Reuters: Interest rate cuts will have little effect on the economy.

By Luiz Guilherme Gerbelli

SAO PAULO (Reuters) - Brazilian monetary policy has lost momentum and will take longer to be fully reflected in economic activity, amid a scenario of severe recession and low confidence among both households and businesses.

Experts interviewed by Reuters unanimously stated that the current cycle of cuts in the country's benchmark interest rates will immediately help economic agents renegotiate their debts, but they believe that a return to more consistent consumption and investment will take longer.

In past monetary easing cycles, households and businesses had tighter budgets and therefore responded more quickly.

"Now families and businesses depend on a cycle of Selic rate reductions to renegotiate debts under more favorable conditions," stated economist and partner at the consulting firm Tendências, Alessandra Ribeiro. "The decision regarding new consumption and investment should only happen later."

The drop in benchmark interest rates is considered one of the main tools of Michel Temer's government to stimulate the economy. The cycle of Selic rate reductions began in October of last year, taking the Selic rate from 14,25 percent to the current 13 percent, with expectations that it could reach single digits later this year.

On Wednesday night, citing weak economic activity, the Central Bank surprised the market by increasing the pace of interest rate cuts to 0,75 percentage points.

The debate about the impact of falling interest rates on economic activity is quite recent and has been gaining traction within consulting firms and research institutes. Therefore, its measurement is still being calculated.

Under normal conditions, the Brazilian economy took, on average, six to nine months to fully respond to cuts or increases in the Selic rate. But, in the current situation, this period may be longer. According to Tendências' calculations, each 0,25 percentage point cut in the Selic rate usually generated 0,1 percentage point growth in the Gross Domestic Product (GDP) at the end of four quarters.

But the current scenario, according to data from the Central Bank, shows that the percentage of household income committed to debt has decreased only slightly over the past two years, remaining consistently above 40 percent.

On the corporate side, 48,7 percent of publicly traded companies had insufficient cash flow to cover debt expenses in the third quarter of last year, according to the Ibmec Institute's Center for Studies. In 2010, this figure was 22,7 percent.

"The reaction tends to be slower, but the drop in interest rates is part of the solution. It's a classic instrument that allows companies to refinance their debts under much better conditions," said the chief economist of Banco Safra and former Secretary of the National Treasury, Carlos Kawall.

RISK OF FURTHER RECESSION

The weak impact of monetary policy on activity is even more perverse because some believe the economy will stagnate or even contract this year.

This scenario would reinforce the already low overall confidence, which tends to delay and/or diminish the effects of monetary policy. In December, confidence indicators for the construction, services, and industry sectors, as well as consumers, fell to their lowest level since mid-2016.

Another variable that will continue to be monitored regarding the ability of monetary policy to help economic activity will be the behavior of the bank spread—the difference between the bank's cost of funding and the rate effectively charged to the final consumer—which tends to increase, or decrease more slowly, during times of great uncertainty and a worsening assessment of risk in the economy.

Even with the Selic rate stable for much of 2016, only to begin declining in the final months, the average overall spread had risen 4,9 basis points year-to-date through November, according to the latest data from the Central Bank. Thus, final interest rates also increased, making credit more expensive and hindering consumption.

"The cycle of falling interest rates is very important, but the impact that this reduction will have on the demand for credit is still uncertain," summarized Livio Ribeiro, a researcher at the Brazilian Institute of Economics of the Getulio Vargas Foundation (Ibre/FGV).

(Edited by Patrícia Duarte and Alexandre Caverni)