Good news in the economy and a stumbling block – 06/29/2023 – André Roncaglia

The end of the first half of 2023 brings a crop of good news for the Lula government. Record trade balances and foreign capital inflows into the country have kept the exchange rate below R$4.8/US$. This not only reduces inflation, but also raises, in the short term, the purchasing power of wages, strengthening consumption.

The growing projections for GDP growth in 2023 (2.2%) are based on the government spending package and, with a more effective performance by the BNDES, investment in physical and social infrastructure tends to increase employment and income, in line with the decarbonization of the economy.

Finep plans to release R$ 40 billion (in four years) for investments in innovation, with lasting effects on the economy. The Minha Casa, Minha Vida program will stimulate civil construction, and the Desenrola program will alleviate the family debt of a third of the population, while the family budget expands with the boosted Bolsa Família and the real readjustment of the minimum wage.

On the aggregate supply side, the Ibre-FGV report showed that labor productivity grew —for the first time in years— in the first quarter of 2023. Along the same lines, the approval of the reform of taxes on consumption will raise the productivity of the economy and business confidence.

Even with unemployment stable at 8.5% in May, official inflation (IPCA) fell to 3.9% in 12 months, with possible deflation in June. The combined effect of exchange rate appreciation and the decline in international commodity prices has caused deflation in producer prices. As a result, the IGP-M accumulates a drop of 6.86%, and the IGP-DI, of 5.49%, in 12 months. This year’s record harvest tends to bring down even more the Broad Producer Price Index (IPA-DI), which fell 3.37% in May and has accumulated a drop of 8.89% in 12 months; the Safra Plan launched this week stimulates the production of food for the domestic market, reinforcing the downward pressure on prices.

The combination of this good news made interest rates on public debt contracts maturing in 2031 fall below 11% per annum. The data make clear the room for monetary easing, with market economists already making mea-culpa for forecasting errors (self-criticism is demanding too much).

It is, therefore, unusual for the Central Bank to stick, by will, to the inflation expectations collected by the Focus bulletin. Even with the clear predominance of cost channels (international prices and exchange rate) in the behavior of the Brazilian inflation rate, the Central Bank imposes the narrative of the expectations channel as a true balance.

BC’s rhetoric is reminiscent of Calvinball, from the famous Calvin cartoon: a game where you can change the rules to always win. After changing several times the reason for keeping the Selic in the stratosphere, the Copom now uses the June meeting of the CMN, in which the raising of the inflation target for the period 2024-2026 was discussed.

As soon as this possibility was suggested, the market raised the effective inflation target for 2024 to 4%. for 2024, 4%, and for 2025, 3%. This informal agreement between BC and the market therefore refutes any mechanical relationship between raising the official target and the weakening of expectations.

The Copom disguises itself as a mere spectator of a rigged game that only it can win. Keeping the official target at 3% was the condition imposed to cut the Selic in August, closing 2023 close to 11%. This is the political (and institutional) price that the BC charges to return oxygen to the economy.

To paraphrase Drummond, in the middle of the road to economic recovery there is a stumbling block: the Copom under Campos Neto.

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