War changes projections for Brazil’s public debt, with chance for new fall

RIO DE JANEIRO, BRAZIL – The war between Ukraine and Russia has had direct and indirect effects on the economy. One of the most recent is the revision of projections about the relationship between public debt and Gross Domestic Product (GDP) in 2022.

Although the market is still betting on an increase in the debt compared to the 2021 level of 80.29%, revisions are already being made. One of them, from XP, now projects a drop in debt following last year’s movement.

The specialists consulted by CNN Brasil Business affirm that this relief in the debt, of a fall or a smaller increase, does not revert the tendency of increase that has gained strength since 2014, nor the need to carry out structural reforms.

THE EFFECT OF THE WAR

The economist at XP, Tiago Sbardelotto, says that before the war in Ukraine, the government expected to have a worse primary result, with a larger deficit. Combined with an interest rate throughout the year much higher than in 2021, the perspective was of lower revenue collection and higher debt interest, and therefore the debt would rise.

For 2022, the debt/GDP ratio was projected to be 83.7%. The interest rate situation has not changed, with the Selic starting the year at 10.75% and expected to end at least 12.75%. But the prospects for tax collection have improved.

“What has changed is that, with the war and the appreciation of commodities, tax collection tends to rise, and the nominal GDP, which is the denominator of the equation, has also risen a lot, and this is more than enough to offset the rise in interest rates,” he says.

The nominal GDP is measured by multiplying the Gross Domestic Product by the “GDP deflator”, an inflation indicator slightly more comprehensive than the Broad Consumer Price Index (IPCA).

In other words, with the perspective of higher inflation thanks to the shock in commodities, from oil to wheat, the inflationary effect tends to increase tax collection in the short term through higher prices and the nominal GDP.

The fall projection made by XP considers a limited duration for the conflict, two to three months, which according to the economist, “would already be enough for the impact of the shock to be transmitted to the economy.

“There have been discussions, negotiations, and this generates a market response, but the uncertainty about the conflict still pressures prices. If the war ended today, a good part of this effect would already be in the economy,” he says.

Juliana Damasceno, an economist at Tendência Consultoria and an associate researcher at FGV IBRE, does not bet on a fall in the debt/GDP ratio but rather on a slower growth than predicted before the war.

The consultancy expects the ratio to be around 81%, at most 82%. The causes are “cyclical drivers,” as well as in 2021, due to high inflation.

“We thought commodity price, exchange rate, and inflation drivers would be weaker this year. But commodities and inflation are still on the scene; they haven’t lost traction. They are not things to celebrate even if they bring some benefit,” he evaluates.

The increase in fuel prices, also due to the rise in commodities, is another “promise of higher revenues” and should indirectly affect the debt.

Damasceno considers that the nominal GDP should be high thanks to inflation, even with the prospect of low growth in 2022, but it is not yet possible to say whether it will offset the increase in the stock of debt. “But if [nominal GDP] is going to be higher, it makes the debt grow less.”

Regarding the Selic rate, the researcher says that there will be a higher cost of carrying the debt due to high interest rates and for issuing new debt, which is also a factor that complicates the scenario of a reduction in debt/GDP in 2022.

RISKS WITH SPENDING

The drop projection made by XP already takes into account, according to Sbardelotto, recent measures of the federal government called “fiscal renounces” when there is a loss of revenue with the temporary reduction of taxes.

That is the case of the exemption of PIS/Cofins in diesel and the cut of the rate of the Tax on Industrialized Products (IPI) to 25% – and that should still reach 33%.

“With these two measures, we can still have a very positive balance, but additional measures beyond these are already starting to weigh. Despite sometimes being individually small, it becomes a big impact when it is added up,” he says.

He evaluates that the impact of the tax waiver measures affects subsequent years more than 2022 itself, which also depends on how long they last. For the economist, there was room to carry out these tax breaks, but now this space is “much more limited.

The risk, in this case, would be that new government measures would generate costs and reduce revenue to the point of offsetting the benefits by high inflation, and then the debt would grow.

“You can’t think about tax breaks on gasoline; it’s a very high cost, the same thing for public transportation or salary increases; this puts pressure on the budget, especially for the next few years.

Juliana Damasceno considers that the more positive picture does not come from a structural increase in tax collection and that it could be even higher in 2022 if it weren’t for tax breaks.

“They are easy measures when you know you will have much higher tax collection, but there is a lack of planning. The danger is that they are not temporary; they are postponed because then the tax collection is compromised because there was no structural improvement,” she says.

Another risk, according to the researcher, is that measures such as zero taxes can only be done once, but prices remain very volatile. If the scenario worsens, the government may try to carry out new measures to contain inflation and leave the sphere of taxes to that of spending increases.

In this case, the spending ceiling had a gap in 2022 of R$6 billion (US$1.3 billion), and that has already fallen to R$1.7 billion. “The budget execution is more complicated, the revenue can be less strong if it exonerates too much, and there is pressure on the spending side, such as readjustment of servers. It shows the lack of planning and effort to make reforms and revisit spending,” he says.

There are also risks that the presidential election may generate a devaluation, especially if it is more polarized and populist. The increase in the dollar would reflect on fuels and could lead to spending measures by the government that worsen the public debt picture.

With these factors, the researcher affirms that the projections for the debt have been changing a lot since the beginning of the year and that the scenario is still uncertain and may get better or worse.

DEBT IS STILL EXPECTED TO RISE IN 2023

Damasceno affirms that, as the factors for the fall of the debt in 2021 and possibly in 2022 are conjunctural, linked to the pandemic and the war, once they pass, the tendency is that the debt will resume the upward trend due to the lack of structural reforms.

“For 2023, the expectation is of a brake in the price of commodities, which helps less in inflation and income starts to show what is structural. Growth should also not be so great, so we project a greater expansion of debt than this year,” he says.

Tendências’ current projection is for a debt/GDP ratio of 82.2% in 2022, compared to 82.9% before the war. For 2023, the forecast is 84.1%.

According to the economist, the problem is that reforms to reduce the structural components of the public debt are lacking.

“The two main candidates [in the polls] have not given indications of this, of dealing with the problems of spending, the budget, the governance of the budget. There is also a lack of administrative reform,” she says.

For her, it takes effort and willingness to use the political capital necessary for these reforms, which also end up being relatively unpopular. “Society needs a broader assistance, we have not zeroed out the Auxílio Brasil line, and there is no room for that today,” she says.

The XP projection, according to Tiago Sbardelotto, is that the central government revenue starts to lose strength in the second half of this year as inflation recedes, but still with a positive year.

Already for 2023, the fall should be accentuated, with the collection at a modest level and without historical records.

“On the other hand, the ceiling has been holding down expenses. In 2023, we should have a deficit in the same proportion as this year, since revenues and expenses are falling in almost the same proportion. The interest account starts to weigh heavily from 2023 on, and then the debt should grow again,” he says.

According to the current projection, which considers maintaining the spending cap and does not expect new populist measures, it would be possible to have a surplus in the primary result in 2024 or 2025, but maintaining the upward trend of the debt in relation to GDP.

The debt stabilization would only come around 2027 and then would be followed by a reduction. For 2023, XP expects the debt/GDP ratio to be at 82.5%, which would be the highest value of the historical series disregarding 2020 when it was 88.8% due to pandemic spending.

With information from CNN Brasil Business

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