Moments of Definition
Executive Summary
The fiscal adjustment has reached a critical moment. To reduce the debt/GDP ratio, Brazil needs higher primary surpluses than promised by the government. Without political support for greater spending cuts, which cannot be restricted only to discretionary spending, the government can only try to gain time by generating non-recurring revenues. All the same, attaining the promised targets is not possible. The perception of the gravity of the picture is reflected in Brazil’s CDS quotations, which are high and gradually rising.
The large wage inertia and high annualized core inflation rates could induce the Central Bank to keep raising the SELIC rate. However, with the real interest rate near 8% a year, the tightening cycle has only not reached an end because of the Bank’s insistence on bringing inflation down to the central target of 4.5% by the end of 2016. Concern over the recession is also a factor working to end the monetary contraction period sooner.
The Brazilian economy has been in the doldrums since the second quarter of 2014, and the recession began well before Levy started the adjustment. As he has repeatedly said, resumed economic growth requires actions to stimulate supply rather than demand. In part this can be achieved through a weaker exchange rate, helping to restore industrial competitiveness. A process of import substitution is under way, but it is still tenuous. On several occasions we’ve called attention to the fact that due to the high unit labor cost measured in reais, the competitiveness of the country’s exported manufactures is still low. Unfortunately, the recession, by lowering real wages, will play an important role in recomposing this competitiveness. Thus, a quick recovery cannot be expected.
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