IFI: Brazil likely to see 10 more years of primary deficit and breaches of spending cap

RIO DE JANEIRO, BRAZIL – Brazil is not expected to register a primary surplus over the next decade and may see its gross debt exceed 100% of GDP until 2030 – much higher than other emerging countries. The assessment comes from the Independent Fiscal Institution (IFI), linked to the Federal Senate, which in its base scenario points to a sequence of at least 17 years of unbalanced accounts.

According to the institution’s forecast, the central government’s gross debt should close the decade at 103.4% of GDP. The base scenario considers a growth rate of 3.0% in 2021 – against 2.8% estimated in November -, 3.4% in 2022 – the same level as in the last report -, and 3.2% on average between 2023 and 2030.

Inflation as measured by the Broad Consumer Price Index (IPCA), in the base scenario, would stand at 3.2% in this year and next, and would average 3.0% in the following seven years. The basic interest rate (SELIC), in turn, was estimated at 2.75%, 4.25 and 5.9% for the respective periods. The data are included in the Fiscal Monitoring Report (RAF) issued by IFI.

In the pessimistic scenario, indebtedness could rise by more than 40 percentage points, to 135.2% of GDP. In this case, the scenario would be for economic growth of 2.4% in 2021, 1.3% in 2022, and an annual average of 1.3% from 2023 to 2030. Inflation would stand at 3.9% this year, 4.0% the following year and would average 4.3% by the end of the decade. The SELIC could reach an average of 9.4% over the last seven years.

In the optimistic scenario, gross debt could start to fall starting next year and reach 74% of GDP in 2030. The respective growth projections would be for 4%, 3.2% and 3.5%. And for inflation, 3.2%, 3.2% and 3.0%, in the same order. The SELIC could average 5.9% between 2023 and 2030.

The IFI perceives greater clarity in the fiscal horizon for 2021, but draws attention to the persistence of uncertain factors regarding the Brazilian economic rebound, particularly those associated with the evolution of the novel coronavirus pandemic in the country and the progress of the immunization program against the disease.

The institution reduced the risk of breaching the spending cap this year from high to moderate, after signals from the rapporteur of the Emergency Proposed Constitutional Amendment (PEC), Senator Marcio Bittar, who intends to exclude the new emergency aid from the fiscal rule. The exclusion, while maintaining a significant impact on public accounts, provides budgetary relief to meet the established targets. The benefit is to be paid by extraordinary credit and without the need to comply with fiscal rules.

“The expense, the magnitude of which is not yet known, will be realized without prejudice to compliance with fiscal rules,” says economist Felipe Salto, executive director of the IFI. “What is happening is that in the economy it is not just a question of accounting, spending is going to happen.”

The IFI estimates that the government will spend R$34.2 billion with the new round of emergency aid – it would amount to R$45 billion, although with the use of R$10.8 billion from the Bolsa Família (Family Grant). In the baseline scenario, the program would run for four more months and cover 45 million beneficiaries. The installments would amount to R$250 – which would require a supplement in the case of Bolsa Família beneficiaries, who receive an average of R$190 per month.

“The government probably has greater control over this data today, due to last year’s experience, and should possibly be able to have a better capacity to project these expenses for 2021,” points out the economist.

Economists also project spending of R$20 billion on the purchase of vaccines and R$10 billion on other expenses to fight Covid-19. As in the case of the emergency aid, the resources would not be subject to fiscal rules. The slowdown in spending growth, such as social security and welfare benefits, has also helped to ease the situation.

“Despite the change, the situation is still quite complex. Of course, if these R$34 billion in aid were within the cap, the risk of a breach would be very high, and it would certainly be necessary to find a way out of this. The PEC presented today copies last year’s solution, which is to remove these expenses from the spending cap,” says Salto.

The measure has made compliance with the spending cap in 2021 more predictable. For 2022, an election year, the high inflation recorded in the second half of last year and projected for the first months of this year should open up fiscal room for a looser government budget. The correction of the spending cap is based on the accumulated IPCA over 12 months counted up to July of the year prior to the fiscal year.

The price dynamics lead the risk of breaching the spending cap to persist as moderate until 2025, according to IFI’s assessment. As of this year, the evolution of mandatory spending should put pressure on the budget in order to place discretionary spending significantly below the minimum required for the operation of the public machine.

“The risk of a breach is high from 2025 on, since discretionary spending may fall well below what is estimated as the minimum required. Between 2025 and 2026, we will have spending subject to the cap 0.1 percentage point higher than the spending cap, which represents a high breaching risk. If it were an accomplished fact, we could say that it would represent a breach of the cap,” points out Salto.

In other words, in order to comply with the spending cap, measures that tackle mandatory expenses would be needed. This is one of Minister Paulo Guedes’ (Economy) priorities and is addressed in the Emergency Pact. However, the text was reduced throughout the past months and now the trend is to pass points with mild impact, since there is a rush to enable the new emergency aid.

In Salto’s opinion, the strategy of simultaneously discussing a fiscal adjustment program with controversial instruments and the extension of the emergency aid involves complex political negotiations.

One of the points under discussion, the removal of minimum spending in the Health and Education areas from the Constitution, for instance, is likely to be hard to pass.

“Disengagement is a very complex issue,” he observes. “If we assume that the aid is an emergency expense, it is difficult to conceive a bolder text for this medium-term fiscal adjustment, because the two things have been linked,” he analyzes.

Transparency

During the press conference, Salto also analyzed the impact of President Bolsonaro’s recent decision to eliminate the federal taxes on diesel for two months, in an attempt to mitigate the rise in fuel prices at gas stations – and thus contain pressure from truckers on the government.

According to IFI’s calculations, the measure costs the public coffers between R$3 billion and R$4 billion, should it not be subsequently extended.

“This seems little, in absolute terms, when we look at the main aggregates of federal public spending, but it is significant, because the fiscal margin is very tight and the announcements are being made without the accompanying compensatory measures,” he says.

“The government can say that revenue is underestimated in the Budget Guidelines Law (LDO) and that the Annual Budget Law (LOA) will have R$3 billion more revenue and that this would offset the reduction in PIS/Cofins [tax on diesel and cooking gas],” he suggests. For the economist, greater transparency is needed from the federal government in specifying the compensatory measures.

Despite refraining from going into the substance of the issue, Salvo sees potential macroeconomic impacts on Bolsonaro’s recent decisions involving Petrobras.

“From the market’s perspective, risk perception, which also affects the macroeconomic scenarios (ultimately, interest and exchange rates as well), a framework of greater intervention, uncertainty and lack of transparency undermines the macroeconomic scenario and will indirectly have fiscal implications,” he says.