The Fiscal Risk Clouding the Horizon
The quality of a projection depends on the reliability of the indications given by the government about its economic policy bearings. If it respects the spending cap and wins approval of new reforms that strengthen the fiscal anchor, the economic recovery will be facilitated. But the speed of the recovery largely depends on the dynamics of the pandemic. In any event, we are far from certain the government will follow a fiscal austerity program. Its planning horizon is the presidential election in 2022, and so far it has been showing a populist bent, which in combination with the fragile fiscal situation is reflected in the asset market, through a steep positive slope of the yield curve and weakening of the real, with consequences that will be analyzed in this Quarterly Report.
The “base case” assumed in the projections is that 2021 will start with the government trying to stay near the spending cap. If this course is maintained, the recovery will continue apace, with GDP in 2020 falling by 6% and climbing by 2.5% in 2021, inflation tethered to the target, the SELIC rate kept at 2% a year, and strong elevation of the trade surpluses and current accounts. But this is just the base case, around which the risks are asymmetric, with a higher probability of abandoning the fiscal anchor than respecting fiscal austerity.
In this case, the real will depreciate more, favoring net exports, but due to the increased uncertainty, this will not stimulate gross fixed capital formation. The rising prices of tradables together with erosion of the efficacy of monetary policy will make it harder to control inflation, which will tend to rise. Instead of fiscal austerity, opening more room for monetary stimuli, the opposite will happen. With the steeper positive slope of the yield curve, either the Treasury will have to pay higher premiums to roll over the debt, or it will tend to redeem bonds with longer maturities and replace them with those having shorter terms. In the medium term, this will hamper management of the public debt, which will grow due to the lesser interest of nonresident investors, a pattern that has been occurring since the country lost its investment grade rating.
In summary, this is a scenario of high risks that would suppress the appetite for fixed capital investments and stimulate the outflow of capital, disfavoring cyclical recovery.
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