Solange Srour: Framework does not bring debt stability – 04/04/2023 – Market

Just over three months after the start of Luiz Inácio Lula da Silva’s (PT) third term, economist Solange Srour’s assessment is that the PT’s government began even before January 1, with the approval of the PEC ( proposed amendment to the Constitution) that increased spending. She sees a profound change in the economic agenda, compared to the previous government, of Jair Bolsonaro (PL).

For the chief economist in Brazil at Credit Suisse bank and columnist for Sheetthe Central Bank is right to keep basic interest rates at the current level of 13.75%, and the government’s criticism of the entity’s president, Roberto Campos Neto, cannot signal that the institution’s autonomy is at risk.

Still in his assessment, one of the milestones of the current administration, the new fiscal framework presented by Minister Fernando Haddad (Finance) still needs to make it clear whether it will achieve the goal of debt sustainability. “It’s a framework that doesn’t bring debt stability in the medium and long term. For that to happen, we’re going to need a spending reform.”

How do you evaluate the first three months of Lula’s government? The government started even before the 1st of January, there was an important work in the approval of the PEC [proposta de emenda à Constituição], which had important consequences for the economic agenda. A spending increase of around 2% of GDP was approved [Produto Interno Bruto]when the inheritance of what would be necessary to approve to maintain the Brazil Aid [hoje rebatizado de Bolsa Família] would be of the order of 0.8%.

The government delivered a good part of its promises in the social field and will try to achieve this with more taxes. The most important reform of this mandate is the tax one, for now, it is the only one we have. It is a government that begins after the election results with an economic agenda, in my opinion, quite different from the previous one — with higher spending and a different social profile.

It is now clear that the fundamental pillar of the fiscal policy to bring debt sustainability will be the increase in revenue.

Is the set proposed in the new framework positive? It is still unclear whether the debt sustainability objective will be achieved with what has been announced so far. These are intentions to achieve a surplus greater than what the market was expecting, but there is a huge gap between intention and reality.

The main basis of this framework is to increase taxation, not to control spending. On the contrary, we are going to go back to the rules that existed before the spending ceiling for education and health. The objective of the primary result to be achieved will depend on whether Congress is willing to approve the increase in the tax burden.

But it is a framework that does not bring debt stability in the medium and long term. For that to happen, we’re going to need a spending reform. We reformed the Social Security, but no economy that has the expenses that Brazil has today is sustainable. There is still a long way to go to bring mandatory spending to growth closer to that of GDP, without the ceiling rule, they will grow higher.

Is it a throwback to the ceiling? Wasn’t it important to think of a way to unlock public investment, something the president complained about throughout the campaign? I think the spending cap was a rule that forced Brazil to make choices. I understand that the ceiling was criticized, as it lost its meaning after being so modified as to open up spaces for new expenses. But if the path was to increase social spending three times in the post-pandemic, this discussion could be in the public debate with some spending reform that would not be paramount at this time. Without adjusting other expenses, the solution is to increase taxes, and the tax burden is already very high. The discussion forced by the ceiling was what ended up leading to the approval of the pension reform. The ceiling was doing its job until it became too easy to pass a constitutional amendment to increase spending without discussing reforms.

Can Haddad’s framework have a longer life than the roof? I see it as a bridge to discuss spending again, and the timing of this discussion will depend a lot on market conditions, which end up directly interfering in the economy. Without discussing a spending reform, we will need to keep increasing the tax burden every year and the economy will not sustain itself. If that happens, Brazil’s potential GDP, which is no longer high, will be lower, nobody wants growth to remain low. I think it will be inevitable to discuss a framework again.

How to evaluate Haddad’s performance as a minister? The Ministry of Finance is very aware of the challenges that Brazil faces. In spite of all the positive surprises that we had in the last two years, regarding the primary result and the debt-to-GDP statistics, the structural challenges are present. The ministry is acting within the political limits of the government. This work of bringing the tax recovery [sobre combustíveis] and some predictability in relation to the trajectory of public accounts is welcome. Otherwise, uncertainty would lead to a more significant drop in GDP.

It may be that for four years what has already been presented will be enough, but we still cannot assess this because everything depends on economic growth, on variables that affect revenue. It’s a positive start to work, but there’s still a lot to be done.

The president has complained about analyzes of the economy’s performance, a pessimism that Datafolha also picked up from the population. Is this pessimism justified? The market expects a significant deceleration in GDP from last year to this year, but this is not pessimism, it is reality. We have a high interest rate and it should stay that way for a long time. In our scenario, the Selic [taxa básica de juros] should be stable until the end of the year.

Datafolha also showed Brazilians’ dissatisfaction with interest rates. Inflation remains high, we live in a country that has high inertia and there is an ongoing deceleration of activity, which could help in the deflationary process and is helping, but not enough to bring a forecast of low inflation this year. We expect it to be around 6.5%. This is one of the reasons why interest rates are high, the Central Bank cannot give up this objective of price stability, also because it is something harmful for any government.

Apart from the inertia and high inflation, there is all the questioning about the target regime and the actual autonomy of the BC, which has brought an expectation of higher inflation for the coming years. Bonds indexed to inflation end up embedding higher inflation and this hinders the drop in interest rates. Another issue is whether there will be a greater role played by state-owned companies and public banks, something that affects private investment. These issues today bring lower investment prospects.

Is President Lula wrong to criticize the BC’s interest rate policy? The BC maintains de facto autonomy is crucial for growth. History shows that economic growth is favored in the medium term, when the Central Bank acts autonomously. We see attacks not only from governments, but from businessmen, economists and many people in the newspapers who think that the BC is going against the grain.

In my opinion, he is preserving an important achievement for Brazil. Central Bank autonomy was a long process and could be at risk, even if Congress does not approve its end. The most important thing is that autonomy is maintained in practice, no relevant country is discussing changes in the monetary framework.

Haddad has also been talking about the cost of credit offered by banks and the government foresees a package to unlock credit. Is there room for that? The cost of credit being high is a longstanding debate and has nothing to do with the organization of the financial system. Competition has increased a lot in recent years, with the entry of fintechs. Of course, if the Selic needs to stay high to contain inflation, we have an increase in default and spread [diferença entre o custo de captação dos bancos e a taxa final cobrada do cliente]. If this is attacked in an interventionist way, the effect can be the opposite.

When criticizing the market, Lula even mentioned Credit Suisse [o banco passa por um processo de aquisição emergencial na Suíça]saying that the bank made a guess about everything and that it had been saved by the State. It’s not a question. We work in a very technical way, all our projections, scenarios are formed through econometric models, an economic framework. Projection of inflation, GDP, Selic, everything is done using models.

How should the relationship between the market and the Lula government be? Can the framework calm tempers? In fact, there is no such thing as a relationship that has to be smoothed over. We need more information about what is being proposed and understand how the relationship between Congress and the government will be.

How expectations will evolve is something that will depend a lot on the completion of this framework, what will happen with monetary policy and whether the BC will be able to act autonomously and reduce the Selic rate. It is also always necessary to contextualize Brazil in the global scenario, the reform agenda becomes more or less important depending on the external situation. But it will most likely not be as favorable as it was for Brazil in recent years, the external growth vector is smaller going forward and the scenario is less positive going forward.

---

X-RAY
SOLANGE SROUR, 46
Chief Economist for Brazil at Credit Suisse. He holds a master’s degree in economics from PUC-Rio