Thursday, 5 March 2009

Brazil Said to Be Considering Reducing Primary Surplus. Reaction? Negative

O Estado de S. Paulo, Folha de S. Paulo and other prominent newspapers in Brazil reported yesterday that the government is considering cutting the primary surplus target for this year to 2.8 percent of gross domestic product from 3.8 percent of GDP. We assume the government is seeking to maintain investment spending programmes under President Luiz Inácio Lula da Silva's Growth Acceleration Package -- the $220 billion Frankenstein he announced couple of years ago. Well, there's no free lunch -- now that the central bank has started to reduce interest rates in a significant manner, the government cannot loosen fiscal limits, so no surprise if the central bank at some point stops the monetary front-loading. We are sure there is no consensus among government officials over the feasibility and convenience of such move, which by the way must be an idea of Guido Mantega, the Brazilian finance minister, and his Workers' Party ideological friends.

As the economic slowdown eats out tax collections in significance and political pressure for more state aid to fend off a recession mounts, attaining the target without streamlining programmed expenditures would be quite hard. Markets will react to this very negatively -- pushing debt costs higher, and making it harder for the government to finance its consolidated fiscal shortfall. As Goldman Sachs Group Inc. economist Alberto Ramos puts it, this announcement may fail to spark a reactivation in private investment (says Ramos that ''the corporate sector might fail to believe that higher fiscal spending will lead to higher growth and would therefore not increase investment spending.´´ To me, simply, 'if the government is investing on my behalf, why then should I invest? I better pay more dividends, or hoard cash.´)

Bottom line -- the excesses are beginning to surpass any possible limits that were thinkable or feasible a few months ago. In Brazil, fiscal policy is all about making permanent spending commitments, and those who covered that country for years know that no fiscal expansion in Brazil has only short-term impact (there is a tendency to create long-term spending programmes.) Once the economy recovers, you can't dismantle them -- they are politically-rewarding. One more reason for credit agencies to backpedal on their decision to award investment-grade ratings to a country with such difficult -- and unresolved -- structural problem.

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