by John Fitzpatrick

On July 1 every year around the papers are filled with articles about the “Plano Real”, which succeeded in breaking the vicious circle of hyperinflation to which Brazil had been subject for over a decade. More space than usual was devoted to the subject this year since it was the 10^th anniversary. Conferences, interviews with leading players, newspaper supplements, television discussions and so on all marked this decisive day. Is it too much to hope that in 10 years´ time we will have forgotten the Plano Real and be celebrating another anniversary - the day when the Brazilian economy started to take off? Alas, the answer is “yes”.

For all its merits, the Plano Real turned out to be a defensive measure and was not backed up by other initiatives to bring about economic growth, particularly cutting government spending and reducing taxation. Unfortunately there are still no signs that either the current government of President Luiz Inacio Lula da Silva or opposition parties have any ideas or initiatives in mind to bring about this great leap forward.

Hyperinflation Killed Off
There is no doubt that the Plano Real was a great success in its immediate aim of killing off hyperinflation. By succeeding where previous instant miracle plans had failed, it may even have saved Brazilian democracy. By stopping inflation in its tracks and keeping it down, the Plan showed voters that sometimes politicians could take good decisions and that the country´s fate was not necessarily tied to boom and bust cycles. (Brazilian history is so often taught as a series of economic cycles – sugar, gold, coffee etc. – that many people cannot imagine the country developing in any other way.) Unlike previous plans which had caused immediate hardship, including freezing private bank accounts under the Collor administration, the Plano Real had a smooth, well-planned entry.

Although the Plano Real was a smooth landing after a bumpy ride, it could easily have flopped. First of all, it was introduced during the administration of Itamar Franco, who succeeded Fernando Collor de Mello as president when he resigned as he was about to be impeached on allegations of corruption. Franco was an unimpressive figure and a weak leader. As commentator Rolf Mario Treuhertz wrote: “He was unable to curb both inflation and the continuous devaluation of the Brazilian currency, which reached 2,500% and 2,170% respectively in 1993.¹” Franco was later to show great irresponsibility when he defaulted on debt payments to the federal government when he was state governor of Minas Gerais. Secondly Franco´s finance minister, Fernando Henrique Cardoso, was a sociologist by profession and knew little about economics. Cardoso had also been sympathetic to Marxism in his earlier days. However, Cardoso quickly grouped a talented team of professionals around him and let them get on with the business of creating a serious currency based on economic reality.

Thirdly, there were vested political and business interests which had prospered from inflation and the system of automatic indexation of wages, rents, utility tariffs etc. to the inflation rate. It was relatively easy for these interests to conceal gains against a background of non-stop price increases. While they would publicly welcome the end of the inflationary era, privately these groups knew they would lose out. Banks were among the biggest losers. The list of banks which have failed or been taken over during the last decade is a lengthy one and includes famous names like Bamerindus, Nacional, Economico and dozens of smaller institutions. State-owned banks were generally in an even worse position, having been used as piggy banks by generations of pork-barrel politicians, and most of them went to the wall too.

The Plano Real also paved the way for Cardoso to be elected president on two occasions. Brazil should be grateful that someone like Cardoso was around in its moment of need. Although Cardoso was a skilled politician, he was different from previous presidents like Franco, Jose Sarney and Tancredo Neves, who died before assuming office, and Collor. The first three represented the old-style political boss who did deals based on regional and personal interests first, and national interests last. It was in reaction to this type of politician that in 1990, in the first direct elections after military rule, voters chose Collor, a young whiz kid who promised to end the old style of running Brazil. Unfortunately Collor was all style and no substance and corrupt into the bargain.

By contrast, Cardoso was an academic who had lived abroad and was open to other influences and ideas. He knew that the old way in which Brazil had operated – a closed economy which protected inefficient local industry and the crushing hand of the state present everywhere – could no longer continue. He realized that in an increasingly globalized world, in which Communism had become discredited, Brazil had to change its path. He threw away his Marxist principles and, like social democrats around the world, adopted the free enterprise system. State-owned enterprises were sold off and many became efficient private concerns, foreign investment poured in and, with inflation firmly in place, people had money to buy consumer goods. The economy never really picked up any steam and growth averaged only about 2% a year but at least people knew that the Real in their pocket would be worth the same a month or two later.

However, the Plano Real turned out to be a stopgap measure, an all too brief honeymoon, and nowadays seems like a far-off dream. There were a number of reasons why it could not continue and negative soothsayers like the late Rudi Dornbusch, who had questioned its stamina were proven right. Under the Plano Real, the currency was allowed to move within shifting trading bands. This was the opposite of the situation in neighboring Argentina where the peso and the dollar were equal. The fact that Argentina ultimately collapsed and defaulted while Brazil weathered the storm shows that bending with the wind is sometimes better than standing upright and bearing the full brunt. The system was monitored by the Central Bank, which intervened to prevent exaggerated swings. However, this could never have been a long-term solution since it would have ended up being too costly. One still wonders how much Brazil lost during those years when the Real was trading on equal footing with the dollar. (I would be grateful to any reader who knows of any studies or figures on this point.)

In those days Brazilian tourists could fly to Miami and return laden down with electronic and other consumer goods. These spending sprees were basically being subsidized by the government which had overvalued the currency. To recover this money, taxation was constantly increased during the Cardoso years and shows no sign of stopping. A report published this week showed that the tax burden amounted to 40.01% of GDP.

Instead of ending smoothly, the exchange rate system virtually collapsed overnight in January 1999, just a couple of weeks into Cardoso´s second mandate. It is too much of a coincidence for this to have happened at that moment and we must wonder whether Cardoso would have been returned to office by such a large margin had the devaluation occurred before the election three months earlier. Cardoso admitted this week that one of the Plano Real´s weaknesses had been in keeping the currency overvalued for so long. Well, it is now too late to do anything about it. The fact is that the currency was finally allowed to float more than five years ago and has continued to do so ever since. The advantages have been obvious and have led to today´s massive trade surplus, boosted by exports of farm produce, iron ore, steel, orange juice and other commodities.

However, there are other factors to consider. The Real today is worth approximately one-third of what it was worth when those Brazilian tourists were flocking to Miami. Exports are booming but firms cannot afford to buy dollars to import machinery to update their plants. Nor can they borrow money since interest rates are astronomical and will not be reduced in the short to medium term. The Real is also keeping its head above water because the International Monetary Fund has come to the rescue three times in the last decade. The present government says it does not intend renewing the agreement with the IMF when it expires at the end of this year. The trade surplus provides a comfortable cushion for a decision like this to stick. When this comes about Brazil will be on its own once more in a world made uncertain by terrorism, the Middle East and doubts about the strength of the world economy. There will be no more Plano Reals around then.

© John Fitzpatrick 2004