Interest rates have risen since the Government published its new revenue and expenditure estimates for this year.
The market is now projecting interest rates above 12% for the next ten years, leading to a real interest rate of at least 8% per year. No country in the world can afford to pay such a high rate for such a long period. Inflation would return.
The opening of interest rates occurred even after the Finance and Planning secretaries’ interview to explain the September bimonthly report, released on Friday.
The market is reacting very clearly to uncertainty regarding fiscal rules.
“The mistrust in the fiscal framework is increasing, regardless of meeting the primary target and framework this year,” BTG’s chief economist, Mansueto Almeida, told the Brazil Journal.
According to Mansueto, the government seems not to realize the seriousness of the situation. The Treasury thought the market would react positively to the revenue and expenditure report, which did not happen.
“The market reacted quite negatively, especially to the fact that the government increased the primary deficit projection and disbursed R$1.7 billion.”
Although the release of this amount is small in relation to an expenditure (without interest) projected for this year of R$2.24 trillion, the signal alarmed analysts due to the risk of lower-than-expected revenues in the last quarter of the year.
The reality is that the market now gives greater weight to the structural issue of public accounts. The question is how the Government will meet the 2.5% limit for the growth of primary expenditure in the next two years while having a growth rate for mandatory spending well above that, which means cutting public investment in 2026, the year of the next presidential election.
Mansueto spoke with the Brazil Journal about the investor sentiment and what Brasília can do to reverse it.
What will the Government do? Will it change the growth rate of mandatory spending or try some fiscal trick like the bill sent to Congress less than a month ago, which created the off-budget gas aid?
The government should make changes that signal lower growth in mandatory expenses in the coming years. Ideally, discussions on these changes should start late this year to approve them in the first half of 2025, before submitting the 2026 budget to Congress in August next year, already with the new rules.
Without signaling these changes, analysts will always question whether the Government will adhere to fiscal rules until the end of 2026, and many will anticipate attempts to change the rules in the second half of 2025 or in 2026.
This Tuesday (yesterday) the market improved. What happened?
This market improvement was due to the stimulus package in China, which could positively impact commodity prices. More expansion in China energizes bets on emerging countries, especially commodity exporters.
But asset prices in Brazil are still very bad this year given the uncertainty of meeting fiscal rules and an excessive dependence on uncertain and hard-to-predict revenues to deliver primary surpluses in the coming years.
Let’s remember that the Real is competing with the Argentine peso, Mexican peso, and Turkish lira to see which is the worst currency of the year. Brazil has never had such solid external accounts – so what explains the sharp depreciation of the Real and the increase in the yield curve? The perception of higher fiscal risk, that is, that total public expenditure growth will be much higher than 2.5% per year, and inflation will be higher than currently projected in the Central Bank’s Focus survey.
Is the new fiscal framework and primary targets no longer sufficient to instill confidence in investors about the balance of public accounts?
Primary targets have been reduced, and the “zero” primary target for this and next year actually means a primary deficit of R$68 billion this year and at least R$40 billion next year, when considering expenses that impact debt growth but are not included in the official primary target.
Even the small surplus the Government set for its last year – a 0.25% of GDP primary surplus – could actually be a “zero” primary deficit.
The issue is that successive primary deficits and high interest rates mean one thing: faster growth of public debt and greater fiscal risk. And the country won’t move forward.
But in the Government’s projections, the primary surplus grows to reach 1% of GDP in 2028 and continues to increase until stabilizing the debt. Why doesn’t the market believe in these projections?
Because the Government itself showed us in the first semester that both the linkage of health and education spending to revenue growth and the current pace of growth in Social Security and some social programs’ expenses are not compatible with the 2.5% ceiling for primary expenditure growth, as non-mandatory spending would have to be reduced to “zero” early in the next presidential term to ensure total expenses do not breach the ceiling.
Let me be clearer: for the fiscal framework to work, adjustments are needed to be able to observe the 2.5% growth limit of non-interest government expenses without having to completely eliminate public investment.
The only way to salvage the PAC resources is if the government can reduce the growth rate of mandatory expenses.
What if the Government changed the real growth limit of expenses from 2.5% to 3.5%? How would the market react? Would it be a solution, or would we create a new problem?
It would be a real disaster, and we would face such acute risk that could lead us to a scenario of rising inflation further away from the target.
Let me try to explain our fiscal problem more clearly. In the second Lula government – from 2007 to 2010 – with the commodity boom and China growing at 10% per year, the federal government’s record revenue was 19% of GDP for expenses (excluding interest) that were 17% of GDP. There was a surplus of 2% of GDP, over R$200 billion in today’s values, to pay interest and reduce debt. Today, there is nothing left!
Even if the government returns to a net revenue of 19% of GDP in the coming years, the planned expenses for the next two years are slightly above that figure, resulting in a primary deficit.
Our dilemma today is that even the record revenue levels we had when the economy was growing at 4% per year and commodities were booming would not be sufficient today to cover expenses.
How can anyone think of relaxing expense growth even further in this scenario?
Brazil needs to reevaluate mandatory expenses and budget allocations, or we will not resolve this impasse. There is no magic. The remedy may be unpopular in the short term, but it generates political dividends in the medium term, with low inflation, low-interest rates, and more growth.
The Government’s goal is to regain the investment grade, and two credit rating agencies upgraded Brazil’s rating last year. Can we expect to regain the investment grade in the coming years?
We will only regain the investment grade when we can answer the following question: when does Brazil’s public debt (% of GDP) start a clear downward trend? In which year?
Today, no one can answer that question because to achieve a gradual decline in government spending over the years and return to positive primary results that put the debt on a downward trajectory, we must first control the growth of mandatory expenses and make the fiscal framework consistent.
Given the importance of controlling the growth of mandatory expenses, what should the Government and Congress do? Which social programs could be reformed?
Today, Brazil has the lowest unemployment rate in ten years, with real wage growth for workers. An unemployment rate of 6.8% is close to full employment.
So I ask: why is spending on unemployment benefits increasing in such a positive labor market scenario? In such a favorable labor market situation, wouldn’t it be easier to control the growth of some social programs?
Does the floor of some social programs have to be the same as the pension floor, which is one minimum wage?
One thing the Government should also avoid is creating new mandatory expenses or changes that lead to a sharp drop in revenue. One of the topics that most concern the market is the possibility of raising the income tax exemption threshold to R$5,000, as such a large increase in the exemption threshold would have a very high and difficult-to-offset cost.
For those closely monitoring the fiscal situation and considering the country’s context, it is clear what needs to be done. It is now up to the Executive and Congress to find the political will to act – even to prevent further deterioration of this scenario.
And if they don’t act?
(silence)
Source
Arwen Volkov, A graduate of the University of St. Gallen in Switzerland with a degree in International Finance, Arwen specializes in sustainable finance and green investments. She began her career at an investment bank in London, where she developed financing models for environmentally friendly projects. Known for her analytical and strategic thinking skills, Arwen is a sought-after financial consultant. In her spare time, she mentors fintech startups, contributing to their growth strategies. She is also a nature enthusiast and an amateur photographer.
