Under New Management
Executive Summary
The resounding failure of the economic policy practiced between 2011 and 2014 culminated in the replacement of Guido Mantega by Joaquim Levy as finance minister, and prompted an about-face in economic policy. The diagnosis has changed and the new macroeconomic policy orientation aims at: resumption of responsible fiscal policy, with sufficient primary surpluses to reduce the gross debt in proportion to GDP; obedience to the principle that adjustment of relative of relative prices cannot be suppressed even to control inflation; and exercise of monetary policy to control inflation.
The purpose of the course change is to raise confidence, which is a necessary condition for increased investments and better productivity, but the results will not be immediate. The other condition will be provided by the reforms, whose discussion is only just starting. The necessary increase in the primary surplus, through spending cuts and tax increases, will at first dampen economic activity, and the increase in taxes combined with correction of the administered price distortions will raise inflation. This means that GDP growth in 2015 will be lower than in 2014 (probably a recession is in store), and inflation will remain above 7% for a good part of the year. The fruits will only be harvested later, and there will be a high political cost in the short run.
The fiscal adjustments announced so far are realistic but still not enough to reduce the gross public debt. They need to be followed by new primary surplus increases in subsequent years. Fiscal austerity will help the Central Bank, but to anchor expectations, the real interest rate will have to remain above its neutral level for some time.
Not only will the political cost of the adjustment be high, there are other risks that will make the task more complicated. The first is the water crisis, which can lead to electricity rationing. If this happens, contraction of GDP will be more intense, but the mere probability or rationing already has reduced the rate of investments. The second is the crisis facing Petrobras. The company, which has a heavy bearing on the country’s gross fixed capital formation, has lost its capacity to invest. Additionally, the large construction companies are also facing fallout from this crisis, undermining their participation in infrastructure investments. Added to all these factors will be the political developments. Although the outlines are unknown, they will tend to reduce congressional support for the government. All of these factors will generate doubts about President Rousseff’s commitment to the new orientation.
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