ANALYSIS-Brazil reserve rules may rise before interest rates

By Luciana Lopez SAO PAULO, Nov 6 (Reuters) - Brazilian central bankers looking for an exit strategy from looser monetary policy could raise reserve requirements before hiking interest rates. With the country's liquidity crisis seemingly put to bed, bank reserve requirements lowered during the global financial crisis appear to have served their purpose. In addition, policymakers will be loathe to give up a tool that worked so well in the just-passed recession. Combined with central bank reluctance to tinker with the benchmark interest rate just yet, a hike in reserve requirements could be the first sign of tighter policy in a robust economy expected to be a driver of global growth in coming years. And reserve requirement changes could affect voters less directly than higher interest rates would -- no small thing in an election year, as 2010 will be in Brazil. Goldman Sachs sees the central bank raising reserve requirements either late this year or early next, a monthly report from the company noted in October. In contrast, policymakers are likely to start raising rates by the last quarter of 2010, the report added. "Reserve requirements proved a very useful instrument," said Ceres Lisboa, a vice president and banking analyst with Moody's Investors Service in Sao Paulo. Tightening the requirements, albeit not necessarily to pre-crisis levels, would help preserve the chance to use that instrument again someday. "The central bank won't want to give it up," she added. LOOSER POLICY The bank used both interest rates and reserve levels to help revive Brazil's economy during the global downturn. Policymakers chopped 500 basis points off the benchmark interest rate and loosened historically high reserve levels -- at 45 percent for demand deposits before the crisis -- to spark lending among banks, individuals and businesses. The strategy seems to have worked: Bank lending rose for a second straight month in September, though the lag between the easing of reserve requirements and lending makes the relationship inexact. "The big changes to the reserve requirements helped move things past the credit crisis," said Jose Francisco de Lima Goncalves, chief economist for Banco Fator. "It didn't resolve the crisis, but it helped." With Brazil and other countries leaving recession, central banks around the world have begun casting about for exit strategies. Norway, Israel and Australia have raised interest rates already. But India, which is more commonly considered a peer of Brazil, took a different tack. The Reserve Bank of India last week tightened liquidity by raising the share of deposits banks must hold in government securities. Complementing a possible mission-accomplished feeling on liquidity is the Brazilian central bank's caution on raising the benchmark interest rate. Policymakers brought the so-called Selic rate to a record-low of 8.75 percent after five straight cuts this year but held rates steady in September and October. They issued the same statement after both meetings, signaling that they saw nothing new to change their stance. ELECTION CYCLE Next October's elections, in which Brazilians will choose a new president as well as a slew of other offices, also hang over monetary policy going forward. Though the government is unlikely to interfere with the central bank's de facto independence, policymakers will still want to eliminate uncertainty in the economy, said Rafael Cortez, an analyst at Tendencias consultancy in Sao Paulo. Adjustments to the Selic would have more effect on inflation, he said, but changes to reserve requirements would have less direct impacts on voters. "Voters don't feel those changes as much," he said. "They'd have to make a string of associations." Yet the Selic will likely remain the central bank's main monetary policy tool, said Ilan Goldfajn, a former central bank governor and now chief economist with Itau Unibanco. Changes to the rate send stronger signals to the market. Reserve requirements in Brazil can range as high as 42 percent or more, depending on certain bank and deposit rules. In the United States, by contrast, the most onerous reserve requirement is 10 percent. Complicating central bank choices is the imprecision involved in both instruments, said Alexandre Schwartsman, chief Brazil economist for Banco Santander in Sao Paulo. While the relationship between interest rate changes and market reactions is not well understood, he said, "compared to reserve requirements the Selic is a laser-guided tool." Though the argument that lower reserve requirements have done their job carries weight, their complexity could make the rules a less likely candidate for change. "You run the risk of going too far either way," said Schwartsman, also a former central bank director. (Editing by Todd Benson) Keywords: BRAZIL ECONOMY/RATES ([e-mail]; Reuters Messaging: [e-mail]; Tel: [phone]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved.

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