Friday, June 13, 2008

Brazil Announces Plans for Sovereign Wealth Fund

Sources: Financial Times, Financial Times

On June 9th, the Brazilian government announced plans to create a sovereign wealth fund to manage revenues from newly discovered oil fields. Finance Minister, Guido Mantega, said the fund could grow to contain as much as $200 to $300 billion over the next three to five years. The fund will increase the government's target budget surplus from 3.8% to 4.3% of gross domestic product. The oil reserves discovered in the South Atlantic are expected to produce forty to fifty billion barrels potentially making Brazil the eighth largest oil nation in the world. Mantega stated that the fund will have various functions ranging from reducing government spending to stabilizing the exchange rate.

One of the goals of the fund will be to fight inflation. The consumer price inflation in Brazil, currently at 5.25%, has outpaced the government's goal of 4.5%. Mounting concern about inflation has caused the central bank of Brazil to tighten fiscal policy in the last three months. On June 4th, the bank increased interest rates by .5% to 12.25%. After three years of loosening fiscal policy, the bank started increasing the interest rate in April to stave off inflation.

The formation of the sovereign wealth fund is one more step in the transformation of the Brazilian economy. While most of the world is gripped in the midst of a credit crisis, Brazil is starting to look much better to foreign investors. Added to the highest real interest rate in the world, major credit rating agencies have started to upgrade Brazil. Fitch's upgrade of Brazil to an investment grade rating should increase Brazil's attractiveness to foreign direct investment. Fitch's announcement, on May 29th, followed the lead of Standard and Poor's who upgraded Brazil on April 30th.

1) What are the benefits and drawbacks of having a sovereign wealth fund monitor fiscal policy instead of the traditional central bank? Can the two, like in the case of Brazil, survive together in the same economy?
2) Will Brazil's bright economic future systematically raise the rest of Latin America? Or for that matter, how much can Brazil help to relieve the world of the current credit and food crisis?

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