Two Crises: Political and Fiscal
In the midst of the worst recession in the past 35 years, caused by the current government’s mistakes, Brazil is facing two crises: a fiscal crisis, leading to explosive growth of the gross public sector debt in relation to GDP; and a political crisis that threatens the administration’s survival.
There are many possibilities in the political field. One of them, being shopped around by the government to attract support, promises that if Dilma survives the impeachment effort, Lula and a hypothetical new market friendly finance minister will produce a miracle, reproducing the positive result achieved starting in 2003. But the conditions now are totally different: the fiscal responsibility inherited from the FHC administration is long gone and the government will have to win approval of a large set of reforms to stabilize, and later to reduce, the debt/GDP ratio.
The gravity of the current economic situation indicates that a new government will have difficulties in gaining approval of the necessary adjustment, whose sheer magnitude precludes its implementation in the short run. We performed projection exercises that indicate that even with favorable assumptions about economic growth and the real interest rate, a gradual adjustment will mean growth of the debt/GDP ratio for a long period (5 to 10 years), during which it will reach levels much higher than at present (between 85% and 95% of GDP) before starting to subside.
Achieving the necessary fiscal reforms without major hiccups will require enormous credibility, supported by strong political support. We do not see how the Rousseff administration can set out on a path like this if it survives the threat of impeachment. This also won’t be easy for a new government. Without a political accord that assures a cycle of reforms maintained over an extended period, the most likely outcome will be weak economic growth along with fluctuations in the risk metrics and asset prices.
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