Brazil could raise interest rates above 10% in 2022 – Spain’s Crédito y Caución bank

RIO DE JANEIRO, BRAZIL – This year, the Central Bank of Brazil has initiated a cycle of rate hikes to bring them to a current level of 7.75% before the next monetary policy decision, which will happen this Wednesday (8).

According to the report, this cycle of increases in the price of money “could deteriorate the country’s public finances”, as they are “susceptible to changes in monetary policy”.

The text explains that the loss of fiscal consolidation initiated in 2016 and the depreciation of the Brazilian real (R$) have increased inflationary pressures, forcing the central bank to raise rates further, thus generating “a vicious circle.”

In the years leading up to the health emergency, the spending ceiling set in 2016 and the 2019 pension reform gradually restored market confidence in Brazil’s fiscal consolidation and allowed the Central Bank to cut the benchmark Selic rate from 14.25% in 2016 to a record low of 2%.

However, in response to the high inflation recorded in 2021—10.67% year-on-year at the end of October—the Central Bank has already raised rates several times since March to reach 7.75% in October.

Crédito y Caución, the leading credit insurance company in Spain with a 51% market share,  points out that the public finances of the South American economy are “particularly dependent” on this change of cycle.

Chief among the reasons is that they are financed in increasingly shorter terms because of the high proportion of variable rates, and about 37% of public finances are directly linked to the interest rate set by the issuing institution.

Also, in addition to the concern about the effect of the Selic hike, there is the loss of credibility of the fiscal consolidation initiated in 2016. In 2020 Brazil declared a state of calamity to cope with the economic impact of the pandemic, which allowed raising the public deficit to 9.4%.

In 2021, the Administration has again used this clause to exceed the spending ceiling set in the Constitution and the electoral cycle in the coming months “makes a return to fiscal consolidation difficult.”

“The increase in political uncertainty in recent months has heightened market concerns that the spending ceiling may be exceeded again in 2022 for the third consecutive year, or even abolished altogether,” the report explains.

On the other hand, the report notes that with public debt equivalent to 91% of GDP, Brazil already faces one of the highest interest expenses in the world, well above the average for emerging markets and the Americas.

“To put the debt ratio on a downward trajectory, Brazil would need fiscal reforms, such as improving the highly complex tax system and reducing mandatory public spending, in particular the high wage bill, which stands at almost 14% of GDP, well above the emerging market average of 9%,” the report concludes.