The Brazilian government has made containing inflation one of its major goals. Authorities have established a maximum price rise of 4.5%, with an annual margin of variation of up to 6.5% for this year. Nevertheless, according to the latest report by the Central Bank, issued in late June, the current inflation rate is 5.8%. The government wants to get the job done, and it has been raising the basic rate of the country, known as the SELIC, throughout the year. The consequences: Consumption has been limited, and price increases have been minimal. However, the policy has two collateral effects. First, it weakens financing, which means that companies are cutting down on their investments. Second, the higher the government raises its basic interest rate, the more its own debt grows.
“The basic rate acts to cool off the economy in a precise way, and it prevents an upturn in inflation, as a result. However, public-sector bonds are tied to this rate, which is known as SELIC. So, every time the government raises it, it is also increasing its own spending on bonds for internal public debt,” explains Tharcisio Bierrenbach de Souza Santos, director of the MBA program at the Armando Alvares Penteado Foundation.
Bierrenbach sees this as a systemic problem. “The higher the interest rate rises, the bigger the hole it produces. As a result, the larger the need becomes for producing a surplus in the primary account. This primary surplus is achieved at the cost of abandoning investments or increasing the tax burden – or even by doing both.”
To end this vicious circle, Bierrenbach proposes that the government spend less and, instead, do a better job of managing its resources. “They have never cared about foreign bankers. If the results show a nominal deficit of up to 3% of the GDP, they don’t care, despite the fact that it is not so good for us. That’s especially true because the tax burden of the Brazilian population is getting higher and higher. And when taxes are high, it discourages consumer spending, which cools off the economy and foreign investment,” he says.
“What should be done? Brazil’s economy needs to grow while reducing its tax burden. There is only one way to do that: Cut government spending, which has lately been a topic of discussion in the country,” proposes Bierrenbach. “In practice, the government needs a crash plan in management. The administration must look at spending as a whole, and it should immediately undertake a dramatic reduction in ministries and in public sector positions.”
The Zero-Deficit Proposal
With this situation as a backdrop, a proposal was floated recently and backed by the government, for adopting a program that will achieve a public sector deficit of zero. What significance does it have? Instead of thinking about its deficits in terms of what it owes, the government would commit to spending only what it collects. As things now stand, the government spends everything that it collects, but it even owes part of the interest payments that it makes on its bonds. Despite the fact that it covers this debt by collecting more money, new approaches to raising funds tend to increase the deficit on its accounts.
This proposal for a zero public-sector deficit is an attempt to improve the market’s perception about the government’s ability to fulfill its financial obligations. The idea would lead to a decline in interest rates, according to its defenders, who are led by federal deputy Antonio Delfim Netto, a former finance minister under Brazil’s military governments. This goal would be achieved within a period of four to ten years. Nevertheless, for this to become a reality, the government would have to make a greater fiscal effort. In other words, it would have to minimize its spending, which would affect investments in some essential sectors such as infrastructure and social services.
“Delfim Netto’s proposal is exactly along that line,” says Bierrenbach. “The goal for the primary surplus would be changed gradually from 4.25% of the GDP to 4.5%, and then 4.75%; and then to a deficit of zero. It doesn’t matter whether it would take three, four or five years to reach this goal. As a result, the government would be persuaded to carry out the necessary changes within its mechanisms for cutting spending. And, when they reduce that spending, they open the road toward a return of investment. And, above all, toward a reduction in the tax burden,” adds Bierrenbach.
Not everyone agrees with this positive analysis. “The proposal for a so-called ‘zero deficit’ is a conservative notion since it does not consider the possibility of reducing spending through interest rates. It only involves cutting operational spending and, above all, social spending, which have contributed the most during the last seven years to creating the primary surplus. Over the past seven years, 55% of the primary surplus has been a result of their decline,” argues Marcio Pochmann, a researcher at the Center for Labor Union Studies and Labor Economics at the State University of Campinas (UNICAMP).
For Pochmann, the concept of a zero deficit implies raising the target for the fiscal surplus from 4.25% of the GDP to about 7.85%. That matches up with estimated spending on interest for 2005. “In Brazil, we have shown that the rise in the primary surplus is due to the containment of social spending. That way, we have done greater damage to the 140 million Brazilians who use the public health system. That’s because health care – which makes a greater contribution to achieving the surplus – has been the sector that has suffered the third-largest amount of cuts, behind cuts in benefits for federal officials and cuts in Social Security. Retirees and pensioners will be the ones who are most affected by the quest for a so-called ‘zero deficit.’ So will public-sector officials and those who receive health and education benefits.”
Political Crisis
The other factor that abruptly burst onto the Brazilian scene is a political crisis involving a series of members of the federal government and the PT (the party of President Lula) who have been accused of inappropriate conduct. The most serious accusations indicate that the PT has established a network of agents whose task is to spend tens of thousands of dollars each month, bribing federal legislators to win their loyalty to the government. The case has come to be known as the Mensalón Case.
Although these accusations are serious, and there are signs that some people involved with the government are involved, there is still no evidence that the Brazilian economy is being affected by the scandal. Most analysts interviewed by Universia-Knowledge at Wharton said that it is too early to say that the economy is feeling the affects of this political crisis. Nevertheless, there are serious fears that the problem will be prolonged and become more serious, and that greater damage will result.
On the other hand, a recent study by the Brazilian Economics Institute of the Getulio Vargas Foundation (IBRE), known as the Opinion Survey of Consumer Expectations, shows that political turmoil did have an impact on consumer confidence in June. Aloisio Campelo, who directed that study, explains that the responses provide reason for concern. “Consumer confidence, which was falling since January, stabilized in April, but it has now started to fall again. Survey respondents mentioned the political crisis, so we believe that this situation has a significant relationship with the loss of confidence.”
Other indicators provide less conclusive evidence that the political crisis is having an impact. For example, recent data from BNDES (the National Bank of Economic and Social Development), the main credit agency for the business world, produced more hopeful results. Thus far in 2005, spending has grown by 20%, compared with last year. The auto sector registered production growth of 15.7% during the first half of this year. In June, deflation was 0.02%, and private companies and banks took in some $3.3 billion from outside the country. Nevertheless, industrial sales dropped by 1.51% in May, compared with the same month in 2004. And consumers showed less willingness to make purchases. As a result, the Central Bank’s forecast for GDP growth in 2005 was cut to 3.4% from an early forecast of 4%. Private financial markets foresee even slower growth of about 3%.
Nevertheless, it is possible that the political crisis could wind up purging the government of certain vices. “My hope is that this situation could deflate the government machine,” says Bierrenbach.
Economist Pedro Gonçalves, of the SEBRAE-SP economic research consultancy, believes this crisis is having a short-term impact on the economy. “Although the economy is not growing very fast, things are not so bad. It’s just that over the long term, there could be a change that hurts companies,” he says. “If the crisis goes on for a long time and affects levels of investment, it will lead to even more cutbacks in consumption.”
José de Freitas Mascarenas, vice-president of the CNI (National Confederation of Industry) says that it is impossible to say if the political crisis will affect the economy. When all is said and done, the functioning of the government is crucial for the functioning of the economy. “If things go on for a lot longer, it will wind up paralyzing certain areas through changes in the cabinet ministers… What we want, for example, is for the Congress to function independently of those investigatory commissions” which verify accusations against the government and members of parliament, he says.
And the Companies?
How will all of this affect companies?
A policy that is economically restrictive about growth leads to a reduced credit in the market, because the financial system prefers to invest in government bonds, even if interest rates are high. When credit is scarce and expensive, companies do not make productive investments. As a result, the economy becomes fragile again.
“Obviously, the manufacturing sector is not satisfied with this situation,” says Masacarenas. “Generally speaking, people are used to making tactical moves that they can take for a certain time to contain inflation, and that will prevent exaggerated growth in demand. But Brazil has been using this approach in practice for decades, and it is not good for its development.”
Brazil’s small companies agree. “Owners are worried because consumption begins to drop. Within months, small companies are going to have to confront this problem. And what will happen to this country if this deceleration expands in scope and it affects small companies? You have to realize that small and midsize companies provide jobs for many skilled workers,” says Gonçalves.
Without doubt, Brazil finds itself in a delicate situation. On the one hand, it is an economy that has a great potential but does not manage to take off. On the other hand, a political crisis threatens to paralyze institutions and inflict even more damage on the national economy. The country is depending on the political ability of its government, and the skills of its economic team, to avoid moving backward along the road toward development.
