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Gustavo Henrique de Barroso Franco (born April 10, 1956, in Rio de Janeiro) is a Brazilian economist. A former Governor of the Brazilian Central Bank, he is best known for being one of the "fathers" of the Real Plan, the 1994 monetary reform that ended hyperinflation in Brazil. He teaches economics at the Catholic University in Rio de Janeiro since 1986. He is also a businessman, consultant and has served on many boards. He founded Rio Bravo Investimentos where he works as Senior Advisor. He has written several books, academic papers and contributes regularly to newspapers and magazines.
Gustavo Franco attended Colégio São Vicente de Paulo in Rio de Janeiro and Colégio Notre Dame de Sion in 1960/1974. He obtained a bachelor's (1975–1979) and master's (1983) degree in economics at the Pontifícia Universidade Católica do Rio de Janeiro (PUC-Rio), where he developed interests in economic history and macroeconomics. At PUC-Rio he had his first job as teaching assistant working with Edmar Bacha, then preparing a macroeconomic textbook, self-defined as of a neo-structuralist approach, and later to become very popular in Brazil, with several editionsEdmar Lisboa Bacha Introdução à macroeconomia: uma perspectiva brasileira. Rio de Janeiro, Editora Campus, 1982,
Winston Fritsch was his advisor in his M. A. thesis on the topic of financial euphoria and crash in the early years of the Brazilian Republic (1889-1890) and the attempts at monetary reform in connection either adhering to the gold standard or, alternatively to experience with fiat currency models, as proposed by Ruy Barbosa. His M. A. thesis was approved cum landae in 1982 and in 1983 won the prestigious " Prêmio BNDES de Economia" for the M. A. thesis in Brazil. This work was published as a book titled Monetary reform and instability during the republican transition ("Reforma monetária e instabilidade durante a transição republicana"") and became a reference to the period it covers.
In sequence, Franco was accepted in Ph.D programs in the universities of Chicago, Yale University and Harvard, for which he headed. There he chose as fields of specialization, international economics under Jeffrey Sachs and economic history under Barry Eichengreen. He had brief fellowships at the CFIA (Center for International Affairs), CES (Centre for European Studies) and National Bureau of Economic Research (NBER).
Sachs and Eichengreen were his supervisors, and along with MIT professor Lance Taylor, formed his thesis committee. Franco earned his Ph.D Degree at Harvard in 1986, with a dissertation titled Aspects of the Economics of Hyperinflations: Theoretical Issues and Historical Studies of Four European Hyperinflations of the 1920s.A revised version of the dissertation is available at http://gustavofranco.com.br/temas/9. His original thesis had four theoretical chapters on topics as the adoption of indexation in contracts, inflation (stabilization) as public good problem, plagued by free rider issues, the inflation tax as motivation to the process and the dynamics of dollarization, distributive tensions and external balance. The applied chapters were case studies for Germany, Austria, Hungary, and Poland, also including some common themes like the relation between external imbalances, dollarization and fiscal reforms in the context of specific stabilization experiences.
This work was nominated to the David Wells Prize in Harvard and was awarded a national prize ("Prêmio Haralambos Simionides") in 1987, for the best Ph.D. thesis or book in economics, given by the National Association of Graduate Studies in Economics (ANPEC, Associação Nacional de Centros de Pós Graduação em Economia).
He had an intense academic activity during these years; his research interests had three key themes: (i) on high inflation and on the basis of topics and issues raised in his doctoral dissertation; (ii) on Brazil's economic history, mostly in connection with macroeconomic and monetary issues; and (iii) on trade policies, multinational enterprises and economic development, in collaboration with Winston Fritsch.
"Fiscal Reforms and Stabilization: four hyperinflation cases examined" was published in The Economic Journal (vol. 100, no. 399, March 1990) disputed Thomas Sargent's popular explanation to the sudden end of hyperinflation as result of a wide-ranging fiscal "regime change". The role of dollarization and of currency reforms were wrongly downplayed by Sargent, as argued by Franco.
"The Rentenmark Miracle" published by Rivista di Storia Economica (Second Series, Volume 4, 1987), then republished in Barry Eichengreen (ed.) Monetary Regime Transformations London, Edward Elgar Publishing Ltd, 1991, was an account of the unique experience in Germany of Notgeld - that is, emergency monies of private issuance and with "stable value" as they had indexation clauses -, and the way this led to the rentenmark experience. As argued by Franco the rentenmark was a crucial step in the German stabilization, and not a "cosmetic measure", as put by Thomas Sargent.Thomas J. Sargent "The Ends of Four Big Inflations”, in Robert E. Hall (org.), Inflation: Causes and Effects. Chicago, The University of Chicago Press. In fact, the rentenmark model was very relevant for the design of the Brazilian 1994 monetary reform, known as "Plano Real", in which a similar quasi-currency, under the name o URV (acronym for Unidade Real de Valor) played a vital role for the ending of Brazilian hyperinflation.A summary of the Brazilian high inflation experience written by Franco can be found in "The political economy of the Brazilian hyperinflation" in Maria D'Alva G. Kinzo (org.) Brazil: challenges for the 1990s. London, Institute of Latin American Studies & British Academic Press,1993.
Much later, in 1995, Thomas Sargent wrote an article on the Brazilian URV, evoking the German experience with the rentenmark and arguing, as per the mathematician David Hilbert, that one could not solve the hyperinflation problem by "changing the name of the independent variable".Thomas J. Sargent, "Reasonable doubt about the Real Plan" reproduced in Rational expectations and inflation, Third Edition, Princeton, Princeton University Press, p. 241, . The URV, argued Sargent, would have been "a sideshow that hasn't touched the fundamental causes of inflation", Ibidem, p. 242. and again Franco took issue with that, writing in 2017, but this time on the back of the successful adoption of the URV mechanism. According to Franco: "Understandably", Brazilians "did not take these observations seriously" as "the country was enchanted by the URV mechanism in view of practical problems it solved elegantly, efficiently and voluntarily, so that they received with blunt indifference a thesis from an outside observer claiming that the mechanism had no utility".Gustavo H. B. Franco. A moeda e a lei: uma história monetária brasileira, 1933-2013. Rio de Janeiro, Zahar, 2017, , p. 648.
In sequence, Franco and Fritsch worked in two projects directed by Gerry Helleiner for WIDER (World Institute for Development Economics Research) of the United Nations University during 1990 and 1991. The first was on the influence of trade orientation on development models and was published as "Foreign Direct investment and patterns of trade and industrialization in developing countries: notes with reference to the Brazilian experience" in G. K. Helleiner (org.) Trade Policy, Industrialization and Development: a reconsideration. (Oxford, Clarendon Press for UNU-Wider, 1992 ). The second, on the same issues but focused on trade and industrial policies was published as "Import repression, productivity slowdown, and manufactured export dynamism: Brazil,1975-1990" in Gerry Helleiner (org.) Trade policy and industrialization in turbulent times (London: Routledge for UNU-Wider, 1993, ).
Franco and Fritsch also worked in projects for UNCTADTrade policy issues in Brazil in the 1990s. Report prepared for UNCTAD. Departamento de Economia PUC-RJ Texto para Discussão nº 268, October 1991. and ECLA,"The Political Economy of Trade and Industrial Policy Reform in the 1990s", ECLAC (CEPAL) Serie Reformas de Política Pública 6, Santiago, 1993. and published in the academic circuit on these same issues."Política Industrial, Competitividade e Industrialização: aspectos da experiência brasileira recente in Planejamento e Políticas Públicas 3, 1990; "Inversión extranjera directa y pautas de la industrialización y el comercio exterior en los países en desarollo; Notas con referencia a la experiencia brasileña" Desarollo Económico 130, enero-marzo 1991 e "Política Comercial no Brasil: passado e presente Pensamiento Iberoamericano 2, 1992. Franco would return to these themes only after 1995 when, as deputy governor of the Central Bank responsible for international affairs organized a Census on foreign direct investment into Brazil that has been conducted and published each five years since 1995.
In parallel, Franco had executive responsibilities in International Affairs at the Central Bank related to operational aspects of external debt restructuring under the Brady Plan, then at decisive moments, the administrative structures in charge of exchange controls, bound to be transformed by an ambitious deregulation process, the FOREX trading desk and international reserves management.
However, IMF representatives did not feel comfortable with the drafts of the Real Plan shown during the negotiations of the stand-by agreement and refused to go on with the loan, forcing the Brazilian authorities to develop some alternative strategy to acquire the US Treasury bonds in the secondary market using Brazil's international reserves. The deal was described in detail in Guilherme Fiuza's book in the chapter titled Sorry, Mr. Fagenbaum.
Right next to completing Brazil's Brady Bonds
The architecture of liberalization was based on the creation of new and segregated market for US Dollars in which rates were determined by supply and demand in parallel to the official market and to compete upfront with the “black market”. Initially fed only by Dollars sold by tourists, the scope of transactions was gradually extended, while, liberalization in the official market, along with a better balance of payments stance, resulted in gradually eliminating the spread between official and free markets.
From 1988 to 2006, when all legal markets were unified, deregulation consisted in expanding the nature of transactions that could take place in the free market, including gold related arbitrages, and remittances from non-resident local currency accounts,Known as “CC5 accounts”, after Carta Circular n.5 of 1969, the regulatory reference of such accounts. though always preserving full identification of players.
After 1995, under Franco's direction, the Central Bank introduced several new rules for leads and lags in foreign trade, portfolio investment and turned “registry” of foreign capital inflows into a statistical event, and no longer dependent on authorization. Interestingly, however, one key innovation introduced along with liberalization of outflows was the selective restriction applied on certain types of inflows, mostly of a short-term nature. Capital surges had been producing restrictive measures in many countries, most visibly (for Brazilians) Chile, where restrictions took the form of a “quarantine”, or a minimum stay for foreign capital. In Brazil, instead, restrictions were implemented mostly as a tax of foreign exchange inflows, and without any “quarantine”. The formula was used many times over in later moments of foreign exchange abundance in order to reduce appreciation and/or extend maturities of foreign liabilities.For a review and discussion see “Capital inflows into , 1992-98: the nature and effects of controls and restrictions” in Sebastian Edwards & Marcio Garcia (orgs.) Financial markets volatility and performance in emerging markets, Chicago, The University of Chicago Press & NBER.
The URV existed as legal tender, though only as unit of account, during four months: its initial quote with respect to cruzeiro real was CR$647,50, more or less equivalent to one Dollar, as it was its final quote as CR$2.750,00, on July 1, 1994, when the cruzeiro real was demonetized and the URV was turned into the national currency and renamed as real. In consequence of this unusual parity it was not possible to stamp old cruzeiros reais notes, so that one entirely new family of notes was issued at once, a remarkably difficult logistics effort
At the day of the first issues of the new currency, in an unprecedented move, the Central Bank abstained from intervening in the foreign exchange market and let the new currency float. In consequence, the exchange rate between the URV (now the real) and the Dollar, fell below R$1,00 (i. e. it appreciated) with a great positive impact on expectations and marking the successful conclusion of the stabilization process first phase.
The combination of tight monetary policy with floating exchange rates, later under a "target zone regime", or "exchange rate bands", resulted immensely successful to eliminate hyperinflation, but remained one of the more controversial aspects of the Brazilian stabilization experience, and one generally addressed to Franco.See Gustavo H. B. Franco. “The Real Plan and the Exchange Rate” Essays in International Finance n. 217, April 2000. International Finance Section, Department of Economics, .
The results of the Real Plan on inflation, as measured by national cost of living index, IPCA - published by the National Statistics Bureau - IBGE, were as follows:inflation was running at 43,1% monthly (on average for he first semester of 1994), or 7.260% annually, up to July 1994, the first month of existence of the new currency. In July alone prices rose 6,8%, but the accumulated inflation for the next twelve months was only 33,0%. From this level onward, inflation goes on declining slowly: measured by IPCA, inflation fell below 20%, on a 12 months accumulated basis, only in April 1996, 22nd month after the introduction of the new currency; below 10% only in December, 30th month of the real. Within the calendar year of 1997, the rate of inflation was 5,2%, and in 1998 inflation was finally reduced to 1,6%, the lowest rate on record since the creation of the Brazilian Central Bank in 1964.
The first was related to the institutional organization of the monetary system. the National Monetary Council was recaptured and reduced to three members (ministers of Finance and Planning and the Governor of the Central Bank), recomposing the commitment of top level decision making to price stability. Sometime later a Monetary Policy Committee (known as COPOM - acronym of Comitê de Política Monetária) was created securing Central Bank's independence in fixing the interest rate.
Next, federal banks, and especially Banco do Brasil, had to recognize previous losses, be recapitalized, abide by "Basle Rules" and cease to have unrestricted accommodation at the Central Bank. Provincial banks entered a severe adjustment program through which several liquidations and privatizations reduced their size to almost negligible. Some private banks in trouble entered a program through which the Central Bank financed liquidations, resolutions and changes in control of banking activities. It was a heavy agenda with the banking system, public and private, to reorder the monetary system and its governance.
There were numerous fiscal adjustment initiatives, starting with several rounds of debt refinancing with adjustment programs with the states during 1993–1998. The Federal Government gave accommodation to states in exchange for orthodox fiscal programs and several limitations as to their fiscal policies. These programs templates provided a framework to a new Public Finances Law, proposed in 1999, creating benchmarks and limitations for indebtedness and wages expenses, later approved under the designation "Fiscal Responsibility Law", held to be a major progress in securing fiscal balance in the public sector in Brazil .
Another important initiative was the 1993 Constitutional Amendment known as Social Emergency Fund ( Fundo Social de Emergência, approved during the constitutional revision in March, 1993) which removed most of earmarking in the budget, and allowing the National Treasury to regain control of budgeted expenses. Even so, primary fiscal results were weak during the first few years after 1994. Due to the advancement of reforms, these weak fiscal numbers did not become an issue until the Asian crisis in 1997 and especially in 1998 with the Russian crisis, when Brazil entered an agreement with the IMF and started a decade long period of primary surpluses at the level of 3% of GDP.
Franco left the Central Bank after the IMF Agreement and after the reelection of Fernando Henrique Cardoso for a second term in 1998. Franco received late in 1998 Euromoney's prize “Central Banker of the year, 1998”.According to Brian Caplen (Euromoney, IMF Meeting Issue, September 1998, pp. 126-127), " Gustavo Franco's bold use of power: Brazil long needed a heavyweight in the central bank chair and now it's got one. Gustavo Franco earned his spurs in last October's Asia meltdown. His policy regime, especially the use of capital controls, is being studied around the world”.
Shortly after, Brazil moved into what was known as the "tripod" policy: floating exchange rates, primary fiscal surplus and inflation targets. Brazil was ready, at this point, to switch from the exchange rate "anchor" into the inflation targets regime. Franco's account of controversies around the use of the exchange rate in the stabilization effort and of the dialogue between short term policies and long term reform goals was laid out in several of his writings, some in English.Most notably Gustavo H. B. Franco. “The Real Plan and the Exchange Rate” Essays in International Finance n. 217, April 2000. International Finance Section, Department of Economics, Princeton.
Rio Bravo was active in private equity first through Rio Bravo Nordeste I FMIEE (focused on SMEs in the Northeast region), later, in 2007, with Rio Bravo Nordeste II, the largest regional private equity fund in the country. In February 2006 Rio Bravo acquired MVP Mercatto Venture Partners Ltda., renamed as Rio Bravo Venture Partners Ltda., a venture capital management company based in Rio de Janeiro. Later, in October 2010, Rio Bravo raised its first private equity fund dedicated to investments in renewable energy.
In 2005 a Rio Bravo started Rio Bravo Project Finance Ltd to advise clients in infrastructure projects and also Rio Bravo Fundamental, a value driven listed equity mutual fund.
In May 2008 Rio Bravo spun off its real estate based securitization business into a new company called RB Capital, with no shareholding from Rio Bravo partners. In 2016 RB Capital had its control bought by Orix from Japan. In August 2016, Rio Bravo's control was acquired by Fosun International, one of the largest private groups in China.
Franco has been a member of several boards. He is now active as board member of Daycoval, Seguradora Pottencial and as Chairman of Instituto Millenium, a Brazilian think tank.
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Forex deregulation and phasing out exchange controls
Exchange controls deregulation was one of the greatest challenges of the International Affairs section of the Brazilian Central Bank, a modernization imperative and an essential condition for the prevalence of supply and demand as determinants of the exchange rate.
Plano Real
The Real Plan had as central element a monetary reform effected through three successive measures: the first and more important introduced on February 28, 1994, Medida Provisória 434, issued February 27, 1994 late turned into Law 8.880, on May 27th 1994. created the URV (Unidade Real de Valor) mechanism, that is, a "money of account" to be freely used in contracts and obligations in order to realign relative prices and coordinate price fixing around the exchange rate. It was also established that at some point in the near future, the URV would become the national legal tender to replace then circulating cruzeiros reais. Just like the German rentenmark, and reflected also previous models of monetary reform conceived by André Lara Rezende and Persio Arida.The model proposed in 1985, and then became known as the "Larida Plan" was never attempted in its original format, as published as "Inertial Inflation and Monetary Reform: Brazil " in John Williamson (org.), Inflation and Indexation: Argentina, Brazil and Israel. Washington, Institute for International Economics, 1985. At this moment, the new national currency, the URV would have its denomination conveniently changed to real. The second, launched at July 1, 1994, Medida Provisória 542, issued June 30, 1994, later approved as Law 9.069 on June 29, 1995. complemented the reform, demonetizing cruzeiros reais and actually issuing the real. Also, this second instrument introduced some very important institutional changes in monetary governance, with a major reform in the National Monetary Council, and monetary policy. The third, closing the cycle of monetary reform, was a detailed statute for indexation practices that was implemented exactly one year after the real was first issued. Medida Provisória 1.053 issued on June 30, 1995, was reennacted many times until final approval as Law 10.192 on February 14, 2001.
Institutional aspects and "fundamentals"
Before the Real Plan, five stabilization attempts failed between 1986 and 1991 all of which involving price freezes, all but one creating a new currency and one, the so-called Collor Plan in 1990, with an asset freeze much like monetary reforms in Europe following World War II.As extensively described in John G. Gurley, “Excess liquidity and European monetary reforms, 1944-1952” American Economic Review XLIII March, 1953. Reproduced in Barry Eichengreen (org.) Monetary Regime Transformations, Cambridge, Elgar Reference Collection, 1992 These failed experiments were called "heterodox shocks" not only because of direct intervention in prices and intrusive currency reforms, but also for their practical disregard of fiscal "fundamentals" and monetary policies. The Real Plan followed a different path opening several reforms agendas attacking fundamental disequilibria at the core of the hyperinflation process.
Rio Bravo Investimentos
After a sabbatical year back at the Catholic University as full-time professor, Franco founded an investment company named Rio Bravo Investimentos, based in São Paulo, to manage mutual funds, structured products, and private equity, in association with Swiss Re. In August 2001 Rio Bravo acquired a broker dealer called Mercurio DTVM and started to manage REITs (Real Estate Investment Trusts) and also with the public distribution of securities. Rio Bravo developed investment banking activities from 2003, when it acquired the local operation of Dresdner Kleinworth Benson, until 2007 when these activities were transferred to Lehman Brothers.
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