-Analysis-
BUENOS AIRES — I was never so keen on Brazil’s economic reforms nor seduced by the strategy of wooing markets and investors, chosen by the social democratic governments of Lula da Silva and Dilma Rousseff. So I have not had to offer any mea culpa explanations of why Brazil’s economy has suddenly gone from regional star to sick man of South America.
Brazil’s present and future problems reflect a central point we neighboring Argentines, and our government, should understand very clearly. Any efforts to regain confidence, foment optimism and seduce investors can never supplant a consistent, well-designed macro-economic policy. The Brazilian crisis reflects the revenge of macroeconomics, seeing what happens when an economic program is ill-conceived and financed only by capital inflows and a hefty supply of hope.
A good economic program must be both politically viable and socially tolerable. Without ample social and political backing, it is practically useless. But it should also have macroeconomic coherence. Finding that meeting point of social, economic and political viability without giving any one of them undue precedence is fundamental to competent governance.
Brazil“s current problems are actually less difficult to solve than those of Argentina in 2001-2002, because it has a floating exchange rate and the economy functions with the local currency. But the very strict inflation targets fixed by the Central Bank have not been consistent with the rest of the economic policy.
Four-year limit
A stable, relatively low annual inflation rate of 6-8% was a luxury Brazil could not afford alongside other policy components, especially its fiscal and exchange-rate policies. It entered a vicious cycle where every hike in local interest rates to meet inflation targets would worsen its consolidated fiscal numbers, because the government was the biggest debtor. As the Central Bank insists on imposing its monetary dominance regardless of income shortfalls, the treasury must pay more to borrow while recession worsens, hampering the efficacy of initial adjustments designed to solve the deficit problem.
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Sunset over Sao Paulo —Photo: GAF
It is the opposite of Argentina’s problem where revenues are key, and the Central Bank and monetary policies are subservient to the fiscal deficit. In Brazil the primary deficit (spending deficit excluding interest payments) is close to zero and the hole is entirely “financial” due to the very high interest rate and enormous public debt.
In Argentina, servicing debt is not the main problem because the rate in pesos is low and public debt, accurately measured, is half that of Brazil in terms of GDP percentage. The origins of the problem are almost entirely in the form of a primary spending deficit — in great part for ridiculous energy subsidies.
In both cases the size of the deficit is at the heart of the problem, regardless of how it is being financed. In Brazil, the Central Bank did not lose reserves because the private sector brought in foreign capital.
When the public sector finances a fiscal deficit with internal debt, it pushes the private sector out of the credit market because of the high interest rates. In Argentina, financing without issuing bonds fueled inflation, either openly as in 2014 or surreptitiously, as in 2015. The cause of the current inflationary spurt is the belated effects of government overspending in recent years, over and above the immediate trigger of ending multiple rates.
There is no substitute for reducing the fiscal deficit. Finding financing alternatives to Central Bank bond issues can be a good bridge if the deficit is also being reduced. The medium-term objective should be to reverse within four years (2016-19) the excesses of the previous four. The primary deficit grew from 0.8% of the GDP to more than 5% in Cristina Kirchner’s second presidential term. The new president, Mauricio Macri, must bring that back to zero, while meeting all debt and interest obligations.
Brazil shows us that there is no playing around with the macroeconomic reality for long, as its vengeance can be brutal. The government has time to design a program that is politically viable, socially tolerable and economically consistent. It must start now, and aim to eliminate, not finance, the fiscal deficit in four years.
*Santángelo is Director of MacroView S.A.
