Monday, 1st day of the rest of the life of the Lula years 3 – 04/13/2024 – Vinicius Torres Freire

This week, Luiz Inácio Lula da Silva’s government is expected to say that its goal of saving money in 2025 will be lower than it predicted since last year. The primary surplus target will be smaller — it is the difference between what is collected and what is spent, apart from interest expenses.

Even less ambitious, the objective will still be difficult to achieve, among other problems that will affect Lula-Haddad’s brand new mobile spending ceiling.

The Brazilian government’s accounts are in a dangerous situation, rare since a regime based on the ideas of inflation targeting, floating exchange rate and primary surplus was established, ideas in practice that are often flawed, and since there are comparable statistics. Since 2002.

What danger is this? The average interest rate on public debt is high. You don’t save enough (or anything) to pay the interest and, thus, prevent the debt from growing without stopping. Since 2002, such a bad conjunction has occurred in the years of the Great Recession (2014-2016) and the epidemic.

With Michel Temer’s spending cap and the recession, interest rates began to fall rapidly. The ceiling was bad and marked for death, but it contained the explosive increase in debt.

After the increase in spending due to the epidemic, there was the containment of 2021 — early, which caused a large increase in poverty. More importantly, there was unexpected inflation while interest rates were very low. In real terms, the (implied) interest rate on debt was negative from March 2021 to June 2022. It was an important reason why public debt fell quickly from the Covid peak.

Now, there is the prospect of high real interest rates for years (even with a fall in the Selic rate). There is no prospect of a relevant primary surplus before 2026. The idea is beginning to spread within the government that Lula 3’s mobile spending ceiling, approved last year, will have to be relaxed.

The average nominal cost of debt, the implicit interest rate that applies to the total public debt, is 11.2% per year (in the last 12 months up to February), a real rate of 6.4%. As a result, the public sector, the “government”, paid the equivalent of 6.8% of GDP in interest (R$747 billion in 12 months, the equivalent of around five years of Bolsa Família). In practice, he didn’t pay: he incurred more debt to roll over this bill. It also had to borrow to pay everyday bills, as it has a primary deficit: over R$268 billion in one year. The total (nominal) deficit, therefore, exceeds R$ 1 trillion (9.24% of GDP, of the economy’s annual production).

Since 2002, there have been deficits of this size or larger only in the exceptional moment of the epidemic and in the Great Recession or as a result of it, in 2016 or 2017.

In other years, the average interest rate on debt was lower or not much higher than it is now. But there were large primary surpluses, as under Lula 1 and Lula 2. Part of the interest bill was paid. Debt even fell, also given GDP growth.

Lula 3’s mobile spending ceiling is already at risk. Lula-Haddad’s “fiscal framework” allows for a certain real increase in spending each year. But there are expenses that grow even more: Social Security (also due to the increase in the minimum wage), health and education. The increase in these expenses will flatten the others (such as investment in works). There will therefore be pressure to relax the ceiling.

Unless there is exceptional growth in GDP or taxes, which are unfeasible in the foreseeable future, the debt will increase for many years.

There is no level of debt at which a crisis will necessarily trigger. But the situation is dangerous (in case of a new round of interest rate increases due to high inflation, for example); implies lower economic growth.

Debts are contained with combinations of rapid economic growth, inflation, expenditure containment and financial repression (interest rate flattening, viable only in certain countries and in certain international contexts).

What will Lula 3 do?

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