A Disastrous Proposal
With a public debt that is too big for a developing country and with a real interest rate higher than the economic growth rate, Brazil needs to generate primary surpluses sufficiently large to reduce the debt/GDP ratio to avoid losing control of inflation and hampering economic growth. However, even before indicating who will be the new finance minister, Lula’s transition team has sent to Congress a proposed constitutional amendment (PEC) that would raise the margin above the spending cap (as now defined) by R$ 198 billion in 2023 and R$ 175 billion per year in the next 3 years. If that proposal is approved, in 2023 the debt/GDP ratio will increase by 5 percentage points, and subsequently to almost 90% of GDP in 2026.
The announcement of this proposal immediately generated an upward shift of the long end of the yield curve (DI rate for 3 to 10 years), accompanied by weakening of the exchange rate, a decline of the IBOVESPA, and a steady increase of daily volatility. What Lula and his PT colleagues seem unable to understand is that without credible fiscal rules that will lead to gradual reduction of the debt/GDP ratio, the real interest rates will rise and erode economic growth. Although discreetly, the president of the Central Bank clearly stated that the fiscal path proposed by the government-in-waiting will aggravate inflation and interest rates (both the market and neutral rates).
Although it is unlikely that lawmakers will give Lula a blank check for the next four years, instead preferring to negotiate approval of spending increases proposed by the executive branch each year in return for political benefits (naming of political appointees and “secret budget” spending), this situation does not portend fiscal responsibility. In this report, we detail the disastrous consequences if this PEC is approved.
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