Activity slowdown and default challenge BC’s conviction on interest rates – 02/25/2023 – Market

The risks to economic activity, the increase in defaults and the signs of greater financial difficulties faced by companies should challenge the Central Bank’s conviction about maintaining the current interest rate level.

For a group of economists, the latest evidence justifies a reassessment of the scenario by the Central Bank, in order to anticipate the interest rate cut with the aim of stabilizing activity, even with inflation still far from the target.

For others, however, the fiscal risk —translated into the expansion of expenses and the absence of concrete guidelines on the new spending framework— and the resilient inflation still speak louder and inspire caution, justifying the maintenance of monetary policy by the BC.

Until recently, interest rates were the target of criticism from President Luiz Inácio Lula da Silva (PT), who even publicly defended an increase in the inflation target to pave the way for easing the monetary tightening —the Selic is currently in 13.75% per year—and economic growth.

In recent days, the Ministry of Finance has issued more scathing warnings about the possibility of a credit crisis in the country.

The executive secretary of the Ministry of Finance, Gabriel Galípolo, said in an interview with the newspaper O Estado de S. Paulo that the government and the economic team are focused on avoiding a credit crisis and may resort to “compensatory policies”, without detailing which.

The BC itself has made considerations about the slowdown in credit concessions and economic activity and about the rise in defaults in the minutes of Copom (Monetary Policy Committee) meetings since October last year.

Recently, the theme also came up in conversations between members of the institution and members of the financial market.

The Comef (Financial Stability Committee), a BC body focused on preventing systemic risks, also mentioned in a November report the existence of “uncertainties to be monitored”.

“Family debt and income commitments have increased. […]. In the case of legal entities, there is an increase in problematic assets in smaller companies. Thus, a substantial frustration in the performance of economic activity may result in an increase in credit risk”, says the document.

The issue posed by economists is that, regardless of any change in the inflation target, the monetary authority may be led to cut interest rates in a scenario where the worsening economy makes the “cost of disinflation” too high.

Those who agree with this assessment list some factors, such as the rise in defaults by individuals and companies, the slowdown in GDP (Gross Domestic Product) and the financial difficulties of companies, some of which resorted to judicial protection to be able to negotiate debts.

According to BC data, the default of individuals in operations with free resources rose from 4.4% at the end of 2021 to 5.9% in December 2022. In the case of legal entities, the indicator went from 1.5% to 2.1% in the same period.

The Americanas case, in which the discovery of an accounting fraud uncovered a much larger amount of debts than previously known, also contributes by increasing banks’ aversion to granting credit.

“The way he [Lula] broached the subject [dos juros] it’s bad, but on merit maybe he’s not so wrong. It is something new, something that we are starting to see and are concerned about”, says economist Manoel Pires, from Ibre/FGV (Brazilian Institute of Economics of the Getulio Vargas Foundation).

Pires recalls that, during the pandemic, the government itself had to encourage companies to take credit so that they could have enough cash to honor commitments. Part of these loans was borrowed at 2% Selic —11.75 points below the current level.

The considerable increase in cost had already led the previous government to extend the payment deadline for lines such as Pronampe, aimed at micro and small companies. Still, many are out of breath to pay the financial cost of these debts.

“At the beginning of the year, a little warning signal began to light up that maybe we have interest rates a little too high and that, eventually, this idea of ​​making a soft landing, deflating the economy by slowing down to a GDP of 0.5% at 1%, perhaps it is not so certain. It may be that it begins to enter a situation of more significant retraction of activity”, says Pires.

The Ibre/FGV projects a rise of 0.2% in GDP this year, but this takes into account the positive performance of agriculture and livestock. Without that boost, there would already be a recession.

“If this is true, it makes sense to discuss with the Central Bank some reassessment of the disinflation process in order to be able to reduce interest rates a little”, says the economist.

In an interview with the CDPP (Public Policy Debate Center) blog at the end of January, economist Persio Arida, former BC president, also said he believed in a movement to cut interest rates.

“Different from other analysts, I think that the next move by the Central Bank should be towards starting a cycle of low interest rates. And for several reasons: economic activity is weakening, we have a latent credit crisis and the real has been valuing,” he said.

To the Brazil Journal, he later clarified that he had no opinion on the most propitious moment to reduce the Selic, but reinforced the central idea of ​​the argument. “The signs of economic slowdown seem very clear to me, and it is up to the Central Bank to stabilize the economy,” he said. wanted by SheetPersio declined to comment further.

In a report released this week, LCA Consultores says that “avoiding the risk of a credit crisis erupting requires careful action by the economic authorities and the largest credit providers”. The institution does not rule out the possibility that the BC will need to resort to emergency measures to increase liquidity and irrigate the markets, in order to avoid contagion of the crisis to the financial system.

“An acute contraction of credit, moreover, could lead the Central Bank to anticipate a cycle of reduction of the basic Selic rate”, says the document. The LCA considers, however, that the timing of the interest rate cut, currently scheduled for the end of 2023, will also depend on the prospects for the public accounts and the possible revision of inflation targets.

Economist Carlos Kawall, founding partner of Oriz Partners and former secretary of the National Treasury, has a divergent view. He sees no room for a reduction in the Selic rate before 2024 given the fiscal expansion policy adopted by the Lula government in the midst of an inflationary scenario that is still resistant.

“The problem we have is a maladjustment of the macroeconomic policy. The lack of definition with the fiscal rule is also part of this context. The government is not even convinced about re-taxing fuel”, he says.

In his view, the Americanas case and the warning about the credit crisis in the country fit into a microeconomic scenario, in which the effects are concentrated in one segment. Therefore, they should be treated based on measures aimed at the capital of financial institutions, such as emergency lines of financing.

“It is not possible today to look at episodes of credit and say that the therapy for this is the reduction of interest rates”, says Kawall. “The solution to this problem is not to mess up monetary policy as a whole, because that will negatively affect the economy as a whole.”