Brazil’s Zero-Deficit Target Unlikely to Survive Slowing Economy - BNN Bloomberg

(Bloomberg) -- It’s only a matter of time until President Luiz Inacio Lula da Silva ditches his own government’s zero-deficit fiscal target to keep spending big as Latin American’s largest economy loses steam next year, according to Genial Investimentos.

Assurances by the ruling Workers’ Party that it will respect Finance Minister Fernando Haddad’s strategy to eliminate Brazil’s primary fiscal deficit in 2024 will not hold true as public spending will outpace tax collection, Jose Marcio Camargo, chief economist at Genial, said in an interview in Rio de Janeiro. 

“The target will have to change if Haddad is unable to increase tax revenue,” he said. “The question now is when and by how much.”

Camargo, 76, knows the benefits of social spending — he’s one of the designers of Lula’s flagship Bolsa Familia program which provides income transfers and helped lift millions of Brazilians out of poverty two decades ago. But he’s also worried about the impact of excessive government spending on public debt and creditworthiness. 

For weeks, investors have been on edge after Lula indicated he’d rather ditch the zero-deficit target, which doesn’t take into account interest payments, than make cuts to investments and programs he considers essential to improve Brazilians’ living standards. While other fiscal rules approved earlier this year ensure public spending won’t get out of control, a strict deficit goal would also limit lawmakers’ ability to pass tax cuts and subsidies. 

Haddad has since been trying to salvage the proposal by cajoling Lula’s allies and members of Congress into helping him plug a budgetary gap through tax hikes and other measures to boost revenue. On Thursday, a member of Lula’s cabinet said the 2024 primary budget deficit would indeed be zeroed. 

Read more: Lula to Keep Zero-Deficit Goal in Budget Plan, Minister Says 

Bracing for the Worst

But the government can still make changes to the proposal. And with Brazil’s public finances already deteriorating, Camargo says investors are bracing for the worst.

In September, Brazil posted a primary budget gap of 18 million reais, the fifth straight month the government ran a deficit. Congress has yet to approve measures that would help generate the 168 billion reais ($34.5 billion) in new revenues that Haddad is seeking to fulfill his budget proposal. Meanwhile, social expenditures like the minimum wage and pensions are set to increase.

“The market is very concerned about how the fiscal issue will evolve,” Camargo said. Without a credible target no one will be able to keep tabs on spending and “we’re going back to a scenario like we had at the beginning of 2023.” 

At the start of the year, Brazil’s Congress lifted a constitutional spending limit, allowing billions of dollars to be doled out to aid poor Brazilians. That whipsawed markets.

Spending fears waned with the August passage of the fiscal framework bill, a set of rules proposed by Haddad to shore up public finances. Investors expected the law would mitigate the tail risk that public debt spirals out of control. Currently, the government’s debt-to-gross-domestic-product ratio is running at nearly 75%, according to data compiled by Bloomberg.

Now, with Lula vowing to maintain spending regardless of tax revenues, “You can no longer calculate how debt will evolve against GDP,” Camargo said, adding that the government could adjust the target as soon as March. 

On top of a volatile global outlook, marked by high interest rates in the US and a possible slowdown of China’s economy, Camargo says Brazil’s fiscal performance will determine the direction of its assets next year. Markets have rallied recently on Brazil’s central bank cutting rates and on bets that the Federal Reserve will soon follow suit.

For Camargo, the fear of many market participants is that Lula may follow in the footsteps of his hand-picked successor Dilma Rouseff, who doubled down on fiscal stimulus to avoid a recession last decade. 

“Will he continue to increase spending, and with it the deficit, to keep the economy from decelerating? That would be disaster.”

Read More: Brazil’s Economy Unexpectedly Shrinks as High Rates Take a Toll

Genial is headquartered in Sao Paulo and offers banking, brokerage and asset management services. It has 170 billion reais in assets under custody, and oversees 45 billion reais under its money management unit, Plural Gestao. 

--With assistance from Robert Jameson.

©2023 Bloomberg L.P.

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Brazil’s Zero-Deficit Target Unlikely to Survive Slowing Economy - BNN Bloomberg
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