Brazil: The Real Economic Plan In Brazil - An Overview

I - Introduction

In order to better understand the Real Plan and its beneficial affects for Brazil, it is important to first know Brazil's recent political history.

In this regard it is paramount to stress that as of December 1989, for the first time since 1960, 80 million voters elected in two round ballots Fernando Collor as President

President Collor began deep reforms on the Brazilian economy, trying to overcome the stagflation that characterized the 1980's. The measures adopted during his term included tariff reductions, privatizations, a floating exchange rate policy and two failed attempts to deter inflation.

However, in June 1992, the Brazilian Congress initiated an investigation on charges of corruption involving the President. In December 1992, in the midst of the impeachment trial, Collor resigned, but could not avoid being condemned for corruption and his political rights were suspended until 2001.

His Vice President, Itamar Franco, assumed the office. After a turbulent period, as inflation continued to rise, Franco appointed Fernando Henrique Cardoso (Brazil's current President) as Finance Minister in May 1993.

Cardoso acted as a prime minister de facto starting an ambitious stabilization plan, referred to as the Real Plan, in order to prepare his own ticket for the presidency in the October 1994 elections. In July 1994, the last phase of the plan was implemented and inflation declined from 50% to 3%. Cardoso, who was far behind in the polls, won the election in the first round of balloting. Cardoso's four-year term began on January 1, 1995.

II - Short Summary of Brazil's Recent Economic History

For a long time the Brazilian economy has been the largest in Latin America with a diversified industrial basis, a modern and sound financial framework and a strong and export-oriented agricultural sector.

Brazil boasts one of the fastest growing countries in this century -which includes a 7% average GNP-Gross National Product- growth between 1945 and 1980. Brazil faced a complete erosion of its industrialization model in the 1980's and, in recent years, it has had a record of erratic growth largely due to growing fiscal deficits and spiralling inflation.

The recurrent threat of hyperinflation in the latter half of the 1980's and in the early 1990's prompted successive Brazilian governments to adopt a series of economic programs. From 1986 through 1991, these programs relied mainly on price and wage controls and diminished indexation of the economy, as well as periodic contractions of liquidity. These programs generally did not attempt to deal with Brazil's public deficit problem.

In 1990, the administration of President Collor implemented an emergency economic program, which included a substantial withdrawal of liquidity, as well as a wage and price freeze, higher taxes and planned cuts in government spending. The program also included a privatization program and a move towards a free floating foreign exchange rate. This program contributed to a recession in 1990, but did result in a decline in inflation and a sharp reduction in the nominal public sector deficit. Further progress was limited, however, by the government's inability to control spending by state governments and public enterprises, falling fiscal revenues due to the recession and certain other factors.

In 1990, real GNP declined 4.4%, the steepest annual decline in modern times. A new set of economic measures adopted in early 1991 again was based mainly on wage and price controls. The initial impact was relatively favorable. However, these actions provided only a temporary reduction in inflation. A new economic cabinet named in early May 1991 achieved more centralized control of public finances, initiated some long delayed structural adjustment measures and accelerated negotiations with foreign creditors.

Positive real economic growth at low rates resumed in 1991 and continued in the first half of 1992 but declined in the second half of the year due to Collor's impeachment, resulting in an overall decline of 0.9% in real GNP in 1992.

During the Franco administration, the position of Finance Minister was filled six times, most recently by Mr. Fernando Henrique Cardosos appointment in May 1993, the appointment of Mr. Rubens Ricupero in early April 1994 to succeed Mr. Cardoso, who left office to run for the Presidency, and, on September 7, 1994, by the appointment of Mr. Ciro Gomes.

III. - The Real Plan

In February 1994, the Brazilian government announced an economic plan designed to control Brazilian inflation and to stabilize the Brazilian currency. The Real Plan was introduced in three stages.

The first stage, the passing of a constitutional amendment to implement a balanced federal budget, occurred on February 28, 1994. The measures adopted included the creation of a "Social Emergency Fund" into which the federal government now pays certain amounts that had previously been paid to state and local governments, expansion of the existing privatization program, and measures to improve tax collection.

The second stage, which required that the various inflation indices currently in use be substituted by a new index, the URV, published daily by the Central Bank, to reflect basically the daily exchange rate between local currency and the US Dollar, was implemented on March 1, 1994.

On that date, the URV represented CR$647,50 or US$1.00. Use of the URV for contract indexation was compulsory in the case of wages and contracts entered into after March 14, 1994. It was not required that financial contracts be indexed by reference to the URV.

During this stage, the Cruzeiro Real was permitted to devalue against the US Dollar only at the rate of inflation as reflected by the URV (although movements within a small band around the central rate were permitted). Daily movements in the URV were estimated by the Central Bank for purposes of fixing exchange rates. Accumulated monthly charges were required to match the average of the change in the URV's component indices.

In the third stage, implemented on July 1, 1994, the government discontinued the URV, and the Real replaced the Cruzeiro Real as Brazil's currency. The value of the Real was determined by reference to the level of the URV at July 1, 1994, maintaining the parity between URV-Real-US Dollar equal to 1 to 1. While the Central Bank had established the ceiling for the selling rate, the bid and selling rates were permitted to vary according to market conditions.

The content of this article is intended to provide a general guide to the subject matter. A specialist's advice should be sought in order to provide professional advice on a case to case basis which will meet specific circumstances.

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