Uncertainties for 2024 only increase with the abandonment of the fiscal target – 11/01/2023 – Solange Srour

If doubts regarding the economy and global geopolitics already made the scenario for Brazil in 2024 more uncertain, the weakening of the fiscal framework, with the increased chances of changing the primary deficit target, calls into question the continuity of the good news this year: growth in activity above expectations, generalized drop in inflation and a cycle of falling interest rates.

The scenario for the main global economies inspires caution with Europe on the brink of recession and China providing stimulus to avoid disappointing growth. Even for the USA, whose performance has been extremely positive, the outlook has fluctuated a lot. Over the past year and a half, analyst consensus on the direction of the American economy has varied between soft landing, hard landing and no landing at all. While the prevailing view is now of a soft landing, forecasts are far from stable.

The most immediate risk in the country is the sharp increase in long interest rates, explained in part by the increased probability that monetary policy will need to remain quite restrictive for an extended period, given the resilience of the labor market and inflation more related to demand.

At the same time, we have an increase in the risk premium demanded by investors who carry American debt. The accelerated growth of the primary deficit in recent years is now combined with the increase in interest payment expenses, bringing the prospect of unsustainability to the debt.

As the US election campaign approaches, there will be no clarity on how the necessary fiscal adjustment will be conducted. On the contrary, after the War in Ukraine, the outbreak of war in Israel and the fear that there will be a conflict in Taiwan, the consensus among Republicans and Democrats is that defense spending needs to rise in the coming years. The feeling of worse geopolitical risk also brings greater concern about setbacks in globalization and its positive impacts on inflation and growth in the world.

It is in this turbulent context that signaling a change in the primary target to 2024 tends to have very negative effects. Firstly, it weakens the economic team’s effort to seek fiscal adjustment via tax increases. Congress will hardly be willing to bear the burden of approving measures that bring opposition from organized sectors of society when the government shows little willingness to pursue the primary goal.

Secondly, if in the first year of the framework the goal is changed to avoid a contingency, any commitment to future goals becomes no longer credible. The framework itself is weakened, since, if there is no commitment to approaching the targets, the same must apply to complying with the real expenditure growth limit of 2.5%, established with the new fiscal rule. With the return of minimum wage levels for education and health and the new minimum wage rule approved, the risk of changes to this limit has also become high.

After the statements against the measure to eliminate the primary deficit, the interest curve increased the pricing for the Selic at the end of the monetary easing cycle. Fiscal policy affects Copom decisions through its impacts on aggregate demand and through the risk channel, which in turn is transmitted by the exchange rate and inflation expectations. The BC has drawn a lot of attention to this last channel, since even with the inflation target maintained at 3%, the anchoring of expectations was incomplete.

The BC’s inflation projection models take into account the fact that analysts no longer believe in meeting the fiscal target; but the problem is that, when it becomes clear that the government does not support spending-cutting measures, the chance of these projections getting worse increases. The side effect is “twin unanchoring” – a term that the Central Bank uses to describe the fact that the lack of anchoring of expectations about fiscal policy leads to unanchoring in relation to inflation targets –, which hinders the fall in inflation and interest.

In economics we learn that agents react to signals and that expectations matter. Remaining without fiscal rules when the international scenario is uncertain is quite risky and could end up hindering our economic performance next year.

I would like to take this opportunity to congratulate the Department of Economics at PUC-Rio for 60 years of undergraduate studies, 45 years of postgraduate studies and research and 30 years of the doctoral program. During these years, the department contributed intensely to Brazilian economic policy and is internationally recognized for having trained professionals whose academic research was at the frontier of economic science. I am eternally grateful for the professional and personal training that PUC professors and colleagues provided me.

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