RIO DE JANEIRO, BRAZIL – Metaphors with home economics are often used by analysts to explain to lay people the risks of a country becoming over-indebted. While they are not always adequate and can oversimplify public accounting issues, some are applicable. Take, for instance, the current state of the Brazilian economy.
It could be said that the country entered the crisis triggered by the pandemic as a consumer who has reached his overdraft threshold and then gets a large unexpected bill. He will get into more debt in the short term and will have to readjust his spending even more heavily than he had planned. In 2013, before the last great national crisis, Brazil had a gross debt in relation to its GDP of 60.2 percent, when the average in emerging countries was 38.2 percent, according to data from the International Monetary Fund (IMF).
Years of fiscal neglect later and with the need to pass the constitutional amendment creating a mandatory government spending ceiling, to force a much-needed adjustment, the country closed 2019 with a debt of 89.5 percent of GNP, and for this year it is expected to reach 101.4 percent, when the average for emerging countries will be 62.2 percent. In seven years, the difference in relation to our peers has almost doubled to 40 percentage points. The situation was not good and has worsened.
The indicator’s surge in 2020 is explained by the heavy fiscal spending made by Jair Bolsonaro’s government to prevent a sharp GDP drop, with measures such as the emergency aid. The disaster was averted, but its price is high. Brazil will face the greatest fiscal crisis in its recent history, which can be a major threat to stability and growth.
Brazil is the large emerging country with the worst relationship between debt and GDP. Among developing nations, it is better only than exceptionally negative cases like Angola, Lebanon and Sudan. Even Argentina, which has just declared the largest moratorium in its history and has almost exhausted its dollar reserves, is expected to close 2020 with debt below 100 percent of GDP. Nations with a similar economic profile, such as Turkey, and neighboring Chile and Peru will not reach 45 percent. Closer to Brazil’s situation are the United Kingdom and other developed nations. The difference is that the market relies on the fact that the wealthy will always be able to honor their commitments and will not charge high interest to buy their debt bonds.
With the emerging countries, reliability is not the same. It is certain that investors are more understanding in the current crisis and there will be more patience. But the situation in Brazil is peculiar. Those monitoring public accounts had already alerted to the scenario looming since the start of the pandemic. But it was only in the past few weeks that the fiscal risk entered the stock markets’ radar, when after a strong rebound in the IBOVESPA index, faced with the worst moment of the pandemic, the game turned.
There was a 4.8 percent drop in the index in September. In the year, the Brazilian real also became the emerging country currency with the largest drop against the dollar, at about 40 percent. In addition, the withdrawals of foreign risk investments in Brazil already stand at US$24 billion this year, against US$11 billion last year.
The best illustration of the changing mood in the markets, however, is related to what is called an increase in the slope of the interest curve – with low short-term rates and increasingly high long-term rates. This is explained by the controlled inflation and the fiscal commitment undertaken by Minister Paulo Guedes’ economic team as the government’s guideline, Brazil managed to lower its basic interest rate in recent times, until it reached an unprecedented two percent per year. But over the past month the market has begun to project future interest rates well above this level, at up to eight percent.
The impact of this will be that, should the Treasury decide to issue longer-term bonds, it will need to pay more. Or, if it does not accept these conditions, it will have to anticipate the maturity of its debts to cover government spending. That is what is currently happening. “The Treasury does not want to take on this cost, and there is little appetite for long-term bonds today, particularly from foreigners,” says the former head of the Central Bank’s open market department and independent consultant to Omninvest Sergio Goldenstein.
On Thursday, October 8th, the Treasury issued 25 million bonds maturing in April 2021. As a result, there are R$268 billion to be paid within six months, approximately 19 percent of the fixed-rate debt and six percent of the total. “We are not talking about default risk, because, at the limit, the Central Bank would start to act to avoid insolvency,” says Ana Paula Vescovi, ex-executive secretary of the Ministry of Finance and chief economist of Santander Brazil. “The risk is not knowing what to do to stabilize this growing debt.”
Risk assessment agencies are watching. At the start of the pandemic, they reviewed Latin America’s grades in an extraordinary way. Standard & Poor’s kept Brazil’s rating at BB-, three steps below the good payer seal, but revised the outlook from positive to stable. Until the end of the year, a new review will be released. “The fiscal deterioration will be worse than expected in April, but on the other hand, the economic contraction was more moderate,” explains Livia Honsel, chief analyst of S&P’s Brazilian rating. “Such a high debt limits the prospect of improving the rating.”
For the markets to relax, the government needs to at least signal clearly that Guedes’ agenda to control the accounts will prevail, through the macro- and micro-reforms, and that the latest proposed basic income program, called ‘Renda Cidadã’ (Citizen’s Income), will only be created if there are cuts in other areas. The room is tight. The Budget submitted to Congress projects a new primary deficit of three percent next year. Considering that the economy would grow by 2.5 percent a year, a fiscal effort of 4.5 points would be required to reduce the debt with a surplus of 1.5 percent of GDP, according to ex-Secretary of the Treasury Mansueto de Almeida.
“This must be maintained for a decade, or the annual surplus will need to be higher than 1.5 percent. We cannot keep the debt that high for a long time,” he says. The risk in not managing the accounts is the market losing confidence in Brazil, demanding higher interest rates, the government creating more taxes to pay off its debt, leading to an increase in the dollar, and for this to lead to high inflation and impoverishment of the population.
Brazil has already seen this movie, several times over. To return to this scenario would be to lose almost three decades of hard-won progress.
Source: Veja