Uncertainty and low growth – 03/04/2023 – Ana Paula Vescovi

The public sector in Brazil has achieved, since 2013, primary results below what is needed to stabilize the debt. There are ten consecutive years of fiscal imbalances, when public debt grew by 52% and reached 87% of GDP in the year of the pandemic. In this context, several agencies and analysts predicted that the debt would approach 100% of GDP in a few years, which once again raised an alert about Brazil’s fiscal fragility. But that didn’t happen.

Where did we go wrong in our predictions?

The first error was related to the speed of post-pandemic recovery, far above what we all estimated due to uncertainties regarding the effect of the vaccine against Covid, the effective containment of contagion and the impacts of the numerous stimuli adopted. We estimated 3% GDP expansion in 2021, followed by 1% in 2022. Although we were on the optimistic end, GDP grew stronger: 5% and 2.9%, respectively.

The second was related to inflation. We estimated IPCA at 5% and convergence towards the center of the target (3%) already in 2024. Inflation, however, proved to be very resilient —also in other countries— and closed 2021 at 10.1% (twice what we estimated ). Last year, it slowed down to 5.8%, but with the help of tax cuts. Inflation was reflected in the expansion of nominal GDP (+16.9% in 2021 and 11.4% in 2022) and helped to inflate government revenues, collected in high frequency. According to IMF data, Brazil was one of the countries that most reduced the debt due to the inflationary component (16 percentage points).

Thus, in 2022, the Brazilian public sector ended the second year with a primary surplus, with a strong recovery in GDP, a resilient labor market and a deleveraged corporate sector. Instead of growing, the debt retreated to the level of 72.9% of GDP at the end of 2022, also helped by upward revisions of nominal GDP by the IBGE. So why do risk premiums remain high and consistent with recent periods of fiscal stress?

Questions are beginning to arise about the real gravity of the fiscal situation. Or if we, the analysts who study the subject, are excessively alarmist. But the facts are indisputable.

Since the pandemic, limits have been tested. The tax rule has been modified four times by constitutional amendment in Congress, exceptionalizing 9.3% of GDP since 2020, of which 4% were post-pandemic. Expenditures have been dammed up, as well as the public deficit, with the postponement of the payment of precatorios (R$ 55 billion accrued are foreseen as unpaid this year) and their non-complete accounting. Between 2022 and 2023, we estimate that primary spending will grow by 4.5% on average, in real terms.

The gross debt/GDP is about 20 points above that of our peers, with twice the interest account, largely due to the high need for government financing; the high level of mandatory expenditures over total primary expenditures (92.8%) and the tax burden (close to 34% of GDP) greatly limits the space for a faster fiscal adjustment.

Also, 70% of expenses are indexed to past inflation, in an economy with an average growth of just 1% after the 2015/2016 crisis.

In addition to the facts, uncertainties hover over the future.

It is not known for sure what the effect of the contractionary cycle will be on the fiscal result, and to what extent the current result will be reversed by the economic slowdown and the expected disinflation. In addition, there is a lot of unpredictability about how long and intense the cycle of commodities will be, whose prices should fall due to lower growth. Thus, there is uncertainty regarding these effects on government revenues. Social security expenses tend to grow by 2.5% per year or more, raising doubts about the stabilization of this expense in proportion to GDP, even after the 2019 reform.

In the field of economic policy, it is not known what the new fiscal framework will be like, how effective it will be in coordinating expectations and what kind of political commitment will sustain it. In the same way, the approval of a tax reform brings many risks, due to the many details it contains and because it is intensive in political articulation. What will be the contribution, if approved, to the improvement of the business environment in Brazil, in the long term? And, finally, who will be the new members of the Central Bank board? Will the goals change?

Domestic and external uncertainties have increased risk premiums embedded in the yield curve. At ten-year-ahead rates, we estimate that these premiums reached 4.5 percentage points in the recent period, the highest level since the 2008-2009 crisis, putting pressure on futures rates and increasing the cost of capital. We estimate that the exchange rate is R$0.75 above the level it could be, if risk-free.

Brazil could do much better if it diluted risk premiums, which would also help to reduce current inflationary pressures (a more appreciated exchange rate) and contain medium and long-term inflation expectations. On the other hand, possible failures in building a safer and more predictable macroeconomic environment, through new bets on fiscal —or even parafiscal— stimuli to stimulate activity, could contribute to fueling an inflationary spiral.

This time, through inflationary surprises, the errors in the projection of scenarios may even be smaller, but the loss of confidence in fighting inflation may be longer lasting.

Working to reduce uncertainties seems to be, therefore, the best direction for economic policy and for the country.

In the previous article, in which I commented on inflation targets, I made a mistake when I wrote that the convergence towards setting targets three years ahead started in 2016. In fact, it started in 2017, the second year of the Temer government. Thanks to former BC director Carlos Viana for the warning.