There was a time not so long ago, said Arminio Fraga, when Brazil’s economy was the envy of countries around the world. “From 1900 through 1980, Brazil delivered an average of 3.5% growth per year, second only to Japan. For such a long period of time that is extraordinary and, unfortunately, we in Brazil took it for granted.”

Fraga has been president of Brazil’s Central Bank for nearly three years, charged with monitoring the largest economy in Latin America. At the Dec. 1 Latin American Conference, part of the Wharton 2001 Global Business Forum, Fraga explained how Brazilian finances collapsed in the 1980s and early 1990s and how the current turnaround is destined to continue.

“The collapse seemed hard to believe,” he said. “It was as if our model just stopped working. For 12 years, we had zero percent growth. We had uncertainty and volatility. It affected everything, including the self-esteem of our people. It deeply changed the way Brazil looked at itself.”

In hindsight, Fraga noted, it is easy to detect what went wrong. First, a military regime was in power that was openly hostile to democracy just at the time other nations were shedding that attitude. Second, the economy itself was closed and too much was run by the state. Combined with high inflation, that gave economic leaders both inside and outside the government no chance to have discussions on planning.

“There was 20% inflation a month at times. If you delayed something two weeks, it was already costing 10% more,” said Fraga. Since the government controlled more than 50% of the gross domestic product – everything from steel, cement and power generation to chemicals, fertilizer and the railways – there was little flexibility and no real impetus for private investors to get involved.

In addition, he said, there was no focus on education. More than 20% of Brazil’s school-aged children weren’t attending school in 1990. “With 50 million poor people in Brazil, if they couldn’t get an education, they were giving up hope. That is no way to revive an economy.”

It was a vicious cycle that seemed to have no end. Weak fiscal policies caused hyperinflation which made the chance to work on fiscal policies almost impossible. The turning point, he said, came in the mid-1990s when the government felt forced to privatize some industries. “Brazil had tried all sorts of gimmicks, from wage controls to price controls to asset freezes to controlling the exchange rate. All of them were like breaking the thermometer to get rid of the fever. They were extremely short-term solutions.”

But privatization, he said, was a step on the road to a permanent fix. Money started to come in for investment. Hyperinflation eased. Politics returned to civilian control and a new constitution was instituted in 1998. The federal government came up with a real budget for the first time in decades. Social security laws were reformed and new government workers were, for the first time, put on defined contribution plans.

Then it was time to work on the banking system, which, Fraga said, was fairly chaotic even in good years. Each of Brazil’s 27 states had a commercial bank with access to a printing press. “That is no way to run a banking system. No one was concerned with maintaining stability save the Central Bank.” In addition, he said, each state controlled the power distribution company and almost all were under the weight of huge debt.

Then, however, the federal government put the state banks under stricter supervision of the Central Bank and privatized the power companies. “This led to important changes in the way the state and local governments functioned, at least in terms of finances,” said Fraga. “They were more transparent. People could check more easily on their governments. Transparency is necessary to run clean government, which can only help economic planning.”

The one risky action the government took financially, said Fraga, was to let the Brazilian currency float. When other countries were tying their currencies to the dollar, Brazil decided it was right for a large, diversified state to keep its currency somewhat independent. “Fortunately, we were also targeting inflation at the Central Bank, which we feel is a good way to run a bank … If you have targets, people know the goals and hold you to them.” He admitted that the burgeoning world economy helped as well. “But our goal coming out of our bad period was efficiency, stability and soundness. We have been fortunate in maintaining that. We now have a well-capitalized federal banking system.”

What all this has brought, Fraga pointed out, is a return of investment from the private sector both in Brazil and around the world. He said that in the last six years, there has been $150 billion in direct investment coming into Brazil, which is the third highest amount in the world behind only China and the United States.

“So we have better technologies and new management cultures,” he said. The privatization initiatives have expanded, particularly in telecommunications, which Fraga said is vital for such a large country. “I live in Rio and a phone line there cost $5,000 ten years ago. And even then, you weren’t assured of a dial tone. Now a digital phone line is virtually free and everything is working nicely.”

Furthermore, Brazil ran a budget surplus last year and spent far more money than in the past on health-care and education; now, Fraga noted, only 3% of children between the ages of 7 and 14 are not in school.

“I’m not saying there aren’t problems in our country. We have far too many poor people and our growth this year was only two percent,” Fraga said. “But we have recovered from the really bad times. This idea that investing in Brazil was for high yield is for the birds. We want to be investment grade. I’m convinced that if we continue the things we are doing now, we will go up to that investment grade sometime soon.”