The Easy Credit That Fueled Brazil's Boom Now Imperils It

By PAULO PRADA

RIO DE JANEIRO—Brazilian policy-makers have fueled their country's economic boom through a state-owned bank that keeps business flush with credit.

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.Now the engine that has helped the nation become a global player in beef, oil and mining is colliding with another policy imperative: battling inflation.

The Brazilian National Development Bank, in its latest spur to the economy, last week announced it would lend $1.6 billion at below-market interest rates to help a large company to build a pulp and paper mill.

Two days later, Brazil's central bank raised its benchmark rate—for the fourth time this year—to the highest of any major world economy, 12.25%.

The opposing moves point up the central, and increasingly controversial, role of Brazil's highly active state development bank, the financier of a vast array of projects, from dams to ports to corporate takeovers.

Though the success of Latin America's largest economy is well known, less recognized is how much it owes to massive government lending. For a sense of the scale: The development bank's loans last year, just within Brazil, totaled triple the amount the World Bank lent to more than 100 countries.

The problem, to critics, is that by stoking demand in an already fast-growing economy, this level of lending fans inflation and leaves the central bank no choice but to set high interest rates that burden other borrowers and hurt exports by driving up Brazil's currency. The real is up nearly 40% against the dollar in two years.

."The government is trying to heat and cool the economy at the same time," said Marcos Mendes, an economist who advises Brazil's Senate. "Monetary officials have few options but to remain strict when the government keeps pouring money into vehicles like the BNDES," as the development bank is called.

The debate over the development bank's approach is growing sharper as Brazil starts to see some less-favorable economic numbers. Forecasters have cut estimates of 2011 growth to a range of 3.5% to 4%, about half last year's. The pace was 4.2% in the first quarter.

And while unemployment is a modest 6.4% and declining, inflation has picked up sharply, to an estimated 6.5%, more than a point higher than last year. Speculators have piled into the housing market, driving double-digit price gains in some cities and stirring talk of a potential bubble.

Food staples such as beans and rice have nearly doubled in price in three years. "Things were getting better for a while because there's definitely more work to go around," said Rosângela Oliveira, a 47-year-old former São Paulo factory worker now on disability. "But," she added, "things are so expensive now the gains are disappearing."

The president of the development bank, Luciano Coutinho, defends its extensive provision of credit, saying the bank is merely filling a vacuum left by the private sector.

Because of Brazil's history of economic volatility, he said, Brazilian commercial banks historically have been unwilling to bet on the future by providing long-term credit. "Either the BNDES provides this financing or there won't be financing at all," Mr. Coutinho said.

In any case, to the government, the rationale for state lending is more than just economic stimulus. For the Workers' Party governments that have led Brazil for over eight years, the lending is also a means to broader goals, such as projecting Brazil's growing economic might abroad. The bank seeks to build up large Brazilian corporations that can wield global clout.

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.The idea, inspired in part by a study Mr. Coutinho co-wrote years ago, is that Brazil needs marquee multinational companies to compete against the developed world and emerging giants like China.

"Brazil still has relatively few companies of global magnitude when you compare it to other big developing economies," Mr. Coutinho said in an interview. Mostly, he said, it has a collection of formiguinhas, or "little ants."

To remedy that, the bank finances large mergers and acquisitions, helping Brazilian companies that have proved their mettle to snap up competitors.

From 2007 through 2009, the state bank provided more than $2.8 billion in credit to a former family-owned slaughterhouse, JBS SA, to help it acquire control of other food companies. Among them were two in the U.S., meat-packer Swift & Co. and chicken producer Pilgrim's Pride Corp.

JBS, which has diversified beyond food, is the recipient of the latest big loan the bank announced, $1.6 billion to finance a pulp and paper plant.

With moves such as this, the bank is "the one body in Brazil where you most clearly see the government's ideology," said one of its former chiefs, Luiz Carlos Mendonça de Barros. Recalling how a past military regime used the bank to push industrialization, he added: "Then as now, the object was to mold the shape of Brazilian capitalism."

The development bank's leaders say it is wrong-headed to blame their lending for Brazil's increasing inflation and interest rates.

On the contrary, they argue, inflation shows the need for their lending. Rising consumer prices, the bank's leaders say, just prove that the country needs more investment—to make sure the future supply of goods and services can meet future demand.

"The way to sustain growth is to expand your supply ahead of demand," said the bank's planning director, João Carlos Ferraz. "That makes us the most strategic, long-term partner of the central bank, in that we avoid inflationary bottlenecks."

The bank provides the financial muscle behind countless infrastructure and other projects across Brazil. Its initials emblazon job sites from Amazon highways to downtown Rio. The bank has lent more than $3.5 billion to companies controlled by Brazil's richest person, billionaire Eike Batista, for projects including two ports.

"There's not a corner of the economy where it isn't involved," says João Roberto Lopes Pinto, a Rio-based political scientist who helped persuade the bank to publish more data about its loans, which are so extensive that even other parts of the government sometimes complain they don't fully comprehend them.

The bank proved its worth after the financial crisis dried up credit globally in 2008. The bank opened the spigots. The result for Brazil was a 2009 that was merely flat—followed by a smart comeback in 2010, thanks partly to the country's role as a commodity supplier to China.

Brazilians pay a payroll tax to help finance the bank. To supplement this funding and the bank's revenue from its loan portfolio, the government injected $116 billion from the treasury into the bank's coffers over the past two years.

The treasury also pays the difference between the rates at which the bank lends—as low as 6%—and rates of up to 14% at which the treasury raises money for the bank on world bond markets. Filling this gap costs the government around $13 billion a year, by one estimate.

The bank traces its history back to 1952, when it was formed to support large projects needed to lift Brazil into the developed world. It financed highways and dams, and helped bring the country a Volkswagen auto plant. Military rulers who held power from 1964 to 1985 used the bank to industrialize the country further.

A centrist civilian government in the 1990s altered the bank's role, using it to oversee privatization of state monopolies such as the mining company now called Vale SA.

But starting in 2002, the left-leaning da Silva government, for which the notion of selling off public assets was heresy, shifted the bank's role yet again, using it to reassert the state's interest in Brazil's banner companies.

When a group of Vale employees sold their shares in 2003, the bank exercised a right to buy them instead of letting private investors do so. More recently, the bank backed the ouster of a longtime Vale chief executive who had resisted a government push for the ore producer to diversify beyond mining to create more jobs.

In return for its loans, the bank often gains an equity stake and board seats, further increasing the government influence at major Brazilian businesses. Mr. Coutinho, the bank's president since 2007, sits on the boards of Vale and Petróleo Brasileiro SA, whose headquarters are across a footbridge from the black office tower in Rio where he works. At JBS, the bank holds securities that will soon give it 31% ownership of the company.

Some critics say that as a development bank, the institution ought to be doing less for mammoth companies and more to nurture smaller ones and nascent economic sectors, to diversify Brazil's commodity-heavy economy. Just a quarter of the bank's loans last year went to firms with sales under $40 million. Mr. Coutinho said that the bank reserves its lowest-rate loans for businesses in "innovative" sectors, but that these aren't as plentiful as he would like.

Others wonder about the value of funding of corporate takeovers abroad.

"How does Brazil benefit when JBS buys an American company that sells American food to American consumers? It doesn't even boost our exports," said Mansueto Almeida, an economist at a government research institute.

The main thing that concerns some economists in Brazil is that following the economy's recovery from the financial crisis, the bank continues to supply credit at a rate far above pre-financial-crisis levels. The bank made $96.3 billion in loans last year, its most ever.

"It's one thing to have an emergency plan for a time of a global crisis, but another for that to become your standing policy," said Gustavo Loyola, a former president of Brazil's central bank.

The government has pared back its funding of the bank to $30 billion this year, although that figure, too, remains well up from before the crisis. Mr. Coutinho has laid out plans to slowly reduce the bank's role in the economy, by decreasing the percent it will finance of big new projects.

Realistically, this role can recede only so much, given major infrastructure projects on the agenda in Brazil. The country is preparing to play host to the 2014 soccer World Cup and the 2016 Summer Olympics. Stadiums and other facilities will have to be built. The government also wants to modernize energy, road and rail networks.

One project is a planned high-speed rail link between São Paulo and Rio. For that alone, the development bank is expected to lend $13 billion.

Write to Paulo Prada at paulo.prada@wsj.com