Bloomberg Línea — The first challenge for Brazil’s next president, no matter who wins at the polls Sunday (30), will be to review the spending ceiling rule. According to economists consulted by Bloomberg Línea, the government needs to reform this rule so that it can accommodate expenditures that do not fit in the budget under the current system.
At the same time, a new fiscal rule would help restore investor and business confidence in public debt sustainability and help the Central Bank secure conditions to reduce interest rates, which would lead to higher growth in the country.
The cap rule limits the increase in public spending to the inflation rate of the previous year. With this, spending that is already taken for granted next year would exceed this limit. Among them is the permanent increase in cash handouts in the program Ayuda a Brasil to R$600 ($114), to an extra cost of about R$52 billion (almost $9,82 billion)
The handout paid by the cash transfer program that replaced Bolsa Família was increased from R$400 to R$600 in July by Congress, but the increase only lasts until the end of the year.
Both President Jair Bolsonaro (PL) and former President Luiz Inácio Lula da Silva (PT) promise to maintain Auxílio Brasil at R$600 if elected. Lula also promises to give an additional R$150 per child up to six years old in each family. And Bolsonaro suggests paying a 13th salary to women beneficiaries of the program. Both measures tend to further increase the investment in the social program.
In addition, there are other campaign promises adding pressure on the spending ceiling, such as granting minimum wage adjustments above inflation (Lula and Bolsonaro, although the current president has not done so in his four years in office), amending the Personal Income Tax table (Lula and Bolsonaro), increasing the salaries of federal employees, which have been frozen for four years and which have been losing with inflation (Bolsonaro), among other measures.
In addition to these additional expenses, the government plans to maintain the tax exemption on diesel and gasoline next year. This measure would cost about R$50 billion ($9.5 billion). A study by economists Manoel Pires and Bráulio Borges, from Ibre-FGV (Brazilian Institute of Economics of the Getulio Vargas Foundation), estimates that there could be an impact of R$382.7 billion in extra spending next year ($72.3 billion), or 3.7% of GDP, due to these and other additional expenditures that may occur — with high probability today.
Faced with spending pressure, most economists agree that the coming administration will need to define a fiscal “exemption” in 2023, that is, a license for the government to spend above the limit imposed by the cap. Former Finance Minister and former Central Bank President Henrique Meirelles — who has declared his support for Lula and is participating in discussions with the president’s campaign — estimates that this license would be R$100 billion (close to $19 billion).
Sergio Vale, chief economist of the consulting firm MB Associados, believes that the amount of R$100 billion represents the minimum necessary to cover the out-of-pocket expenses: “It will be between R$100 billion and R$150 billion to start with. We know that it will not stay only in the social program. We will have to accommodate the minimum wage, the precariousness, the salaries of civil servants that it is not very clear how much increase they will have,” he said in an interview with Bloomberg Línea. “This is the first big challenge: rearrange the fiscal house. Bring tranquility to the fiscal balance and then the country will be able to think about other things,” the economist said.
Vale said that another priority is to make a tax reform, as a way to simplify the payment of taxes and improve the country’s business environment. He said it would be important for the government to move forward with a project in the first half of next year, at the same time that it makes a review of the spending ceiling rule. “As much as it already has a design, a tax reform is much more complex, because it involves several sectors, several states. It is a tax reform that is going to spend much more political time than changing the ceiling rule,” he said.
Economic slowdown
The increase in public spending comes at a time of economic slowdown. Despite the recent positive GDP performance, most economists expect a weaker pace in 2023. Economists anticipate that the next government will not be able to count on strong tax revenues, as was the case in 2021 and 2022.
“The government’s overestimation of next year’s tax collection capacity is as serious as the new expenditures. As the country is coming from two years of very strong collection, part of this euphoria now is being extrapolated to 2023, which we know will be a year of weak growth,” said Luciano Sobral, an economist at Neo Investimentos. “All these arguments have been postponed until after the elections. Yet this is a predicament that is waiting around the corner to show up,” he assessed.
Rising interest rates around the world — and especially in the United States — may cause a global slowdown and even a recession in the world’s largest economy, probably next year, taking a toll on Brazil. China, which is the main destination for Brazilian exports, is also struggling.
The deadlocks imposed by Beijing to contain the outbreaks of Covid-19 and the fall in real estate indicators should reduce China’s GDP growth to one of the lowest levels in decades. “This slower growth in China is bad for commodities because it drives down the price. That means an exchange rate appreciation. In this regard, the real has one more factor to remain at a higher level,” said Marco Maciel, partner and economist at Kairós Capital.
These issues of the international scenario put in check the recent improvement of the Brazilian economy. In the first half of the year, GDP growth was much faster than expected. Growth was 1.1% in the first quarter and 1.2% in the second quarter, which has led economists to forecast further growth in 2022. According to the Central Bank’s latest Focus report, the market expects GDP to grow by 2.76% this year.
Economic growth is driven mainly by the recovery of the services sector — which accounts for about 70% of GDP — and by the increase in household consumption. Services benefit from the return of face-to-face activities, such as spending in restaurants, bars, hotels, air travel and buying from street vendors, among others. Rising commodity prices, which benefit exports and the agricultural sector, and the release of social benefits approved by Congress with the support of the Bolsonaro administration, such as the Auxílio Brasil at R$ 600, a bonus for cab and truck drivers, and also the expansion of the ‘vale-gás’, which subsidizes the purchase of gas canisters for the poorest families, also contributed to increased growth.
Most economists, however, believe that this boost is expected to lose steam by the end of 2022 or 2023, due to the global environment and also because of high-interest rates in Brazil, which mainly affect the credit-dependent sectors, such as construction and the durable goods sector, ranging from cars to household appliances.
This week, the Central Bank’s Monetary Policy Committee (Copom) maintained the Selic rate at 13.75% YoY while indicating that it should remain on hold for an extended period of time until inflation prospects return to target. The effects of high-interest rates will be felt throughout next year in the Brazilian economy, restraining demand.
Most financial market economists forecast a GDP expansion of just 0.63% in 2023, according to Focus. “As much as an upside GDP surprises, we’re going to have a more complicated period, especially next year, with the effect of tight monetary policy,” says Andrea Damico, partner and chief economist at asset manager Armor Capital. “There hasn’t been a stronger effect of monetary policy on the economy yet, but it will happen. That’s 400 basis points of interest rate hikes above the neutral (level).”
Inflationary respite
While the slowdown of the economy is a challenge, inflation should give a respite in the first year of the new government. After peaking at 12.13% in April, the 12-month cumulative HICP was 7.17% in September and will close the year at 5.6%, according to market forecasts. By 2023, inflation is expected to reach 4.94%; more in check, but still above the Central Bank’s target (4.75%).
Although the reduction has to do with the tax cuts promoted by the government in fuel, electricity and telecommunications, a number of other factors have also contributed. One is the drop in oil prices, resulting in successive cuts in fuel prices by Petrobras. Another is a reduction in the prices of commodities such as soybeans, corn and wheat, following a peak in the first semester.
In both cases, the price declines are related to the prospect of a slowdown in the global economy. Moreover, shipping freight rates have fallen in recent months, which also eases costs in the sector and reduces pressure for price increases. However, curbing inflation in the future should be a more difficult task for the Central Bank, as the government’s economic stimulus and an improving labor market tend to strengthen demand.
“Current and short-term deflation is the easy part,” says Maurício Oreng, deputy director of macroeconomic research at Santander Brazil. “The hard part is to reduce inflation at a time when the economy has no downtime and is shifting back from spending to services. It’s going to be quite complicated and will require a tight and rigid monetary stance for quite some time.”
Unemployment and income
Another positive factor for the economy is the recovery of the labor market. After peaking at 14.9% in the January-March 2021 period, the unemployment rate fell back to 8.7% in the quarter ending in September. Formal employment increased again, which contributed to an increase in workers’ income. According to the IBGE, the mass of income reached R$266.7 billion ($50.4 billion) in September, an increase of 4.8% over the previous quarter and 9.9% over the same period last year.
Employment expansion helps consumption and economic activity. But economists believe that the creation of new jobs should slow down from here on, reflecting slower economic growth next year and monetary tightening. Stimulating the generation of higher-quality jobs is, therefore, one of the challenges for the next president to improve the population’s purchasing power and income. Currently, of the 99.3 million employed Brazilians, 39.1 million (39.3%) work in the so-called informal sector.
