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Central bankers don't usually command hero status, but Brazil's Arm?nio Fraga comes close. Lured away from a plum job at Soros Fund Management two years ago, Fraga averted what looked like certain disaster after Brazil precipitously devalued the real in January, 1999. Since then, his cool head and talent for monetary policy have steered Brazil toward sustainable growth and low inflation -- a feat that had eluded countless of his predecessors.BusinessWeek Sao Paulo Bureau Chief Jonathan Wheatley caught up with Fraga on Jan. 19 at the central bank's Rio de Janeiro office. Here are edited excerpts from their conversation:Q: You came back to Brazil at a time when it seemed the country was heading for hyperinflation and recession. What went right?
A: The worry was that Brazil would end up facing deep recession and high inflation, and that the clock would be turned back to the years of frustration from 1981 to 1993, that were quite possibly the worst years in our history. I won't deny we were scared, and I don't want to belittle the work that was done, but we knew what we had to do. That was to get the fiscal accounts in order.
Floating the currency was part of the solution. As to the worry that this would lead to inflation, we knew two things. First, that Brazil had got rid of indexation [the automatic raising of prices and wages in line with inflation]. Second, that the economy had a lot of slack after two years of stagnant growth, which was a cushion for inflationary pressures. What we didn't know was that the degree of pass-through from the depreciation would be so low. And I hate to brag, but maybe the fact that we came out early and very strongly, and said we would switch to inflationary targeting helped also.Q: There has been some relaxing of fiscal policy recently, with pay rises for public-sector workers and higher spending in other areas. Couldn't that be storing up trouble for the future?
A: No, there has been absolutely no loosening whatsoever of fiscal policy. We had a target for a primary surplus of 3.25% of gross domestic product last year, and we generated a surplus of 3.5% of GDP. All this year's spending is in the budget numbers. There's a budget law, and we have to stay within specific limits.Q: How fast can Brazil's economy grow now without causing problems?
A: That's the big question we ask ourselves every month [at meetings of the monetary policy committee]. The speed limits seem to be higher than they were. We're looking at 4.5% growth this year and possibly more going forward.Q: One reason Brazil's economy can't grow more quickly is a lack of competitiveness. How much is that holding the country back?
A: We've been doing surveys of total factor productivity. In the 1980s in Brazil our average was minus 0.8% a year. That's terrible, especially for a developing country that should be catching up. In the 1990s, we moved forward to plus 0.9% a year, although that was from a low base.
Now we are spending more on education, we have good infrastructure, for example, in telecommunications following privatization. A few years ago, you had to pay $5,000 for an analog [phone] line that hardly worked. Now you can get a high-speed digital line, and it's virtually free. Our productivity rate is now above 1% a year, which is very promising.Q: How worried are you by the current-account deficit?
A: The current-account deficit declined last year, from $33 billion to $24 billion. This year it will grow a little, to $25 billion or $26 billion. So long as the gap isn't too large or too poorly financed, it's not a cause of concern.
If you compare Brazil with some Asian economies, you can see why the current-account deficit hasn't declined more. In recent months, we've had GDP growth at a year-on-year rate of 5%, while the current-account deficit hasn't declined. In Asia, they've achieved huge turnarounds in their current-account deficits but at the cost of negative economic growth of between 5% and 10%. If our GDP growth had been a lot lower, we could have seen a reduction in the current-account deficit. In fact, our deficit is part of a positive picture -- not a negative one.Q: Growth in exports will be essential in cutting the current-account deficit. What can you do to help exporters?
A: Tax reform. There are some emergency-type taxes in place that are not good for the efficiency of the economy. [Social security contributions] add about 6% to the cost of exported goods. We intend to address these questions this year. We're hopeful that progress will be made.Q: You've been praised in the past for telling it like it is and not covering up risks. But recently some observers have noticed a more positive spin coming from the central bank. Is there a greater concern to present policy in a more positive light?
A: I always try to be careful. I don't know about other people. Sometimes I lose track of the very important changes that have been put in place in the past 10 years. We've gone from a closed economy with hyperinflation to an open one with stability. So we can be allowed to be positive about the future. Not optimistic, as that implies a sense of bias. There's no complacency.