In the United States, if you have a typical variable rate credit card, like a Visa or Mastercard, the average annual percentage rate (APR) is roughly 15-16 percent.
This pricing of interest payments is directly related to the U.S. Fed Funds Rate (FFR), which last week averaged 0.08 percent, well within the target range for interest rates that the Federal Reserve Bank established in December 2008 of 0.00 to 0.25 percent (while deep in the throes of the global financial crisis).
Last week, the Brazilian Central Bank (BCB) issued a report on credit card interest rates in Brazil. Itaú Unibanco and Bradesco, the two largest private banks in Brazil, have adopted average monthly interest rates of 17.96 and 14.92 percent respectively, which annualized correspond to an APR of 626.03 and 430.62 percent, according to the report.
The typical consumer in Brazil with a Visa or Mastercard, has the equivalent of an APR of 345.8 percent. At the extreme is Banco Cetelem, which issues cards for purchases at Brazil's equivalent of Amazon, Submarino, at 20.04 percent a month, which corresponds to an APR of 795.38 percent.
The annual credit card interest rate in the United States is roughly the equivalent of the monthly credit card interest rate in Brazil.
By way of comparison, and also last week, the BCB raised its equivalent of the FFR, the so-called SELIC, to 13.25 percent.
Brazil has lived with these kinds of interest rates for at least two decades.
This post suggests that the Real Plan of 1994, needs to be restructured into a Real Plan II, and that given Brazil's current macro-economic and political crisis, there is no better time to do it than now.
Brazil's Hyperinflation and the Real Plan
In the mid to late 1980s and until 1994, Brazil suffered from hyperinflation. At its peak, inflation reached over 2000 percent a year. The vast majority of the country's working population were forced to spend their hard earned wages immediately. Purchasing power declined not by the day but by the hour. The government indexed inflation, meaning that it became legal for merchants to raise prices according to a standard set of formal percentage increases for goods and services.
For instance, the price of basic staples like bread, butter, eggs, etc., would be one price at 7:30 am, a different price at mid-day and still another price at the close of business. In short, for tens of millions (including those in the informal economy) inflation aggressively ate away at the value of cash holdings. The non-working poor were also hit hard, not so much because their pocketbooks suffered directly from inflation, but because government support and services in an economy out of control become much more scarce.
Nevertheless, it is important to recognize that there is a substantive difference between Brazil's poor in 1994 and the poor in 2015. Millions have migrated out of abject poverty over the past 20 years, due to the combined efforts of the Brazilian Social Democratic Party (PSDB) and the Worker's Party (Partido dos Trabalhadores or PT), under respectively President Fernando Henrique Cardoso of the PSDB (1994-2002), Luis Ignacio "Lula" da Silva (2003-2010) and Dilma Rouseff (2011- Present) of the PT.
Even so, if Paul Krugman and Thomas Piketty are outraged at the concentration of wealth in the developed world, they would be appalled at Brazil, then and now. During hyperinflation, the rich got richer. The Brazilian financial markets, like their cousins to the north, are creative. The financial product they came up with to "beat" hyperinflation, or better leverage it, was an instrument known as the "overnight."
Restricted in its use by investment amount minimums, which excluded everyone but the wealthiest, monies invested in the overnight instrument were rolled over day after day, with daily compounding far exceeding the rate of inflation, resulting in exorbitant gains - exactly the opposite impact that the working poor suffered.
Like many countries, Brazil has its own penchant for use of an ideological lens when it comes to analyzing macroeconomics. It didn't take long for the fifth estate and more importantly political parties, to pick up on the theme of wealth disparity between the rich and the poor, and how that situation was being exacerbated by hyperinflation.
Beginning in the mid-1980s, Brazil suffered from a number of failed attempts at controlling hyperinflation, until 1994, with the introduction of the Real Plan. The Real Plan, conceived of by President Cardoso, when he was Finance Minister in the prior Itamar Franco administration, and then implemented by some of Brazil's greatest economic minds immediately after Cardoso's election, brought inflation down to single digits in a year of its launching. And inflation has largely stayed in single digits ever since (there have been a few exceptions).
The Real Plan created economic stability in Brazil, and with inflation tamed, the economy took on the semblance of normality. By the late 1990s, Brazilian macroeconomic policy was officially based on three principles: a primary fiscal surplus, a freely floating exchange rate and an inflation target.
In theory, the primary fiscal surplus means that Brazil will not spend more than it takes in (primarily via taxes). The freely floating exchange rate means that the Brazilian currency corresponds to what it is worth in the marketplace without government intervention, for instance to benefit certain export sectors. The inflation target is in fact a bandwidth, between which inflation will not be allowed to rise (6.5%) or fall (4.5%), which is an implied promise of the government for price stability.
These are the "three pillars," of Brazil's economic stability, but they cannot be divorced from a global macroeconomic context, nor from the policy tools at Brazil's disposal to maintain economic equilibrium. Regulating the money supply, subsidies, taxes, balance of payments, etc., all figure into the idea of the three pillars. But in classic Orwellian style, there is a fourth "invisible" pillar - interest rates.
If hyperinflation was Brazil's heroin in the late 1980s and early 1990s, high interest rates, particularly since 1994, are its methadone.
Brazil's Banks and the Impact of Interest Rates
Brazil has one of the highest interest rate regimes in the world. With the recent increase of the benchmark SELIC to 13.25 percent, it may be the highest.
Most importantly and since 1994 when the Real Plan was adopted, the top Brazilian commercial banks have broken records, quarter after quarter, year after year for revenues and profits. And the compounding effect of twenty years of the Real Plan continues unabated, and this is particularly noteworthy when one realizes that the major borrower is the government itself.
First quarter 2015 banking results show that the top banks in Brazil (Banco do Brasil, Itaú Unibanco, Bradesco and Santander) generated collectively USD 4.7 billion (R$14.2 billion) in profits. These profits are crisis-proof. This was a 19.8 percent increase over the same quarter last year. That kind of quarter on quarter growth is an entrenched and natural expectation in the Brazilian banking sector.
This trend continued unabated during the 2007-8 global financial crisis. Brazil was one of the first countries to "come out" of the global crisis, in large measure because commodity exports were still strong and because Brazil did not have (and does not have) a viable home mortgage market that lent itself to the kinds of derivative structuring and packaging of tainted mortgages, which drove the downturn in the United States. During these turbulent times, the Brazilian banks maintained steady growth in revenues and profits
Credit analysis, a lost banking art with respect to the private sector, can be dispensed with when the principal client is the Brazilian government. In essence, the Brazilian government prints money, distributes it to the private banks and then the banks lend it back to the government in exchange for government bonds that are indexed with interest for inflation (remember the overnight). With the SELIC at 13.25%, it is easy to understand why Brazil's internal debt burden is burgeoning at over USD 1.4 trillion (R$4.1 trillion).
To put this in perspective, the 12 stadia for the World Cup cost USD 3.5 billion over the 2010-2014 timeframe. During that same period Brazil paid its creditors USD 429 billion.
What no one talks about, however, is that the current generation of Brazilians has never known a low inflation - low interest rate environment. High interest rates in Brazil have impacted the very way the average person perceives existence, and the way Brazilian businesses and the government itself behaves.
The average Brazilian does not think long-term. The emphasis is on short-term impacts and short-term returns. Most businesses in Brazil of any decent size pay as much or more attention to their treasury department and its cash management capability (remember the overnight) as they do to company operations. This leaves the long-term, particularly long-term planning, in at best a secondary role, if not out of consideration altogether.
High interest rates for the past 20 years, has created an ancillary set of impacts for society. In effect, it has literally narrowed the vision of policy makers, and compromised the ability of both individuals and government to plan for the future.
Real Plan II
Banks in Brazil need to become what they are traditionally supposed to be, lenders to small and medium size businesses, which are the true job creators of any society. This can only occur in a low interest rate, low inflation rate environment (using international benchmarks). Brazil has not had such an environment in at least three generations.
The government's current three-pillar model of macro-economic planning and management, involving a primary fiscal surplus, a freely floating exchange rate and inflation targeting, needs a reorientation and reprioritization.
A three-legged stool is not as stable as a four-legged stool. The fourth leg that needs to be introduced as a requirement of fiscal and monetary policy, is a publicly announced planned reduction of interest rates.
In essence, what is being proposed is similar to the Brady Bond restructuring of various sovereign debtor nations in the 1980s. This restructuring must be married with government reform.
Brazil cannot do this by itself. Brazil's creditors - the banks, hedge funds and corporations, family offices and high net worth individuals (both foreign and domestic), need to be invited.
Brazil's current Finance Minister Joaquim Levy is being proactive in pushing government reforms, largely based on how Brazil drifted away from the three pillars and what steps need to be taken to return to that original paradigm, but his vision to create a firm foundation for sustainable growth, is not bold enough.
There is no better time to do this, than in a time of crisis - and Brazil is in the midst of the greatest political and economic crisis in its history.
The first Real Plan reduced 2000% inflation to single digits in roughly one calendar year. It was a success in terms of deconstructing hyperinflation, but it was also a repetition of a pattern, of using government macro-economic policy tools, to reinforce and enhance returns on investment for a select few. High interest rates became the easy money solution and trade-off for the end of hyperinflation.
Brazil's economic bottleneck is infrastructure. Infrastructure requires long-term debt financing and Brazil simply cannot create a coherent long-term nationwide infrastructure program with the SELIC at 13.25%.
Real Plan II would operate along the following parameters:
1. A publicly announced 12-month planning process, with a subsequent 24-month phased in reduction of current interest rates (13.25%) to an agreed upon interest rate target range (using a basket of developed country interest rate benchmarks),
2. Coupled with a recalibration of the original three-pillars, and
3. A simultaneous fully coordinated government reform package.
95% of Brazilians make less than USD 50,000 a year - not enough to have a meaningful impact on GDP indicators for national savings, much less to move the needle on investment.
The openness and desire of the 95% for change has already been demonstrated in the streets of Brazilian cities. The ability to change Brazil, however, rests with the other 5%, and in particular with the 1% (or 1/10 of 1%) who truly control the country.
A low interest rate, low inflation rate environment (by international standards) was never part of the first Real Plan's vision. Preserving the easy money "clipping coupons" mentality was.
The crux of the matter, is that today's high interest rates have been sold both internally (in Brazil) and externally (to the global capital markets) as the key tool to keep inflation in check.
The problem with that thesis, is that the current interest rates themselves, when coupled with the inability to implement necessary governmental reforms, becomes more of cause of inflation than a solution or check on inflation.
Government reforms, like a complete overhaul and simplification of Brazil's tax system, and new technologically driven approaches to healthcare and education, along with housing, transportation and other community driven infrastructure needs, coupled with innovation and an open global approach to scientific/technology R&D, are all directly related to master planning a publicly announced reduction of interest rates.
If the first Real Plan tamed 2000% hyperinflation in one year, then Real Plan II can tame Brazil's stratospheric interest rates in three or less.
Simply put, Brazil cannot afford to miss this opportunity.
Robert Wilson is the founder of Gaia Labs, a venture capital firm.