Central Bank of Brazil lowers bank reserve requirements in bid to boost liquidity

The Central Bank of Brazil (CBB) has lowered reserve requirements for banks in a move to inject 45 billion reais ($20 billion) into the country's stagnating economy ahead of presidential elections later this year.

The CBB, which raised interest rates by 375 basis points to 11% in the year to April to fight above-target inflation, said on Friday the new measure "aimed at improving the distribution of liquidity in the economy" following a "recent moderation in credit" and a "decrease in the level of risk in the financial system".

The change effectively allows banks to use as much 50% of the reserves it holds against deposits on new loans or the acquisition of loan portfolios, potentially translating into 30 billion reais ($13.4 billion) in additional credit creation.

A change in the risk weights on payroll and auto loans is estimated to release another 15 billion reais ($6.7 billion). The CBB has also expanded the number of banks that the new rules apply to from 58 to 134.

However Neil Shearing, chief emerging markets economist at Capital Economics in London, said the move "misdiagnoses Brazil's problems" and "risks reflating a credit bubble that looks like it's been deflating slowly".

"Credit hasn't been too scarce, if anything, it's been the exact opposite – there's been too much credit pumped into the economy," Shearing said. "There's not much positive to be gleaned from this move".

He argued, moreover, that it raises questions about the independence of the central bank, adding the move "seems to be aimed squarely at getting the economy going ahead of elections".

If so, that is likely to raise eyebrows in light of the CBB's tough stance on inflation over the past year.

This is a "less overt" way of easing liquidity, Shearing said, but its impact is likely to be similar, meaning it flies in the face of the bank's previous efforts to curb inflation expectations. "It sends confusing signals to the market," he argued.