The Path of the Fiscal Dominance and Another Downgrade
In April 2008, S&P promoted Brazil to investment grade. Since 2000, the country had been maintaining primary surpluses that were big enough to reduce the debt/GDP ratio. In 2015, after the government had totally abandoned this commitment, and sent a budget bill to Congress with a primary deficit, Brazil lost that classification, and since then has suffered further downgrades. Unsurprisingly, since 2015 the country has never achieved net inflows of portfolio investments from nonresidents. With the pandemic, there was no way to avoid higher spending, which until August had raised the primary deficit to above 8% of GDP. By the end of the year, this will lead the gross debt to over 100% of GDP, and the government will have to make a much more intense effort to achieve reforms than was implicit in 2016, when primary spending was frozen in real terms. However, other than empty affirmations by the minister of the economy that the spending cap will be honored, all efforts of the government have been focused on finding a workable income distribution program. There are proposals from the private sector, such as that formulated by Vinicius Botelho, Fernando Veloso and Marcos Mendes, which would meet this objective without breaching the spending cap. However, the administration is only interested in an income transfer program that will maintain the high popularity of Bolsonaro, which has grown significantly since the emergency relief program. Hence, there is a risk that the spending cap will not be honored, a situation that is clearly reflected in the prices of assets. The positive slope of the yield curve has already steepened substantially, and the discounts on the purchase of LFTs has increased – even those used in repo operations – which for the time being have been replacing the direct placement of debt by the Treasury. Besides this, the Real is the currency that has depreciated the most in relation to emerging countries’ currencies, and Brazilian bonds have the largest long- and short-term spreads of its peer countries. We reiterate that if fiscal responsibility is not restored, the country will be subject to fiscal dominance and a new downgrade. These developments will only be some of the facets of the economic and political imbroglio to which the country’s is being submitted due to the abject nearsightedness of Bolsonaro, Guedes and politicians of the Centrão coalition.
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