Facing Record Deficit in Public Accounts, Brazil Stumbles in Search of Plan for 2021

RIO DE JANEIRO, BRAZIL – The crisis triggered by the Coronavirus pandemic has forced most countries to increase spending given the urgency demanded by the health and economic areas.

In Brazil it was no different: over R$600 billion (US$110 billion) have already been allocated to tackle the health crisis, including emergency aid funds, credit programs for companies, support for states and municipalities, and health transfers.

This increase – precisely at a time when tax revenue is declining due to lower economic activity – led the Institute of International Finance (IIF) to decree Brazil as the champion in deficit among emerging countries in this month’s report, although it does not detail the results of other nations at this time. But the institute’s April data revealed this difference between Brazil and other emerging countries.

Considering past results, it is a fact that the bill weighs heavily on the Government. In the first seven months of the year, the shortfall reached approximately nine percent of Gross Domestic Product (GDP) and the deficit is projected to reach around 12.5 percent by the end of the year. In 2019, it was 0.9 percent. In a country that has been running in the red for six years, and which should see the GDP plummet by about five percent in 2020, the situation is perceived with concern unless an effective plan to address the fiscal situation is put in place.

According to economists heard, the measures hitherto adopted by the government to mitigate the damage are only a blanket covering the problem, but do nothing to safeguard the health of public accounts. According to the Senate’s Independent Fiscal Institution (IIF), the fiscal framework is the most challenging the country has ever faced.

Felipe Salto, the IFI’s executive director, warns that the Bolsonaro government needs to provide clear signs of what the financing of public policies will be like next year and what will be the role of the constitutional spending cap – which bans expenses from growing at a faster rate than inflation. “Will it be met or will triggers be activated? The annual budget bill is also incomplete because it does not include the announced cash transfer program. Will there be revenue-raising measures to finance a portion of the deficit? There are many unanswered questions,” he says.

Faced with a health crisis of as yet undetermined duration, President Bolsonaro has been facing a deadlock with his economic team to design the future of the emergency aid, directed at the most vulnerable and affected by the pandemic. The aid reached almost half of Brazilian homes in June, and has prevented a higher unemployment growth rate, according to experts. The big question now, however, is where will the money come from to pay for the continuation of the benefit without breaching the spending cap?

Two weeks ago, a new proposal was announced by the government. Called Renda Cidadã (Citizen Income), the program would be a substitute for the Bolsa Família (Family Grant), and would rely on new funds from the money set aside for the payment of judicial escrow accounts awaiting release orders, as well as a portion from the Fund for the Maintenance of Basic Education Development (FUNDEB), the main funding mechanism for education.

However, the proposal has met with resistance in the National Congress and has already been criticized by members of the Federal Audit Court (TCU). “The introduction of Renda Cidadã was badly accepted. To say that they want to defer a mandatory expense [the escrow account release orders] is creative accounting,” Salto says. The new program will be included in the proposed emergency Amendment to the Constitution (PEC) and the proposed “federative pact”, both part of a fiscal adjustment package.

“These amendments have been dormant since last year and are only now resurrected. But even the PEC reports were not presented at a time when new demands for spending emerged. The market is apprehensive and the interest curve is increasing with this lack of direction, of a specific plan two months from the end of the year,” IFI’s Salto adds.

Financing the debt

According to the Senate Fiscal Institute, public debt will rise by 20.3 points of GDP in 2020 but may grow further depending on policies adopted until the end of 2020. The risk of financing the debt is controlled, but it exists and has increased, according to the institution. In practice, with spending exceeding revenue, the government needs to borrow resources, thereby increasing public indebtedness.

But the Institute of International Finance points out that despite the surge in Brazil’s public accounts, the issuance of securities – the papers that the Treasury constantly releases to the market to take money from investors and pay off its debt in exchange for higher future yields – has been moderate.

The reason for this is that the country has chosen to use part of its international reserves, currently valued at US$354.6 billion, and the Central Bank’s exchange profit in these operations – arising from the 35.6 percent hike in the dollar in the first half of the year – to bolster the National Treasury’s cash flow. As the US currency fluctuation corrects the Brazilian international reserves, the exchange gain soars when the Brazilian real depreciates. In August, the Central Bank was authorized to transfer a total of R$325 billion in exchange gains.

This transfer has been adopted by the Brazilian government at other times, but not in such a significant way. In late 2019, a new law changed the relationship between the Treasury and the Central Bank, but still allows the transfer “when severe restrictions on liquidity conditions significantly impact its refinancing (of the debt)”.

If, on the one hand, by using this resource the country finances part of its deficit without having to issue debt, the operation increases the money in circulation and leads the Central Bank to “drain this liquidity” to control inflation through sales of public securities, with a commitment to buy them back at lower interest rates, but within a short period of time.

“The scheme reduces the cost of borrowing for the public sector, but also reduces the average maturity of public debt,” points out the IIF. According to economists, short-term debt has a greater risk of not being paid, given the economic uncertainties, which may cause the government to push the debt, raising the cost of debt.

According to Alberto Ramos, director of economic research for Latin America at Goldman Sachs, there is no escape from debt in this pandemic period. “There are different alternatives to cope with the shortfall. If the country uses its current account balance, an asset is spent. If it uses the exchange profit, the Central Bank needs to sterilize by selling bonds. If a person sells the home’s paintings or is indebted on the credit card, he or she is poorer anyway,” he explains.

According to Ramos, Brazil must continue using part of the accumulated money in the single account before resorting more heavily to the market, which today charges higher interest rates to lend to the Government, amid the scenario of uncertainties caused by Covid-19, particularly in securities with longer maturities.

For the economist, the current risk is the country’s own fiscal strategy and not necessarily how it is paying off its debt. “There is no doubt that all countries needed a shock during the pandemic. But the price to be paid for this policy will not be the same for all of them. If everyone decides to run the marathon, the guy who was already running ten kilometers has a far greater advantage than another who was sedentary,” he says.

Debt may exceed 90 percent of GDP by the year’s end

Ramos points out that the public accounts area in Brazil was already fully deteriorated: six years of deficit and high indebtedness. With above-average increased spending to protect the population and businesses, the Brazilian economy has shifted to an even more vulnerable scenario.

The estimate is that debt will rise from 75.8 percent of GDP, last year’s level, to over 90 percent by the end of 2020, heading towards 100 percent in coming years. “Brazil was doing worse among the emerging economies and now it is even more vulnerable. There is not much prospect of an improvement in the short term.”

André Perfeito, Necton’s chief economist, sees the use of the Central Bank transfers as a means of filling holes but points out that it does not solve the problem. “The financial market is nervous because the government has not yet sent an effective plan to solve the fiscal situation. We are on a countdown moment. The semester is ending and we don’t know what will happen with next year’s budget or how the new social program will be funded.”

The IIF’s assessment is that all spending on emergency actions in Brazil will have to be stopped and further cuts made if the fiscal target in 2021 is to be met – a “difficult task” in the context of a poor economy and strong pressure to increase spending on permanent social programs such as Renda Cidadã. “Substantial cuts would be required beyond 2021,” the organization cautions.

Source: El País