The Government’s Options in an Election Year
Executive Summary
Brazil’s current account deficits are large in relation to the capital inflows, putting pressure on the real. Along with this, inflation is high and economic growth has been decelerating. The situation cannot yet be called stagflation, but there is a risk of this in the near future. Simultaneously, the poor performance of the emerging countries has raised risk aversion, accentuating the capital flows to “safe harbors” like the United States.
In a situation like this, the advisable reaction would be to tighten the fiscal belt, which would reduce absorption in relation to GDP and improve the current accounts, and to allow the real to depreciate, while fighting inflation with an adequate increase in the interest rate. But this would weaken GDP growth even more, something the government wants to avoid in an election year.
In face of this contradiction between what should be done and what can be done in an election year, the government will probably follow a middle path. In the fiscal field, it can no longer use artifices such as creative accounting, and has little room left for off-budget transfers to official banks. Nor can it increase revenues, because this would require revoking the tax relief measures that are part of the “new macroeconomic matrix” by which it has been trying, unsuccessfully, to stimulate growth of industry. All it can do is place certain budget items on contingency until the occurrence of new non-recurrent revenues. An announcement in this respect will come on February 20th.
On the monetary policy front, the most likely outcome is that the tightening cycle will continue until the SELIC rate reaches 11.5% a year, in an attempt to keep inflation around the implicit target of 6%, with the help of interventions in the foreign exchange market to control depreciation.
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