.1
-2
Jan
02
Jan
03
Jan
04
Jan
05
Jan
06
Jan
07
40
Share of Fixed Rate Domestic Debt
34.5
35
30
25
20
15
10
5
0
Jan
02
Jan
03
Jan
04
Jan
05
Jan
06
Jan
07
BAM/IMF April, 2007 53
Public Debt: Impact of a 1% Devaluation
30
Basis Points
25
20
15
10
5
0
-5.0
-5
Jan
00
Jan
01
Jan
02
Jan
03
Jan
04
Jan
05
Jan
06
Jan
07
BAM/IMF April, 2007 54
Public Debt: Expected Trend
63
1Q02 through 4Q06 (quarterly data)
61.7%
58
% of GDP
4Q 06
50.0%
Market
Consensus
March 2007
(annual data)
53
48
43
42.0
38
1Q
02
3Q
02
1Q
03
3Q
03
1Q
04
3Q
04
1Q
05
3Q
05
1Q
06
4Q 2007 2009 2011
06
BAM/IMF April, 2007 55
Thank you!
BAM/IMF April, 2007 56