Q&A with Roberto Campos, Governor, Central Bank of Brazil

Q&A with Roberto Campos, Governor, Central Bank of Brazil

Brazil Economy & Policy Interviews

Brazil’s central bank was one of the first in the world to start raising interest rates as inflation accelerated at home and globally in 2021, a move that has paid off. Inflation is easing in Brazil after peaking at 12.1% in April this year, allowing the central bank to keep the monetary policy rate stable at 13.75% in August and September even as other countries continue to tighten their monetary stances. Brazil’s economy is also on track this year to grow faster than most economists had expected. In a sweeping interview, Campos shares the reasons behind his quick moves to fight inflation, what’s in store next and what the bank is doing to modernize the local financial system, including with a digital currency. 


The interview was edited for length and clarity.


LatinFinance: What would you point to as the standout achievements of Brazil’s central bank over the past year?


Roberto Campos: The Central Bank of Brazil (BCB) has taken several measures in the recent period that produced important results for our society, both on macroeconomic and microeconomic sides.


On the macro aspect, the global outlook has been challenging. In 2021, inflation accelerated significantly, both in advanced and emerging countries, including Brazil. The reaction to face the COVID-19 crisis gave rise to excess demand vis-à-vis the short-term supply of various goods at a global level. This led to imbalances across several countries and sectors, exacerbated by labor shortages, logistical problems, and production bottlenecks. Very early the BCB saw the inflationary process as a more persistent event, with an important demand component. With this diagnosis, the BCB was one of the first central banks to start its tightening cycle. This strategy has already produced results and we now see signs of an incipient reduction in inflation. This timely action was accompanied by improvements in monetary policy communication, which is very important in turbulent moments.


At the same time, we have seen positive surprises to economic activity. In 2021, the GDP growth of 4.6% was higher than initially anticipated. At the beginning of 2022, market analysts were forecasting a very small growth for the year, but after the positive results of the first two quarters, analysts have revised up their forecasts to a median of 2.4%. But GDP growth in 2022 should be higher than the current forecasts. For instance, the carry over for the year is now 2.6%. In line with the GDP growth, the labor market has presented positive developments. The unemployment rate has consistently decreased, standing now below the pre-pandemic level.


On the microeconomic side, we have continued our plan of innovation, through our agenda of structural reforms for the financial system. The Agenda BC# is a comprehensive initiative, with many projects and actions that are integrated and interconnected to form what we call the financial system of the future. Over the past year, we made important progress in the main projects of this agenda, such as Pix, Open Finance and the Digital Real.


Pix, the BCB’s instant payment system launched in 2020, continued its evolution agenda in 2021 and 2022. For instance, it is now possible to make payments on a due date or on a scheduled basis using Pix. It is also possible to withdraw cash from a retailer, which enormously increases the capillarity of the withdrawal service. Furthermore, new accessibility and safety features are already in operation.


The Open Finance project gained traction along the past year. The Brazilian Open Finance model is a world benchmark, the largest in number of institutions and scope. This is an ambitious project that has been implemented in phases, with important advances recently. At the current stage, we have more than 800 participating institutions, over 7.5 million customer data sharing consents, an average of over 260 million API calls in the last weeks, and a total of more than 4 billion API calls.


The BCB has also advanced in the development of a Brazilian CBDC. Our digital currency will be linked to tokenized bank deposits in a token-based system. Our idea is to promote a process of tokenization of the financial system, in which all these projects (Pix, Open Finance, Digital Real) will work in an integrated way.


Financial inclusion and regulation were other areas of important advances. In regulation, we have made significant efforts to set up new rules to increase efficiency and to advance the sustainability agenda in the financial system. In financial inclusion, we have implemented several measures to expand the microcredit, strengthen the credit cooperative sector and promote financial education.


Finally, regarding the legislative agenda, three important achievements were the following laws passed by Congress: the Law of Autonomy of the BCB, the Law of Modernization of FX Legislation and the New Law of Credit Cooperatives.


All those actions are aligned with BCB’s mission to ensure the stability of the currency purchasing power, to foster a sound, efficient and competitive financial system, and to promote the economic well-being of our society.


LF: How specifically have you tackled rising inflation? It has been a global phenomenon, but how did the BCB deal with the issue in Brazil over the period?


RC: Three aspects explain how we have tackled the rising inflation in Brazil in a proactive manner: our early perception regarding the nature of current inflation, our view regarding the costs related to central banks actions, and the fact that inflation in Brazil started to increase before than in other jurisdictions.


First, as I mentioned before, from the beginning we had a different view regarding the nature of the current inflation. While some viewed it as a transitory event with supply origins, we saw the inflationary process as a more persistent event, with an important demand component.


Second, on the costs related to central banks actions, central bankers usually try to avoid committing two types of errors. On the one hand, “doing too little,” or postponing a monetary policy tightening and tolerating more inflation to avoid a slowdown in economic activity. On the other hand, “doing too much,” which means being ahead of the curve, tightening monetary policy more quickly and strongly to prevent higher inflation and the unanchoring of inflation expectations at the expense of a sharper slowdown in economic activity. Central bankers in emerging market economies, with their history of higher inflation, would be more reactive, hence more prone to commit the second type of error. Evidence in the literature also suggests that acting quickly to mitigate the inflation overshoot helps a soft landing than a shallower, but more extended tightening cycle.


Third, the fact that inflation started to increase in Brazil before than in other jurisdictions is related to several demand and supply elements. On the demand side, the rebound of economic activity was faster than expected. On the supply side, in 2021 we had adverse climatic conditions, with historical low rainfall levels. Hence, food (in 2020) and energy prices (in 2021) have been among the major sources of upward pressures on consumer inflation in the last years. The depreciation of the exchange rate has also contributed to raise inflation in both years. The shocks continued in 2022 with the war in Eastern Europe and bottlenecks in production chains. Therefore, consumer inflation remains high, with increases spread among several components, and continues to be more persistent than anticipated.


All these elements led BCB to act very fast to fight against inflation. The institution was one of the first central banks of the world to start its tightening cycle in March 2021. By frontloading policy rate hikes and advancing in the process of monetary tightening significantly into even more restrictive territory, the BCB persists in its strategy until the disinflation process and the expectation anchoring around its targets consolidate.


In fact, more recently we have seen an incipient downward movement in inflation. The effects of the reduction of taxes on energy and fuel prices and the tighter monetary policy stance have played a role, and in the last two months the IPCA recorded a deflation (-0.68% in July and -0.36 in August). Looking ahead, inflation should gradually decrease towards the targets. Professional forecasters’ inflation expectations for 2022 and 2023 (around 6.1% and 5.1%, respectively) are still above the target ranges. However, they are within the target range for 2024 (3.5%) and 2025 (3%).


LF: What have been the implications of the global environment (post-pandemic period, commodities, war in Ukraine, etc.) on BCB policy?


RC: The global economy has been hit by a sequence of severe adverse shocks that have dramatically increased the uncertainty surrounding the economic outlook. Among these shocks, we can mention the new COVID-19 wave with Omicron and lockdowns in China, reinforcing bottlenecks in several sectors, and the conflict between Ukraine and Russia, with sizable impact on commodity prices. These shocks have added upward pressures on inflation globally and reinforced its persistence. More recently, we have seen the tightening of monetary policies in advanced economies, adding volatility to the markets, including in emerging market economies.


In this scenario of increased uncertainty, downside risks for inflation and activity have links and may reinforce each other. For instance, disruptions in supply chains generated by the COVID-19 and in energy and food markets caused by the war in Ukraine may lead to higher or more persistent inflation and more aggressive monetary policy tightening in major economies.


The higher persistence of inflation was a phenomenon already observed during the pandemic crisis. In retrospect, countries have implemented since 2020 unprecedented fiscal and monetary support measures to cushion economies from the COVID-19 shock. The higher household income from government transfers and the mobility restrictions drove households to consume more goods and less services. As goods production are more intensive in energy than services, the demand for energy increased. After the lifting of restrictions, it was expected that households would return to their previous consumption patterns, but this has not occurred. Overall, whereas services are gradually recovering their pre-pandemic levels, the consumption of goods stayed above pre-pandemic levels.


All these developments had important implications for the Brazilian economy, especially on inflation and economic activity. As I mentioned before, Brazil experienced a significant increase in inflation since the end of 2020. The BCB was among the few central banks which since the beginning of the shocks viewed the inflationary episode as a more persistent event, with an important demand component, and acted fast to fight against inflation. We consider that this proactive approach of monetary tightening that led the policy rate to a significantly restrictive territory was timely and makes Brazil now better prepared to navigate in this highly uncertain global economic scenario.


LF: Will global monetary tightening (in the United States and elsewhere) lead the BCB to keep on tightening as well?


RC: Despite the more restrictive monetary policy stance that has taken place more recently in the US and in several other countries, Brazil is in a different stage of monetary policy tightening. Its cycle began much earlier than in other jurisdictions, in March 2021, as mentioned before. Since then, Brazilian policy rate has risen by 1,175 basis points (from 2% to 13.75%).


We have also other important differences when compared to other economies. In terms of the labor market, Brazil had a recovery in employment and wage levels, but has not experienced labor supply shortages as occurred in the US and other advanced economies. Our participation rates are already back to pre-pandemic levels. So, while labor market data indicates a faster-than-anticipated narrowing of the estimate of the output gap, we evaluate that some degree of economic slackness still persists.


On the shifts in the demand for goods and services observed since the pandemic, in Brazil the relocation of consumption between goods and services was smaller than other jurisdictions, where the displacement between these two sectors was larger. In Brazil, the recovery of the services sector was faster. In the first half of 2021 it had already reached pre-pandemic levels (current number is 8.9% above). Conversely, even in other countries which have experienced a significant economic recovery such as the US, the demand for services has not reached pre-pandemic levels yet. This difference has implications for inflation persistence in Brazil when compared to other countries.


On the supply chain bottlenecks, the impacts were significant but less intense than other nations, because Brazil is more closed and less reliant on trade than other countries with economies more open and integrated in global value chains. Nevertheless, due to the ongoing reorganization of international production chains and geopolitical developments, we also see opportunities for Brazil to increase its participation in global supply chains in the coming months and years. With its large natural resources (including renewables), the country has a great potential to increase its role as a provider of energy and food security, also in line with the green transition.


Therefore, taking into account these developments, and the advanced stage of the monetary policy tightening cycle, in its last monetary policy meeting in August, the BCB has raised its policy rate by 50 basis points, and said it would evaluate the need for a residual adjustment, of lower magnitude, in its next meeting. While inflation in Brazil has shown incipient signs of reduction, the BCB acknowledges the non-linearity of the inflation reduction process. Although inflation may come down faster from its peak due to the reduction in energy prices, it may take more time to reduce towards the center of the target, due to its diffusion across sectors and stickier components in the core, such as services. That is why the BCB will remain vigilant and that future policy steps could be adjusted to ensure the convergence of inflation towards our objectives.


LF: Can you highlight some innovations of the BCB in terms of digital banking, blockchains and other technologies?


RC: We are experiencing a period of unprecedented technological innovation in the financial system. In today's digital world, people are looking for ways to represent in a digital format anything that might have value. To this end, encrypted assets have been distributed on a ledger so that they become verifiable, transferable and divisible. This process of asset tokenization allows us to extract, in digital form, value from different types of assets, such as photos, art, properties, ideas and even money.


This innovation process suggests that we are moving towards an increasingly tokenized economy. In the financial market, this process tends to lead to a growing dichotomy between what is account-based and what is token-based. It is in this context of innovations that the BCB has sought to promote its financial innovations.


At the BCB, we have implemented, in the last years, several innovation projects in our Agenda BC#, such as the instant payments system (Pix) and the Open Finance. In addition, we have other projects that are now underway, such as the Digital Real (CBDC) and the modernization of FX legislation. All these projects are different parts of an integrated agenda for the financial system of the future.


In the coming months and years, all these projects will become increasingly integrated in this tokenization process of the financial system. The goal is to connect them and get a common development path with open protocols. In this way, we will move towards a new interoperable system that includes instant payments, tokenized deposits, Open Finance, data monetization and potentially other services. All this on a single track.


This integration will serve as the basis for the establishment of our digital currency. The challenge of the Digital Real is to enable uses that go beyond the payment solutions available today. The Brazilian CBDC will be a tokenized deposit. The principle will be to transform deposits into tokens (stablecoins), which can be converted into a CBDC issued by the BCB on demand. The fact that banks will be the issuers of the stablecoins will avoid disintermediation and problems in their balance sheets. At the same time, tokenized deposits will have the same regulatory principles of conventional deposits, ensuring the security of the financial system. Our idea is to have a pilot project in 2023 and the CBDC up and running in 2024.


Data monetization is another important issue in our agenda. Currently, it is very difficult for users of the financial system to monetize their data. As owners of their information, they should be able to do that. We are working to create, in the future, ways that allow them to monetize their information.


Finally, in our view of the future, it is unreasonable to think that people will have to live with different apps to access information and services from different financial institutions. Our idea is to have an integrated process that allow people to choose a single app that integrates information and services from different financial institutions. In addition to serve as a digital wallet, in this app will be possible, for instance, to make payments, investments, transfers, asset purchases, cash management and contract many other financial services from different financial institutions. This aggregator would allow both online and offline transactions, and would also be linked to a data wallet, where the user could store its data and choose the best way to monetize it. This process is already underway, but we work to accelerate it even further in the coming years.


LF: What are the benefits of the independence of the central bank?


RC: Since the drafts of the Banking Law (Law nº 4,595, from 1964), which created the BCB, there has been a long discussion about the autonomy of our central bank. This led to a process of institutional evolution, where the benefits of an autonomous, transparent, and responsible central bank have become clear to society.


Then, in February 2021, Congress passed the Law of Autonomy of the BCB, and the Brazilian Supreme Court ratified it in a legal challenge in August 2021. The Law of Autonomy brings some important elements. First, it defines price stability as the BCB’s main objective. Without prejudice to this main objective, the institution will also aim to ensure the stability and efficiency of the financial system, smooth fluctuations in the level of economic activity and foster full employment. The law also determines fixed and non-coincident four-year terms for the governor and the deputy governors. These mandates overlap only partially with the presidential mandate.


One of the main benefits of the central bank's autonomy is to separate the political cycle from the monetary policy cycle, which has a longer horizon. Autonomy allows the institution to pursue its objectives in a technical, objective, and impartial manner, reducing economic instability in periods of government transition and aligning the BCB´s framework and practices with the best international ones. Economic literature and international experience show that central bank autonomy is associated with lower and less volatile inflation, without compromising economic growth.


The institutional change brought by the autonomy will contribute to consolidate the institutional evolution and the macroeconomic gains achieved in recent years. Legal autonomy will promote greater credibility of BCB’s actions and thus facilitate the achievement of its objectives. However, we should keep in mind that central banks autonomy is challenged from time to time and, therefore, it is a process in constant evolution, always needing improvements.


LF: Thank you.