This growth that is there is not sustainable, says Pastore – 09/10/2023 – Market

The 2023 GDP (Gross Domestic Product) is being driven by government spending, and this leads the private sector to retrench. In the medium term, there will be a drop in activity at the same time that the country will need to live with high interest rates, pressured by state expenses.

This is the opinion of economist and former president of the Central Bank Affonso Celso Pastore, 84. “As fiscal policy became expansionary and the real equilibrium interest rate, called neutral interest, grew, it is not possible to be optimistic regarding private investment . It has to shrink,” he says.

“Today, the engine of GDP growth is public, not private. Apart from agriculture, the government is responsible for the growth.”

Pastore believes that the conflict between the Lula government and the BC over the drop in interest rates will resurface as activity slows down.

“This growth that is there is not sustainable. The moment it is not sustained, this fiscal and monetary conflict — which was very acute before the BC, in that split decision, lowered the Selic by 0.5 percentage points — will emerge from new, with more strength”, he says.

Regarding the increase in revenue sought by the government, he states: “He is overly optimistic that only he, and no one else, has.”

GDP in the second quarter increased 0.9%, raising growth expectations for 2023 to 3%. Agriculture did well in the first quarter and did not slow down much in the second. What happened was a strong fiscal impulse, with the Union’s non-financial expenses, between January and July, growing almost 9% above inflation. What is your assessment? what about the quality of this growth?
When we look at the government’s contribution to GDP growth, we begin to get the answer to that. It is a stimulating fiscal policy. The fiscal framework was designed to sanction increased spending. Fiscal policy has been expansionary for some time.

When fiscal policy is expansionary, the neutral interest rate, the rate that balances demand with supply with potential GDP [sem gerar desequilíbrios], grow up. Consequently, the degree of restriction of monetary policy, which is assessed by the distance between the real market interest rate and the neutral rate, narrows. And the restrictive effect of monetary policy is smaller.

There is now a macroeconomic policy that promotes stronger growth in aggregate demand. When you look at the consumption side of the government, you see this. And, if the market had paid more attention to employment, the growth surprise, in quotes, would have been smaller.

The employed population has been growing systematically. She didn’t slow down at any point. The real wage bill has been growing, which has supported the growth of private consumption. So, GDP growth, when looked a little deeper, in the data set, is not that surprising.

There is a conflict here between fiscal policy and monetary policy. Monetary policy to bring inflation down is placed in restrictive mode. Fiscal policy is in expansionary mode. Let’s see how this goes from now on.

We had a strong fiscal boost in the second half of 2022, with electoral measures by Jair Bolsonaro. Before taking office, the Lula government obtained another R$150 billion from Congress. Bolsa Família went from R$40 billion a year to R$167 billion, increasing family consumption. There was an adjustment for civil servants and a real increase in the minimum wage. But, if we look at Gross Fixed Capital Formation [investimento] in the first half of the year, there was a drop of 0.9% [ante mesmo período em 2022]. As a proportion of GDP, it stands at a mere 17.2%. Is growth sustained like this?
Of course. There is a phenomenon called “crowding out” of private investment. What is that? The government increases spending, the real interest rate has to rise, because the neutral rate rises. The most sensitive part of aggregate demand to real interest is investment.

Then, the increase in public spending turns into a fall in the rate of private investment.

As fiscal policy became expansionary and the equilibrium real interest rate, called neutral interest, grew, it is not possible to be optimistic regarding private investment. He has to shrink.

Today the engine of GDP growth is public, not private. Apart from agriculture, the government is responsible for the growth.

I think it will slow down. For two reasons. First, the international economy slows down. Look at China, which has a level of debt caused by overinvestment in the real estate market.

In the US, in the best case scenario, if there is no further increase in interest rates, the current rate will remain high for a longer period than was natural in previous cycles of monetary tightening. On a slightly smaller scale, because fiscal policy was less expansionary during the pandemic, this is the picture in Europe. When we look at this, we have an external picture here that says it slows down.

Second, although fiscal policy is expansionary, monetary policy is restrictive. And the terminal interest rate, that is, if you compare this cycle of falling interest rates, which was started by the [Roberto] Campos Neto [presidente do BC]with that of Ilan Goldfajn [ex-presidente do BC] back in 2016, in both cases they started with Selic close to 14%.

And the real rate [acima da inflação] One-year “ex-ante” was at 8% in both. Ilan brought the terminal rate, when he ended the cycle there in 2018, to 6.5%. Well, the Selic will not go to 6.5% in this context for the simple and good reason that back then there was a fiscal framework that froze primary spending in real terms, and because of that it had led to a neutral interest rate significantly below the current neutral rate. The current neutral rate is higher, the Central Bank will not be able to bring that.

Campos Neto is talking about a neutral rate of 4.5%.
As the neutral rate is not an observable variable, it raises questions. And Campos Neto cannot be very explicit about the neutral rate because he would have to directly criticize the fiscal policy that increases the neutral rate, and he probably doesn’t want to do that.

The entire market has a higher neutral. Whether it is 5% or 5.5% is another story, but it is certainly not Campos Neto’s 4.5%. I’m sorry Campos Neto. Neutral is higher, and monetary policy will not be able to generate stimulus for recovery. On the contrary, it is restrictive.

The economy will slow down in 2024. I’m not saying that Brazil will end, nor that there will be a recession, nothing like that. We will see all consultancies reevaluating GDP growth in 2023, which will reach close to 3%. Next year, I don’t know if it will be 1% or 1.5%, but it will be lower than the current growth.

This growth that is there is not sustainable. The moment it is not sustained, this fiscal and monetary conflict, which was very acute before the Central Bank, in that divided decision, lowered the Selic by 0.5 percentage points, this conflict between fiscal and monetary policy will emerge again with more strength.

The government will start complaining about the Central Bank again, and we’ll see how that evolves. But the reason for this is that growth slows down. The hope of [Fernando] Haddad [ministro da Fazenda] of obtaining the resources to be able to meet the primary result target is for revenue to grow.

If we look at where Focus’s consensus projections are today regarding the primary result in 2024, 2025 and 2026, there is a deficit in all three years. The solution to this is to increase revenue. And, to increase revenue, there needs to be more economic growth.

Then you will see the fiscal and monetary conflict reappear. This is a little later, next year.

This is all connected to the issue of the fiscal framework, because, if we have an increase in revenue, which is what the government wants, there would be a reduction in public debt as a proportion of GDP. But this is not guaranteed. The government needs R$160 billion more.
If the government ran primary surpluses, if it met the primary result target, you would have a better result than what we are seeing. The result I’m seeing, based on what he revealed in his revenue projections, is that he has an excess of optimism that only he, and no one else, has.

When you had the framework that froze primary spending in real terms, and it is true that it was extremely rigid, the interest rate curve in real terms of the NTN-Bs [título público atrelado à inflação] showed one-year transaction rate at 1% and ten-year transaction rate at 3% [acima da inflação].

Now these rates are above 5% [além da inflação], with the longest branch closer to 5.5%. I mean, this is a risk premium on top of public debt growth.

I’m not asking the market what it says publicly, what it thinks will happen. Normally the financial market is cautious in this type of public comment. After all, they have financial institutions and they don’t want to expose this to debates, to controversies.

Now, I’m not asking where he’s putting his mouth, I’m asking where he’s putting his money. Where he’s putting the money is a higher risk premium.

And this risk premium is the limit at which the real interest rate will be able to fall. And, if it cannot give in, the framework will, in effect, crowd out private investment. I mean, everything points to private investment leaving the game. Private investment does not end, but it reduces it.

There is a discussion about whether the government should admit that it will not meet the goal of closing the deficit next year. Or insist on the goal to avoid further expenses. Like mr. see this point?
I don’t want to get into that discussion. But I will say this: I looked at the data, I looked at the revenue increase projects and I looked at the commitment to increase spending. And I see that you can’t do both. How are they going to get out of this problem? It’s their issue, but I don’t see how they’re going to do it.

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AFFONSO CELSO PASTORE, 84

PhD in economics from the Faculty of Economic and Administrative Sciences at USP, he was president of the Central Bank during the João Figueiredo government (1979-1985) and professor at Fundação Getulio Vargas. He is a founding partner of the Public Policy Debate Center and AC Pastore & Associados.