VII. The Interest Rate Question

Since the beginning of the Real Plan, the government has implemented a restrictive monetary policy characterized by:

• high compulsory reserve requirements for sight deposits, time deposits, savings accounts, and other forms of savings at, and loans by, the banking system; and

• a high interest rate policy designed to stimulate savings and to restrain consumer credit (Table 11).

Table 11

Interest Rates per Month (%)

	SELIC	CDI
Jul. 1994	6.87	6.68
Aug.	4.17	4.16
Sept.	3.83	3.85
Oct.	3.62	3.65
Nov.	4.07	4.11
Dec.	3.80	3.84
Jan.1995	3.37	3.48
Feb.	3.25	3.24
Mar.	4.26	4.41
Apr.	4.26	4.22
May	4.25	4.25
Jun.	4.04	4.05
Jul.	4.02	4.01
Aug.	3.83	3.81

Source: Bacen

The current debate over interest rates has not given enough emphasis to some considerations. First, it is wrong to speak of a recession. The available data show that there has been no more than a slowdown in the rate of growth. Second, the shortage of credit and the recent financial difficulties of private companies are related to the exaggerated expansion of credit since the introduction of the Real Plan, and not to interest rates. Third, with the re-appearance of consumer credit mechanisms, many new economic agents entered the market, some of whom were not prepared to evaluate risk and to select borrowers.

The above elements indicate that the high interest rates are being blamed for phenomena that occur independently of the interest rates. Despite the recognized high cost of disintermediation, the government's option for a restrictive monetary policy based on high reserve requirements has several advantages:

• the increase in reserve requirements reduced significantly the financial system's lending capacity; and

• the increase in reserve requirements broadened the spread between the interest rate to the saver and the interest rate to the buyer, thereby making it possible to have a restrictive monetary policy without increasing the basic interest rates in the economy.

Interest rate trends have been governed by the need to stimulate savings and the inflow of foreign capital, and, simultaneously, to control domestic credit and aggregate demand. The gradual reduction of interest rates, already begun, is conditioned on the continued decline in demand, the elimination of the trade deficit, and an achievement of a tax adjustment. As can be seen in Graphs 12 and 13, the increase in interest rates during March was caused by the need to:

• contain excessive demand; and

• avoid exchange market speculation that might be caused by the change in the exchange band and by the Mexican crisis.

Graph 12 - Effective Interest Rates (SELIC)

Graph 13 - Effective Interest Rates (CDI)

Despite pursuing a policy of relatively high interest rates and high reserve requirements, the Central Bank still has trouble controlling liquidity. The following three aspects of the problem stand out:

• the need to make adjustments in the state banks;

• the need to gain control of the classical liquidity instruments; and

• the need for adequate tax incentives to stimulate a shift from short-term to long-term savings instruments.

In regard to this third point, recent legislation introduces differentiated reserve requirements. As a result, new short-term savings instruments will require a 40% reserve while instruments of more than 60 days will have no reserve requirement. This change should stimulate longer-term savings.