Government spending turns on a yellow light in the fight against inflation

A yellow light is on about the continued slowdown in inflation in 2024. The warning comes mainly from government spending, but the effect of the weather on food production and tax increases on fuel should also put pressure on prices.

In the third quarter, public administration expenses grew five times more than economic activity. According to analysts interviewed by People’s Gazette, spending tends to continue growing next year, contributing to maintaining the primary deficit (when there is more spending than revenue, excluding interest expenses) and increasing public debt – which, in October, was at 74.7% of GDP , according to the Central Bank.

The IPCA, an inflation indicator that guides the BC’s goals, ended November at 4.68% in the 12 months. The financial market predicts an index of 3.91% at the end of next year, according to the median expectations in the Focus bulletin published on December 26th.

However, the expansion of government spending threatens this slowdown. The effects on inflation can come in two ways:

• by spending more, the government stimulates demand. With more consumers competing for the same quantity of products, prices increase;
• the increase in deficits and debt increases the distrust of economic agents in relation to the government’s commitment to honoring its commitments. As a result, the real depreciates, making inputs and goods priced in dollars more expensive.

“The situation of public accounts will continue to be the main weak point of the Brazilian economy in 2024”, says Alessandra Ribeiro, partner at Tendências Consultoria.

The CIO of UBS bank, Luciano Telo, remembers that the zero deficit promised for 2024 by the Minister of Finance, Fernando Haddad, seems difficult to achieve. According to the Focus of December 26, the market consensus indicated a deficit corresponding to 0.8% of GDP.

“It’s not a good number. The ideal would be a surplus”, says the bank executive. He points out that the market will look closely at issues relating to the collection and performance of public accounts.

Fiscal problems began to gain strength even before Luiz Inácio Lula da Silva (PT) took office. The Transition PEC, approved at the end of 2022, authorized additional spending of R$168 billion, by the government of Luiz Inácio Lula da Silva (PT). A reinforcement was provided by the new fiscal framework, which removed the spending ceiling and allows public expenses to grow above inflation.

Furthermore, government leaders have been pushing for more spending, with an eye on the 2024 municipal elections and a 20-year power project.

Add to this the concern about tax collection. The Minister of Finance, Fernando Haddad, has been looking for several fronts to increase it. But sectors such as civil construction and industry, which are important sources of public revenue, have been sidelined throughout this year. The still high Selic rate, currently at 11.75% per year, should keep these sectors performing more timidly, at least in the first half of the year.

Crop failures and fuel taxes also put pressure on

Another concern for inflation comes from the climate phenomenon “El Niño”, which results in a stronger warming of the waters of the Central Pacific. It affects field production, with heavy rains in the South and Southeast and lack of rain in the North and Northeast. “This is a factor that adds more complexity to the scenario”, says Ribeiro.

Projections are for higher inflation in the first quarter of 2024, when the effects of the phenomenon should still be felt.

The item that should be most impacted is food at home, one of the most affected throughout 2023. In the year to November, this IPCA item registered a drop of 1.83%.

The effects on the harvest are being monitored, as the climate phenomenon causes heavy rains in the South, one of the main grain producing hubs. The National Supply Company (Conab) projects a harvest of 312.2 million tons. 2.4% lower than the record harvest of 2022/23.

“Crops with a longer cycle, such as soybeans and corn, may experience more,” says the coordinator of price indexes at the Brazilian Institute of Economics at Fundação Getulio Vargas (FGV Ibre), André Braz.

The situation in Mato Grosso, the country’s largest grain producer, is also worrying, where irregular rains and excessive heat could cause the biggest crop failure in the state’s history. Estimates point to losses close to 20%.

XP Investimentos increased its food adjustment projections from 3.9% to 4.6% next year, incorporating more upward effects on fresh foods.

Administered prices may also be affected by “El Niño”. The National Confederation of Industry (CNI) is concerned about the greater use of hydroelectric plants, due to high temperatures, and the lack of rain in some regions.

According to the National Electric Sector Operator (ONS), the situation is even more comfortable in plants in the South and Southeast. On Sunday (24), its reservoirs occupied 95% and 61.4% of capacity, respectively.

Another pressure on inflation comes from the increase in fuel prices. Diesel, used to transport cargo, will have federal taxes (PIS/Cofins) resumed from January. The rates had been reset to zero by former president Jair Bolsonaro (PL) in 2022.

On February 1st, another tax increase will come. State governments will increase the ICMS on gasoline, diesel, biodiesel and cooking gas.

The increase in the addition of biodiesel to diesel, which will increase from 12% to 14% in March, is another source of pressure on prices, since vegetable fuel is more expensive than fossil fuel.

A heated job market is another warning sign

Economists are also concerned about the situation in the job market. The unemployment rate ended October at 7.6%, the lowest since March 2015, and the income usually received by people increased by 3.84%, already discounted for inflation, between October 2022 and 2023, according to IBGE

A survey carried out by the Economic Research Institute Foundation (Fipe) shows that, in October, 80.9% of adjustments were above the INPC, an indicator that serves as a guide for most salary negotiations. The median adjustment was 5%.

“Salaries growing at the current rate could contribute to the acceleration of inflation, especially in services”, highlights the senior economist at Julius Baer Brasil bank, Gabriel Fongaro.

The relief in your pockets caused by Desenrola, the federal government’s debt renegotiation program, and the payment of court orders, determined by the Federal Supreme Court (STF), are other factors that could accelerate consumption at the beginning of the year and contribute to greater pressure in prices, says the inflation strategist at Warren Investimentos, Andréa Angelo.