The Falling Credibility of Economic Policy Execution
Executive Summary
Because of the declining tax revenue caused by the recession and the only partial approval by Congress of the proposed spending cuts, it was evident for some time that the primary surplus target of 1.1% of GDP for 2015 would not be met. But there was belief in a moderate reduction of the target, followed by the announcement of a stronger effort in 2016. The surprise came not only from the substantial reductions of the targets for 2016 and 2017, but also from the creation of a “band” in which, if some revenues do not materialize, a primary deficit can occur in 2015.
The government has clearly backtracked on its commitment to fiscal austerity, leading to a drop in confidence in its political power to achieve the adjustment. Incomprehensibly, ministers Levy and Barbosa announced that despite the reduction of the surpluses, the perspectives have improved regarding the debt dynamic. There’s no way to obtain this result.
The real problem is the government’s political inability to cut spending. In rejecting the alternative of an increase in the tax burden, and acknowledging that discretionary spending accounts for a small share of overall spending, the government’s only alternative was to propose cuts of expenditures classified as “obligatory”, meaning protected by law, thus requiring congressional approval. This could perhaps be achieved by a politically strong government, but not by an extremely fragile one.
The market’s reaction – reflected in higher Brazilian CDS quotations and depreciation of the real –is only one manifestation of the dip in confidence, and the perception that the country’s investment grade rating is at risk. This also increases the difficulties in executing monetary policy, because looser fiscal policy imposes greater monetary austerity at a moment when the recession is worsening.
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