Just another BRIC in the wall? A comparison of recent Brazilian and Turkish economic developments.

• Author: Welch, Ben
• Position: Brazil, Russia, India and China - Essay

As emerging markets have become exponentially more fashionable, both as an academic concept and as a home for investors seeking greater returns than are broadly possible in the world's slowed developed economies, comparison of two of the most important emerging markets, Brazil and Turkey, is timely. It goes without saying that the two have significant differences. They are disparate in size (in terms of both population and landmass); exist in profoundly different contemporary regional and geopolitical contexts; and have relatively different historical contexts in their paths to becoming fully democratic nation states. What they share is what this article will focus on. This is not limited to an increased attention on their remarkable potential for growth, but a recent history of serious structural economic development abridged by economic crises.

The international economic environment, characterized by low growth rates and dominated by the quantitative easing of many central banks, has retained its ability to affect the two nations' domestic economies rapidly and profoundly. This is well documented. In October 2012, Ben Bernanke, in his role as U.S. Federal Reserve Chairman, addressed the issue specifically at a seminar in Tokyo: "Concerns have been raised about the spillover effects of our policies on our trading partners. In particular, some critics have argued that the Fed's asset purchases, and accommodative monetary policy more generally, encourage capital flows to emerging market economies. These capital flows are said to cause undesirable currency appreciation, too much liquidity leading to asset bubbles or inflation, or economic disruptions as capital inflows quickly give way to outflows." (1) The environment created by the monetary policies of key central banks is one that has serious implications for policy makers in emerging markets--particularly those with histories of inflation.

This paper compares some of the varying macro-prudential and policy tools used by Brazil and Turkey in the aftermath of the global financial crisis. The comparison is valuable. It illustrates two approaches that might be taken to address current and common problems affecting emerging markets: international capital inflows, inflation, and current account deficits. To this end, looking at how Brasilia and Ankara have plotted their courses in attempting to use policy measures to manage the massively increased levels of liquidity now found in the global financial system, despite obvious structural differences in the economies, is worthwhile. This is particularly so when the shared elements in the two countries' history are considered.

In Brazil and Turkey, inflationary episodes, coupled with a dependence on external debt, have frequently accompanied political instability. Political stability is no longer the concern they once were for either country. However, the memory how the two once combined is worth assessing. It may shed light on how the combination's lingering aftertaste has shaped current governments contemporary approaches to new dilemmas. This paper argues that the apparently successful deployment of "unorthodox" policy by the Turkish Central Bank, when set against Brazil's more conservative approach, has paid substantial dividends over the last twelve months for Turkey. Brazil's approach has, at the time of writing, seemed far less adroit.

Both face what has come to be known as the policy 'trilemma--how to effectively manage exchange rates; interest rates; and deal with the flow of money caused by loose monetary policies around the world. In managing the wave of global liquidity, which has sought out markets with yield, is it acceptable to argue that extraordinary times call for extraordinary measures--and justify the risk of following "unorthodox" policies? In this paper, I suggest that Turkey's approach has, for the time being, been the more effective. Whether this will hold two years from now, only time and the chairman of the U.S. Federal Reserve seem likely to tell.

Two Countries, Both Alike in Dignity

The last twelve months have seen increasing disparities in international perceptions of two of the world's most prominent emerging markets. Brazil has long been lionized as one of Jim O'Neill's, former Chairman of Goldman Sachs Asset Management, four rising economic powerhouses; alongside China, Russia and India. Turkey has, until recently, been treated more with the approach of cave emptor--its inflationary history and current account deficit, combined with long memories of political instability, have acted as red flags for international investors.

On the surface, the similarities seem rare. The vast difference in scale should set the two entirely apart. According to World Bank estimates, Brazil had a population of around 197 million in 2011, making it nearly three times more populous than Turkey. This is underscored by raw geography--when placed against Brazil's 3,288,000 square miles, Turkey's not inconsiderable 302,500 square miles seem small. These simple disparities are enhanced by the economic differences. One is a multi-faceted commodity exporting superpower with a vast internal market, famously the first consonant in the BRIC moniker, while the other is a consumption driven and energy importing economy with a complicated neighbourhood. The difference in natural endowments underlines the scale of Turkey's ambitions. It is the Ankara's intention to be one of the ten largest economies in time for the 100th anniversary of the founding of the Turkish Republic in 2023. Meanwhile, Brazil became the world's sixth largest economy in 2011 with GDP of $2.5 trillion, as it overtook the United Kingdom.

However, when scale is stripped away, key data indicate interesting similarities. While an arbitrary measure, the difference in GDP per capita (as of 2011) is notable, with Turkey's $14,700 comparing favourably to Brazil's $11,900. (2) Both countries came through the international financial crisis relatively unscathed and returned rapidly to growth. Both have subsequently slowed, as the international environment has evolved. A tidal wave of global liquidity, searching for high yielding economies (or, more precisely, economies which actually demonstrate growth potential) has added to concerns, whether perceived or real, of currency "wars" waged against emerging markets. Meanwhile, consumption slowdowns due to political and economic factors in some of Brazil and Turkey's major export markets have added to an environment where the moves of their respective central banks have been watched closely.

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Why Brazil vs. Turkey?

This paper contends that an analysis can be conducted on the premise that both economies suffer from a similar weakness--they are finance constrained. This constraint is vital. It means that external financing is needed. This forces economies to rely on international capital to support their development. It means that interest rates come to be used as a tool to attract capital inflows. This opens the countries to the effects of the market forces loosed by the U.S. Federal Reserve, among others, exceedingly accommodative monetary policy of the last few years. Therefore, an analysis of some elements of macro-prudential policies applied in reaction to this environment is useful in presenting two different approaches to economic management. (3) By understanding Brazil and Turkey's recent economic past, looking at what has followed since 2008, and assessing their respective approaches, it may draw some insights for economic policy making in emerging markets.

A brief look at the recent histories of the two economies shows the main villains to be political and economic instability. Put simply, both economies have faced a similar enemy over the last 30 years--inflation.

Hyperinflation and the Plano Real

In Brazil's case, the story begins with the rash of privatizations, which accompanied the liberalizing reforms of the 1980s. As time came due on Brazil's ruling military junta, a slow march towards full democracy began. This period of political change was accompanied by significant economic difficulties. It drew to a close with a moribund economy and high and accelerating inflation. This happened despite three attempts to break the threat of inflation. Brazil's authorities had manufactured a number of 'heterodox' economic shocks in trying to deal with the problem: 1986's Cruzado Plan; 1987's Bresser Plan; and, 1989's Summer Plan. These three ultimately failed attempts attempted to reduce public sector indebtedness by applying traditional measures: fixing the exchange rate; price, rent and mortgage payment freezes; wage readjustment and freezes; and, bans on indexation. All the while Brazil went through currencies with alarming rapidity--between 1986 and 1994 the country had six currencies. Brazil finally alighting on the Real in 1994, as part of a larger macroeconomic stabilization plan, having enjoyed various incarnations of the Cruzeiro and a number of Cruzados.

President Itmar Franco's appointment of Fernando Henrique Cardoso to the position of Minister of Finance, and Cardoso's subsequent introduction of the Plano Real, began to reign in an economy which was fast running out of control. (4) Cardoso worked to tame Brazil's hyperinflation, focusing on three areas: the introduction of a national equilibrium budget, a process of general indexation, and the introduction of the Real.

The Plano Real attempted to break...