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The Great Recession and Developing Countries
economic policy credibility response during President Lula’s first term (2003–06). Upon taking office, the new administration tightened fiscal and monetary policies. Primary surplus targets were increased to 4.5 percent of GDP from the previous target of 3.3 percent, which had been in place since 1999, and interest rates were lifted to 26.5 percent to dampen inflationary pressures related to the real depreciation. The government also adopted a debt management strategy focused on aggressively reducing the volume of U.S. dollar–indexed debt and began to gradually increase the proportion of fixed-interest-rate debt. The authorities also lengthened debt maturities to lessen vulnerabilities associated with exchange and interest rate fluctuations and rollover risks. With these measures, the government reduced the fiscal dominance on monetary and exchange rate policies. Taking advantage of strong political support in the early stages of its term, the new administration received congressional approval for a second round of social security reforms. Further reforms included the approval of a bankruptcy law and improvements in the domestic credit markets, especially concerning the housing and consumer lending sectors, which sharply increased available credit. The strong commitment to prudential macroeconomic policies was decisive in achieving a substantial improvement in market sentiment. This improvement was reflected in reduced sovereign spreads and steady improvement of credit ratings, which culminated in Brazil’s winning investment-grade rating in 2008 by the three major international credit rating agencies. Further strengthening of the macroeconomic management framework during 2003–08, along with the favorable external scenario, enhanced Brazil’s fiscal and external solvency positions. Strong government balances led the public debt-to-GDP ratio to fall to 38 percent in 2008 (from 57 percent at the end of 2002). The strong fiscal adjustment allowed not only the reduction of debt levels but also the altering of its composition through an effective implementation of a debt management strategy designed to reduce exposure to exchange and interest rate shocks. As a result, the share of debt linked to the exchange rate fell from 35 percent in 2002 to negative territory (the government is a creditor in this instrument) in 2005, and it remained negative until 2008. Debt indexed to the interest rate fell from 42 percent in December 2002 to 31 percent in 2008, while the share of fixed bonds increased from 2 percent in 2002 to 27 percent in