Plano Real Today

Juliana Mello

The Brazil Business

Updated

7 October 2012

In order to understand Plano Real today, it's necessary to rescue the period when the plan was created, analyzing Brazil's situation back then. In this article, we will give a detailed historic of the plan, showing its reflexions in the country's current economic position.

Brazil before Plano Real

During the second half of the 20th century, Brazil was the country with the highest inflation rates in the world. The situation was so hopeless that the 1980s were painted as “the lost decade” for the country’s economy.

This period was marked by a high level of foreign debt, with implications on the public accounts and a high and rising rate of inflation. The sum of these factors turned impossible to the public management to recover and resulted in a decade in which the economy grew very little, a fact that associated with a hyperinflationary process, eroded the purchasing power of the currency.

Aside from being an economic disease, hyperinflation was a social evil and a political threat. Increased poverty, concentrated income, prevented the country from developing and endangered the newfound democracy, after a 21-year military dictatorship. Inflation became the chronic problem of the Brazilian economy, driving the government to create a succession of economic stabilization plans, which main objective was to control the price level. Plano Cruzado was the first to be implemented, followed by Plano Bresser and Plano Verão, all based in the freeze of wages and prices.

The plans managed to reduce in a bit the inflation rate, which was achieving 303% year over year in the early eighties. However, in a long term basis, they resulted as a complete failure, as they couldn’t hit the basis of the inflationary process.

As a result of the recession, tax revenue was not enough to cover the government’s expenses. As a result, the government just ordered the Central Bank - which, at the time, could buy bonds directly from the Treasury - to print the money needed to meet the expenses. The result was a perpetual motion inflationary.

The situation got even worse in 1990, when entered into force the Plano Brasil Novo (Plano Collor), that confiscated savings accounts, based on the idea that if there was no income, the consumption would reduce at the point of slowing down the inflationary pressure.

It worked at a first moment, but the fall in credit supply brought a recession in the economy, leading companies to resign and terminate their activities. Finally, this plan also failed and inflation began to rise again. Not to mention that it caused an uprising among the population, what summed with a lot of corruption scandals, ended up with Fernando Collor’s impeachment, the president of Brazil at that moment.

How Plano Real was thought?

After Collor’s impeachment, in 1992, his vice president, Itamar Franco, assumed the chair and nominated a team to work on a new stabilization plan to control hyperinflation. The sociologist Fernando Henrique Cardoso was appointed to take the Ministry of Finance and together with a crew of economists from PUC-Rio university began with the creation of Plano Real.

The plan that was drafted by this team was based on the dollarization of the Brazilian economy. Of course, simply using the US dollar as the new currency of Brazil would represent an affront to nationalism and it would make impossible for the government to continue printing money to cover its public debts (sad but true).

So, the solution was to create a new national currency that would follow the variation of dollar. Actually, a lot of economists think that it would be better if Brazil adopted the US dollar as a currency instead of creating the Real, as an example of what was done in Panamá. But that is another discussion.

But first, the Plano Real program depended on five factors to be implemented, as follows:

1 - Clear the public deficit - the very factor that generated the issue of money. For this, there would be necessary an increase of five percentage points in all federal taxes and privatizations of state, especially state banks. The government cut BRL 22 billion of the budget

2 – Stop indexing the economy - that is, stop the automatic corrections in prices and wages, which were adjusted automatically according to past inflation (a practice determined by law).

3 - Index the economy according to the exchange rate - That is, to make wages and prices vary accordingly to the Dollar. In practice, the dollar became our new index.

4 - Open the economy by reducing import tariffs - it was valid to combat any escalation rates

5 - Increase sharply international reserves - that is, the government should continually buy dollars, until the time of introducing the new national currency. The more dollars the government had in its reserves, the greater the confidence of international investors in the reliability and robustness of the plan, and would lower the chances of a speculative attack and a flight of capital. That would maintain the investor’s confidence in the new currency, keeping its value elevated. Also it was essential to keep high interest rates as a way to mantain the exchange aprecciated.

Once completed these five steps, the new currency would be born with a value almost equal to the US dollar.

The implementation of Plano Real

Plano Real was the last of the economic stabilization plans to be implemented in Brazil, being responsible for the economic stability that remains until today. The plan began to be implemented in June 1993, being officially put into practice in 1994.

1 - Period of balancing the public accounts, reducing expenses and increasing revenues (this stage was detailed in the previous topic of this article).

2 - Creation of the URV (Unidade Real de Valor), which as a daily indexer that served to convert all the transactions from the US dollar to the Cruzeiro Real, the Brazilian currency at that time. This stage was important to preserve the purchasing power of wages, avoiding shock measures as confiscation of savings and breach of contract, until the new currency was established. The URV was also important to prepare the population for the transition of currencies.

3 - Launch of the Real monetary standard, the new currency that is used until today

The plan was effective in bringing stability to the Brazilian economy, that after a period of high unemployment, allowed the economy to grow sustainably, including recovering levels of jobs. As for the inflation rates, by the end of 1994 they were fixed in 1.71%/month. An incredible decrease, considering that in January 1994, inflation was at around 50%/month.

The fiscal rigor, the adoption of inflation targeting system, the floating exchange rate and interest - that the past 8 years began to fall gradually - transformed and changed the structure of the country.

The changes that have put the country on the route of gold of great changes also changed the profile of the population. Inflation under control changed the tradition of an economy on a collision course with the worker - that way, especially during the 80s and 90s, their income totally committed and devalued by the end of the month, when prices varied from day to night. Time to invest was a challenge.

The plan was so successful that its idealizer, Fernando Henrique Cardoso, got elected president of Brazil in 1994, using Plano Real as his major electoral platform. FHC, as he is better known, was even reelected afterwards, governing the country until 2002, when Lula was elected to the 2003-2008 administration.

Plano Real today

When looking at a longer period, it is possible to understand the importance of Plano Real for the Brazilian economy. In 1993, the official inflation rate year over year was in "modest" 2477%. But the plan as it was conceived in back then no longer exists since 1998. The economic model wouldn’t survive a succession of worldwide crisis. Right now, Brazil is at what is called the second stage of Plano Real.

The second phase of Plano Real started in 1999, when the misfit of government accounts imploded the fixed exchange rate regime. From there, the strategy was to adopt the tripod composed of a floating exchange rate, inflation targeting and fiscal control through primary surpluses, a model that remains until today. With that, the Brazilian economy went on a downward stabilization, which was reflected in higher GDP growth and also improvement in the labor market.

To help control the inflation of prices, the economy has also undergone a process of modernization. Besides the privatization of inefficient state enterprises, was also extremely important privatization of state banks, as most of them were used by their respective governments as an easy and plentiful source of funding. These banks operated with virtually no law and under orders from their state governments, creating means of payment over fist just to fund their misfortunes. The helpless of the rest of the country paid the bill.